Friday, January 20, 2006

Dorfman Part 1 Mini-Presentation

If this is your first visit to Three Grahamian Virtues, please take a moment to read the welcome message and site philosophy:

This is the first of the mini-presentations I will make of formulaic investing methods that are less well established, yet compelling. Think of them as side dishes to the main presentations.

The Robot Portfolio is a seven year old brain child of Bloomberg's John Dorfman. As he puts it, the Robot Port is "a simple computer-driven model that selects deeply out-of-favor stocks." That sums up the theme of Three Grahamian Virtues, so let's see how it works.

Here is what Dorfman recently wrote after the seventh consecutive year of mutilating the market average (29.2% versus 4.9%):

"The Robot starts with all U.S. stocks of more than $500 million in market value. That's about 2,100 stocks. Then it eliminates unprofitable companies and those with debt that exceeds equity. That leaves about 1,400 stocks.

"From these, the Robot selects the 10 with the lowest price- to-earnings (or P/E) ratios (stock price divided by the past per-share earnings during the past four quarters).

"By definition, low P/E stocks are unpopular stocks. Often, they turn out to be good investments. Stocks advance by exceeding expectations, and low expectations are easier to beat.

"The Robot has racked up a 727 percent return in the past seven years, assuming replacement of the stocks at the beginning of each year. Over that span, the Standard & Poor's 500 Index has returned 13 percent."

Does it pass 3GV muster:

  1. Logical? Yes, Mr. Market tends to drive valuation multiples too far down on the low end
  2. Practical? Extremely; the screen takes minutes to set up
  3. Extraordinary Historical Proof? 727% versus 13%

So, the method is logical, absurdly simple, and hugely rewarding. My kind of gig. In gearing up for my chutzpah blackbelt test, I am left with no choice but to presumptuously attempt to improve upon Dorman's method. Below is his method and my (slightly more intensive) version.

Robot Portfolio Methodology (Dorman)
Market Cap greater than $500 million
Eliminate Unprofitable Companies
Total Debt-to-Equity less than 1.0
Buy ten lowest P/E Companies

Robot Portfolio Methodology (Lucas)

Market Cap greater than $50 million

Eliminate Unprofitable Companies

Total Debt-to-Equity less than .2

Select 10 Lowest P/E of companies whose forward P/E for next year is less than 10

No industry overlap (decisions on which to pick favor those companies whose forward P/E is closest to current)

I'd like to explain my rationale. First, it is empirically proven that smaller companies with value characteristics do better than larger, on average. Second, I dropped my D/E threshold lower to reduce risk. I also sought companies whose current earnings are presumably sustainable, so forward P/E had to be pretty close to current levels (this is significant because many of these companies are cyclical). No industry overlap was important because so few companies are owned and I don't want unneccesary correlation.

Robot Portfolio (Dorfman)
Inception Date 15 Jan 2006
First City Financial (FCFC) $11.78
P/E ttm 2.4 ---- P/E forward 14.7
Ashland (ASH) $64.68
P/E trailing 2.4 ---- P/E forward 17.3
Mechel (MTL) $25.20
P/E trailing 2.7 ---- P/E forward 11.1
Precision Drilling (PDS) $33.16
P/E trailing 2.9 ---- P/E forward 2.0
Posco (PKX) $49.58
P/E trailing 3.3 ---- P/E forward 5.8
TBSI International (TBSI) $6.80
P/E trailing 3.6 ---- P/E forward 2.8
Overseas Shipping (OSG) $51.00
P/E trailing 3.6 ---- P/E forward 6.3
SPX Corp (SPW) $47.13
P/E trailing 3.7 ---- P/E forward 16.8
Orbital Sciences (ORB) $13.03
P/E trailing 4.4 ---- P/E forward 24.2
Mittal Steel (MT) $28.03
P/E trailing 4.4 ---- P/E forward 6.2
Average P/E trailing 3.3 ---- Average P/E forward 10.7

Robot Portfolio (Lucas)
Inception Date 15 Jan 2006
Rex Stores (RSC) $15.41
P/E trailing 5.0 ---- P/E forward 8.6
Harvest Natural Resources (HNR) $8.97
P/E trailing 6.1 ---- P/E forward 8.4
Schnitzer Steel (SCHN) $30.83

P/E trailing 6.5 ---- P/E forward 7.7
USG Corp (USG) $72.95

P/E trailing 7.2 ---- P/E forward 6.5
Chromcraft Revins (CRC) $13.19

P/E trailing 7.4 ---- P/E forward 7.3
Sanderson Farms (SAFM) $26.29
P/E trailing 7.6 ---- P/E forward 8.7
National Atlantic Holdings (NAHC) $10.93
P/E trailing 7.7 ---- P/E forward 7.3
Phelps Dodge (PD) $144.59
P/E trailing 8.1 ---- P/E forward 9.3
Cemex (CMX) $62.80
P/E trailing 8.4 ---- P/E forward 9.9

Hurray! Holding (HRAY) $9.36
P/E trailing 8.7 ---- P/E forward 8.4
Average P/E trailing 7.3 ---- Average P/E forward 8.2

It's go time!

- Ian


Blogger Dennis Mangan said...

This site was pointed out to me by Shai, and I've gotta say, it's amazing. Your Modified Robot Portfolio astounded me, and I do believe it should deliver excellent returns. Your attempts at modifying the Magic Formula are excellent as well. Keep it up.

9:27 AM  
Blogger Ian said...

Thank you for the kind words! I will do everything I can to make the site worth your while. I'm always open to suggestions and point-outs to other relevant resources.

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What are your 2008 robot picks?

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