I believe in a margin of safety on positions I hold, not just positions I enter.
So does this mean you’re willing to be overweight cash for long periods of time such as the recent period of rich valuations, or do you always find opportunities with a margin of safety even in the most enthusiastic periods?
Hi Jim,
Thank you very much for the prompt and insightful response. I completely agree with you that the price is high relative to the value of the firm or its growth prospects. Consequently, any measures relating to price, such as PEG or P/E will look high as well.
I am more interested in the likely value growth of the firm (stripped of price) so that if it becomes cheap enough in the current downturn, I may buy it.
As I mentioned, Valueline expects Microsoft’s ROE to continue at very high rates (35%-40%) for the next several years. It also expects its EPS to rise by 13.6% in the next five years, from 2021 ($9.70) to 2026 ($18.35; actually, between 2025-2027).
In contrast, it expects Alphabet’s EPS to rise by 12.67% during the same period, going from $112.20 to $203.75.
So, based on expected EPS growth rate, Valueline expects MSFT to do slightly better than GOOG (almost 1% better per year).
That’s why I am puzzled by your comment that the rate of growth in observable value is likely to be very good for GOOG, but not for MSFT.
I would appreciate it if you clarify this part.
I agree with your view made elsewhere that GOOG is reasonably priced at this time (and that MSFT is not). So based on the price to expected growth rate, GOOG is a buy at this point, but MSFT is not.
Invested in QQQE yesterday @62.10 after digesting Jim’s data over the last few months and weighing risk/reward in these uncertain times. 0.35% expense is not too bad imo considering the ease of access and the quarterly rebalancing.
FYI- From the website:
“The index is reviewed and adjusted annually in December, but replacements may be made any time throughout the year. The index is rebalanced quarterly in March, June, September and December.”
Wouldn’t it be nice if holdings were weighted according to likely value growth rate, maybe in a range from 0.5% to 2% weightings instead of 1% weightings? If one could forecast the growth rates even more or less right, it would make a difference. One way to do that might be to start with equal weight and rebalance periodically according to revenue growth. Just a thought.
“One way to do that might be to start with equal weight and rebalance periodically according to revenue growth. Just a thought.”
Fundamental indices rebalance more or less by revenue growth, but they start with widely varying weightings based on company size, which has little correlation with value growth or stock performance.
“One way to do that might be to start with equal weight and rebalance periodically according to revenue growth. Just a thought.”
…
Fundamental indices rebalance more or less by revenue growth, but they start with widely varying
weightings based on company size, which has little correlation with value growth or stock performance.
You know, that first one sounds like a really interesting idea.
Start each position with equal weight, then let it grow along with, but not faster than, the business.
It’s consistent with the notions that you know some will be long term successes, sut not which;
that sales growth is a surprisingly useful metric to follow winners,
yet recognizing that following the market cap ahead of the growth of the business is the road to overallocation to the overvalued.
In effect, it would trim over-successful positions, but only the portion of growth that was above the growth in the value.
It would have the side effect of selling high and buying low on a regular basis, but rather than
just high and low relative to the initial position size or cap weight size, it would be high and low
relative to some flawed but useful proxy of the progress of the value.
If the stock price rose 10% but sales rose only 50%, it would sell a little.
If the stock price rose 50% but sales rose 100%, it would add to the position.
Alas, I don’t think I have the tools to test that.
Hmmmm.
Jim
As you probably recall, Robert Arnott backtested an earnings growth weighted portfolio.
https://thereformedbroker.com/wp-content/uploads/2014/11/jpm…
Of the portfolios that Arnott backtested, the earnings growth portfolio was the only one for which the inverse portfolio didn’t outperform the non-inverse portfolio, for whatever that implies.
portfolio, annualized return
US cap weighted, 9.66%
Equal weight, 11.46%
Fundamental weighted, 11.60%
Inverse fundamental weighted, 14.06%
Earnings growth weighted, 12.42%
Inverse earnings growth weighted, 10.26%
Earnings growth weighted outperformed cap weighted by about three percentage points and outperformed equal weighted by about one percentage point. Sales growth weighted seems more logical than cap weighted, equal weighted or fundamental weighted, none of which have weightings that correlate with value growth. (As you’ve shown, none of the index portfolios perform as well as cherry picking the top 25-100 companies by revenue growth.)
“As you’ve shown, none of the index portfolios perform as well as cherry picking the top 25-100 companies by revenue growth.”
Cherry picking is not the right word. Mechanically selecting is better.
I agree with Kingran: Microsoft’s business isn’t really cyclical.
"The second thing is, in the conversations we are having with our customers, the interesting thing I find from perhaps even past challenges, whether macro or micro, is, no, I don’t hear of businesses looking to their IT budgets or digital transformation projects as the place for cuts. If anything, some of these projects are the way they are going to accelerate their transformation, or for that matter, automation, for example. I have not seen this level of demand for automation technology to improve productivity, because in an inflationary environment, the only deflationary force is software.”
“In closing, we are entering a new era where every company will become a digital company. Our portfolio of durable digital businesses and diverse business models, built on a common tech stack, position us well to capture the massive opportunities ahead. We expect to close FY22, even in a more complex macro environment, with the same consistency we have delivered throughout the year with strong revenue growth, share gains, and improved operating margins as we invest in the areas that are key to sustaining that growth.”
It is interesting folks don’t see any cyclical hit to Berkshire operating businesses which operate in decidedly cyclical industries, yet they see cyclical hit everywhere else. Is data leading us to conclusions or our conviction is looking for data?
3 months ago, we debated whether RSP would do better than SPY. The theory was that the cap-weighted S&P 500 would do worse than equal-weight RSP due to the former being overweight in “overvalued” tech names.
As you can see in the chart below, in this bear market, RSP has done slightly worse (down 7.2%) than SPY (down 6.8%) over the past 3 months. If you zoom out over the past 12 months, you’ll see that there’s hardly any difference between SPY’s chart and RSP’s chart. There goes the theory about the largest cap tech companies in the S&P 500 being “overvalued” relative to smaller caps. [BTW, I love the ability to post charts and graphs on this new board. Kudos to the Motley Fool crew!]
