Our methodology is really easy to understand once you get to know the things we’re looking at. There’s also some subjectivity in how we implement our thoughts in the simulated newsletter portfolios, and please stop calling what we do advice. We’re not an advisor. We’re not a broker. We’re a financial publisher. While we’re at it, let’s talk a bit about Microsoft, Eli Lilly, and Celgene through the lens of our methodology.
By Kris Rosemann and Brian Nelson, CFA
I know many of you have been following our simulated newsletter portfolios very closely. Since inception in 2011, the simulated Best Ideas Newsletter has averaged roughly a 25% cash position. We wrote up an extensive summary of the simulated Best Ideas Newsletter portfolio recently, and one of the biggest takeaways was that we “held” a rather large cash “weighting.” Our move to “fully invested” should be kept in context. It’s not a matter of having a large cash “weighting” one day, and then not having one the next. It’s that we have had a large cash “weighting” for years and years (and still did very, very well), and now we don’t have one. Here’s an example of how much members love what we’re doing:
“I want to thank you for all your wisdom. I too have been ~30% cash since late 2017 because of your insight. I listened and resisted the temptation of buying as things looked good. It would have been easy to get caught up in the flurry of the market back then while watching our retirement accounts grow. “Putting all our money to work” as others around me did, would have been costly. In fact, a life time of membership fees would not come close to what was potentially saved. As painful as the last 3 months have been, it could have been much worse. I value your research, your newsletters and I look forward to your new release. Congratulations!” — Chip G.
Given the changing market structure (indexing, quant)—you have to read our book Value Trap (order pdf download here)— where a “melt up” is certainly a possibility, as much as a market crash, in my view, I’ve taken the view that being “fully invested” in the simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio and using put options if/when the time comes may now be the best route. It’s more of a change in strategy in how to capitalize on this thesis. Sitting on the sidelines for a melt up is not something I want to happen.
Investing is about considering probabilities and covering both upside and downside scenarios. Remember–those huge cash “weightings” allowed us to capture alpha as the markets swooned this December, and while we’ve now moved to being “fully invested,” it doesn’t mean that we don’t think a downside scenario isn’t still possible. In some respects, we’re expecting one of two outcomes–either the markets spin uncontrollably upward or the markets spin uncontrollably downward, the cause of either outcome the proliferation of price-agnostic trading. This market is not “normal.”
The most important thing, however, is that if you missed any of our emails during the holiday week, my colleague Kris adds them to the website, and we manage our business such that if you read them one or two or even several weeks after, it shouldn’t matter much given our long-term perspective, or probably more appropriately, the price-versus-estimated intrinsic value perspective. Our process is not one in which you’re going to miss “something.” We hardly make any changes to the simulated newsletter portfolios and when we do, we’re not looking for daily or even weekly returns. This might change with put options though. If/when we see a meltdown coming, we’re going to seek protection.
That said, I need you to continue to focus on the things that matter. Stock prices and returns are driven by changes in future expectations (think how the market adjusted prices to reflect Apple’s newly-issued forward outlook as a result of its first-quarter 2019 guidance), namely the causal impact of the influence of public-to-private arbitrage in driving prices (read more about this in Value Trap). If you’re talking about past data and worrying about precision, your efforts are largely wasted. The value of a business is based on the future enterprise free cash flows it generates for shareholders. It is not based on what P/E ratios were 20 years ago, for example. There’s going to be tons of meaningless data out there. Please focus on the data that matters, data that captures future expectations: the fair value estimate, the fair value estimate range.
The Valuentum Buying Index takes into consideration three major characteristics: 1) discounted cash flow valuation (aka enterprise valuation); 2) relative value (aka behavioral valuation); and 3) technical/momentum indicators (aka “the information contained in prices”). There is a flow chart on page 14 of every 16-page stock report that provides complete transparency as to how we arrive at our VBI ratings.
Also, the following article walks through the VBI in great detail, but you have to read Value Trap first, or I feel you’re going to jump to conclusions based on somebody else’s perspective:
In the case of Microsoft (MSFT), we think shares are fairly valued on a discounted cash flow basis (they are trading within our fair value estimate range), it is attractive on a relative value basis (its PE and PEG ratios are attractive compared to the rest of its industry), and its technical indicators are bearish as of the December 26 time stamp found in the upper right hand corner of the report. All of this information can be found on page 1 of the 16-page reports under the chart titled “Investment Considerations” at the top right of the page. A share price decline had taken place since the previous update of Microsoft, which led to the bearish indicator with respect to Microsoft’s technical consideration and helped drive its VBI rating to 3.
It is important to remember that in order to score highly on the VBI, a stock must be exhibiting both an attractive valuation opportunity (on both a discounted cash flow and relative value basis) and attractive technicals, the latter of which indicates that the market is confirming our assessment of the stock’s value. Much more on this in Value Trap. The majority of stocks within our coverage universe typically fall into what we call the “big middle,” or the 3-8 range, indicating that we are typically not looking to add or remove shares from one of the simulated newsletter portfolios.
Let’s now talk a bit about Eli Lilly’s (LLY) dividend. The VBI does not take dividend considerations into account, only the three aforementioned characteristics. If you are looking for an assessment of the health of the dividend, we point to the Dividend Cushion ratio as a helpful tool, and this ratio helps drive our Dividend Safety and Dividend Growth Potential ratings as well. The fair value estimate is generally independent of dividend policy, save for the case when a company pays a dividend, its share price is adjusted lower by the amount of cash no longer on the balance sheet. This cash is now in the hands of shareholders.
Our process is not mechanical. When the Valuentum Buying Index flashes a strong rating, generally 9 or 10, we consider the idea. There aren’t a lot of 9 or 10s on the Valuentum Buying Index and weren’t for much of 2018, and the markets have swooned since. This means our methodology is working. We only have two stocks rated 8 on the Valuentum Buying Index, and one of them is Celgene (CELG), which was just taken out today at a substantial premium today. When you come to Valuentum, come to Valuentum with an open mind. Importantly, read Value Trap. It answers a ton of your questions, and what you might think is counter-intuitive actually grows to make a lot of sense.
We’re truly blessed to have your interest, and we very much appreciate your membership. An investment in Value Trap is well worth it (if you are a member, the digital download costs only $10.49). We sincerely hope many of you will write reviews of the book on Amazon, too. I will send a reminder in the coming month or so about this. Valuentum flies under the radar when it comes to external exposure on CNBC or social media, and we’re hoping to change that in 2019. I think sometimes when people don’t see a large following on social media, they may not think we have a lot of members. Our exclusivity sometimes works against us.
However, we do have a lot of members, and you know it. Value Trap is now the #1 New Release for Stock Market Investing on Amazon! That is exciting, and we only have each and every one of you to thank! We want to talk more and more with you during 2019 than ever before, so we can all be on the same page with where we are coming from. This means, however, that you have to read Value Trap. We’re not trying to sell books. We really need our biggest fans and our deepest critics to read it!
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Valuentum members have access to our 16-page stock reports, Valuentum Buying Index ratings, Dividend Cushion ratios, fair value estimates and ranges, dividend reports and more. Not a member? Subscribe today. The first 14 days are free.
Brian Nelson and Kris Rosemann do not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.