FAQ: How Do We Use the Valuentum Process?
publication date: Mar 15, 2016
author/source: Valuentum Editorial Staff
A version of this article was originally published in August 2012.
How do we use the Valuentum process?
First and foremost, stocks in the Best Ideas Newsletter portfolio should be considered our best ideas at any point in time. The Best Ideas Newsletter portfolio can always be found on page 8 or 9 of our monthly Best Ideas Newsletter. Stocks in the Dividend Growth Newsletter portfolio should be considered our best dividend growth ideas at any point in time. The Dividend Growth Newsletter portfolio can always be found on page 5 of our monthly Dividend Growth Newsletter.
Let's talk about how the Valuentum Buying Index (VBI) informs which ideas we include in our actively-managed portfolios. We've noticed via our statistical backtesting that the momentum factor behind our process tends to be much more pronounced (powerful) over longer periods of time. This was one of the interesting findings of our academic white paper study. We try to replicate this dynamic with the update cycle of our reports (and the time horizon for our ideas to work out). That's why our reports are updated regularly (at least quarterly) or after material events and not daily or weekly. We don't want to whipsaw our membership, nor do we think churn is the way to generate outperformance.
Though the time frame varies depending on each idea, we expect our best ideas to work out over a 12-24 month time horizon (on average) -- any shorter than that is mostly luck, in our view. We tend to add firms to our Best Ideas Newsletter portfolio when they register a 9 or 10 on our Valuentum Buying Index (VBI) and tend to remove firms from our Best Ideas Newsletter portfolio when they register a 1 or 2 on the VBI. You'll notice that we have a qualitative overlay in the portfolio, which is necessary and similar in thinking as if you were to imagine a value investor not adding every undervalued stock to his/her portfolio. There are always tactical and sector weighting considerations in any portfolio construction.
As for the time horizon for ideas, we like to maximize profits on every idea, with the understanding that momentum does exist and that prices over and under shoot intrinsic value all of the time. A value strategy (10 --> 5) truncates potential profits, while a momentum strategy (4 --> 1) ignores profits generated via value assessments. We're after the entire profit potential. So, for example, if a firm is added to the Best Ideas Newsletter portfolio as a 10 and is removed as a 5, we would have tuncated profit potential. Most of our highly-rated Valuentum Buying Index rated stocks have generated the vast outperformance of the Best Ideas portfolio.
Importantly, regarding the Valuentum process, we do not add all firms that register a 9 or 10 to the newsletter portfolios. For example, Google (GOOG, GOOGL), a current Best Ideas Newsletter portfolio holding, registered a 10 on the Valuentum Buying Index, but we remained patient and didn't add the company to our portfolio until after it reported earnings in late 2012, which provided us with an even better entry point (as new information came to light). We engage in a qualitative portfolio management overlay to maximize returns and minimize risk. The rating informs our process, but the team makes the allocation decisions of the portfolio on the basis of a number of other firm-specific and portfolio criteria.
After adding stocks to the Best Ideas Newsletter portfolio, we may tactically trade around these positions when they have VBI ratings between 3 and 8 depending on the size of their weighting in the portfolio or their attractiveness relative to other opportunities (a rating of 3 through 8 is typically equivalent to a 'we'd hold'). We tend to remove firms from the Best Ideas Newsletter portfolio when they register a 1 or 2 on the system. Importantly, however, firms in the Best Ideas Newsletter portfolio, which have generally registered a 9 or 10 (or a high rating) on the scale when added, should be considered our best ideas at any point in time.
eBay/PayPal is probably one of the better examples to use for illustrating the prolonged outperformance driven by undervalued stocks that are beginning to generate good momentum. We like to capture the entire pricing cycle and not truncate it as most value investors do. We no longer include eBay in the newsletter portfolio, but its split-off PayPal is retained.
There have been more straight-forward opportunities in our Best Ideas portfolio, especially in the case of EDAC Tech, which had tripled since we added it to the portfolio (never registering below a 9 along the way). The VBI ratings on our most recent 16-page reports, downloadable directly from our website, reflect our current opinion on the company.
The Valuentum Buying Index, like all methodologies, informs the investment decision process, but in constructing a portfolio, a qualitative overlay is not only necessary but has been shown to optimize performance in the white paper study. Please let us know if you have any further questions at firstname.lastname@example.org.