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In this article I’ll explain my hands-off, no tinkering, annual portfolio system. I’ll show how it’s beaten the indices for the last four years, in a range of environments, and how you can do it yourself. You just need the steely temperament needed to close your eyes and step away from the trade buttons.
This all stems from an experiment I started in December 2018. My hypothesis was that you could do much better than the UK small cap indices with the bare minimum of work. By excluding perennial cash burners, blue sky ‘jam tomorrow stocks’, and ethically challenged businesses, I reckoned you could do much better than the FTSE. I also wondered how much of a benefit you would get if you went a bit further, and just focused on actual businesses. You know, those making real cash flows with decent people in charge.
In many ways, you can think of this as being like a more hands version of the StockRanks system the folks at Stockopedia use. Their system is purely quantitative, but it comes from the same philosophy: get rid of the dogs and your investing results will massively improve.
But, without any further ado, let me explain to you how it all works.
An annual exercise
Every December, with a mince pie in hand and festive spirit in my heart, I download a list of every UK listed company.
That’s about 2200 businesses worth of ‘raw material’.
As UK investor, this is my universe in the broadest possible sense of the word.
To start with, I run this universe through a purely mechanical filter, looking for the following characteristics:
- Is it an operating company? I’m not considering funds or investment vehicles here
- Does it operate in a sector I understand? I don’t do biotechs, mining, oil & gas, or other commodity plays
- Is it between £20m and £1bn in market cap? This is my sweet spot: big enough to be investible, not so big as to be overanalysed
This year, 477 businesses passed that first stage filter. It’s a huge drop off – predominantly because there are an enormous amount of investment vehicles listed in London. Funds, ETFs, trusts and so on. There are 168 iShares vehicles alone.
After that, I run what’s left through a subjective filter. This answers five questions, some of which require shoot-from-the-hip judgements:
- Is it UK managed?
- Is it consistently profitable?
- I give them a free pass if they have a single year with some sort of write down, or had a tough time during COVID
- Are revenues meaningful relative to the size of the business?
- I used to call this the ‘blue sky filter’
- Do I think this business is ‘clean’?
- This is the most subjective: I call it ‘ethics, regulator, country and accounting’
- Countries operating in certain countries, sectors or with certain individuals are tainted from step one, in my view
- Is the balance sheet acceptable?
- I use simple metrics to determine this: eyeballing the current ratio and the net shareholder deficit versus free cash flow
I let a company fail on one of these tests, but I kick ’em out if they fail more than that. This eliminates another 15% of businesses.
What I’m left with is a funnel process which looks something like this:Continue reading“Beating the UK indices in 10 hours a year”