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Long only, value, growth at reasonable price, long-term horizon
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Summary

  • After a year of investing on my own, I wanted to see how my returns stacked up to the market. The answer: They could be worse.
  • A rules-based strategy to trading can be helpful, but only if you stick with it, trade unemotionally, and are highly self-critical of your own performance.
  • Most amateur investors are better off indexing. Even enterprising investors will find it hard to achieve favorable risk-adjusted returns. But alpha can be achieved, albeit with phenomenal difficulty.

About one year ago, I started investing in stocks, planning for my wife's and my retirement some 30+ years hence. Not knowing anything about investing in the least, I started with 10 shares of DIA. Since that time, I've been steadily contributing to our investment accounts, selecting investments based upon Morningstar valuations, articles on Seeking Alpha, and price targets from Finviz. It has been, to say the least, a learning process. I've made some profits, but I've made my share of dumb trades, emotional trades, panicked trades, and just general mistakes. I've been fortunate enough to make more money than I've lost, but I wasn't sure whether or not this was due to my mad skills as a stock-picker (which I would absolutely love to believe) or dumb luck (which seemed more likely). Plus, given the number of hours of my life over the past year I've dedicated to this hobby, has it really been worth it? Should I have just been dollar cost averaging into SPY?

Taking what I've learned from my experience - both good and bad - as well as principles derived from Ben Graham's The Intelligent Investor, I've come up with my own investment credo. This consists of the following:

  1. Non-Dividend paying stocks will be sold at Fair Value or at prices above FV. Dividend paying stocks will be sold at or above FV * (1 + Yield).
  2. Cash from SOLD positions must be reallocated to existing or new holdings with identical or better qualitative and quantitative characteristics. For example, for stocks under Morningstar analysis, Moat, Stewardship, and FV uncertainty (e.g., Low > Medium > High) must represent equivalent qualities or upgrades.
  3. Cash reallocations, whether from SOLD positions or NEW money, must be allocated to positions trading at a large margin of safety from a 50% weighting of M* FV and Finviz 1-y Target Price (see #5 for criteria).
  4. All trades must be done with (at minimum) $2500 increments (i.e., trading costs must represent no more than 0.5% of all activity).
  5. New initiated positions require the following margin of safety depending on M* FV uncertainty: Low = 10%, Medium = 15%, High = 20%.
  6. Self-determined valuations must trade with at least a 30% margin of safety. These are considered speculative plays regardless of certainty.
  7. Speculative plays may constitute no more than 5% of the portfolio's total value.
  8. Target total return for the portfolio is 12% per year, inclusive of trading costs. Risk adjusted return after trading costs as measured by the Sharpe Ratio (compared to 5-year risk-free rate) should at minimum exceed the 1-year S&P 500 Sharpe ratio (compared to the 5-year risk free rate) by at least 5%.

Still, even with these rules in place, I had no idea how I was doing compared to the broader market. I certainly have made money, but was the effort worth it? Was I delivering alpha or just taking on excess risk? To determine this, I analyzed my stock purchases and sales over the past year and determined their performance on a raw and annualized basis. I then pro-rated the performance based upon the amount of capital utilized as a fraction of total principal. I derived a standard deviation based upon daily returns for each holding, as well as a standard deviation of daily returns for the SPY. I then derived Sharpe ratios for my portfolio and the SPY as compared with the 10-year T-note. The data and my comments follow. I directly invested all dividends.

HoldingTotal Shares PurchasedAverage Cost BasisDividends PaidDate First PurchasedDate SoldCurrent Price / Price as of Sale% Gain (loss) [Total Return]SPY Return in Timeframe
AMT37.279$80.22$24.472/27/14n/a$92.2215.90%7.39%
APA14.07$83.28$28.0312/13/136/19/14$100.1723.23%11.40%
ATW42$53.26$0.0012/30/13n/a$50.15-5.84%8.55%
AWRE300$5.35$0.0010/22/131/21/14$6.0012.15%5.57%
BAX86.006$67.12$73.8112/30/13n/a$76.6515.67%8.55%
BBL68.93$58.83$56.6412/26/13n/a$70.5521.61%8.53%
BIDU20$166.88$0.003/3/147/25/14$222.8833.56%7.87%
BLK24.229$295.49$71.572/18/14n/a$314.917.65%8.30%
BRK.B51$114.46$0.0011/29/13n/a$127.5511.44%10.84%
CFI50.123$19.35$0.0010/30/133/7/14$19.711.82%7.37%
CLB31$152.50$0.007/24/14n/a$147.22-3.46%-0.47%
CVX18.377$112.64$44.272/10/147/24/14$134.0021.56%11.38%
DE37.202$87.32$18.873/21/14n/a$86.17-0.75%6.70%
DIA10.188$136.54$121.176/5/136/20/14$169.0035.59%24.54%
EARN106.765$13.60$111.841/9/14n/a$16.6933.00%8.66%
EBAY100$50.86$0.005/1/14n/a$52.753.72%5.49%
ECON130.994$26.87$25.5210/4/13n/a$28.657.41%18.79%
EMCG80.85$25.03$21.4210/4/13n/a$26.577.30%18.79%
ENB41.493$38.55$82.2612/11/137/15/14$47.3029.35%11.98%
ESRX88$66.64$0.009/30/13n/a$66.35-0.44%19.41%
ETP72.02$53.37$56.1312/20/13n/a$59.0412.27%9.91%
EXC130$25.03$130.001/7/143/7/14$29.4922.71%2.61%
GEOS60$43.35$0.007/23/14n/a$43.891.25%-0.46%
GILD35$69.91$0.004/21/145/1/14$78.8312.76%0.69%
HCP135.823$35.91$113.9612/11/13n/a$42.3220.69%12.26%
IPGP31$64.61$0.007/15/14n/a$62.85-2.73%0.25%
KO97.529$37.24$61.9010/14/13n/a$41.0012.00%17.37%
MA54.126$74.59$10.019/19/13n/a$75.751.80%16.70%
MCD16.347$93.05$34.279/24/13n/a$95.725.24%18.35%
MOAT192.827$28.17$81.3010/30/13n/a$30.6210.36%13.80%
MON27$117.17$0.007/23/14n/a$115.79-1.18%-0.46%
NOBL126.337$42.59$60.2011/15/13n/a$46.029.28%11.43%
NOV42.378$63.95$423.892/27/147/23/14$86.1159.61%7.89%
NVO65.874$34.91$39.4012/9/13n/a$45.9133.80%10.60%
ORCL46.287$33.81$11.0610/8/13n/a$40.3320.13%21.24%
PCLN2$1,241.92$0.007/23/14n/a$1,227.78-1.14%-0.46%
PEP15.11$79.64$15.003/7/147/23/14$91.6716.56%6.49%
PETM35$58.25$0.006/5/14n/a$70.2620.62%2.17%
PG63$80.38$0.006/3/14n/a$79.56-1.02%3.04%
REGN2$238.57$0.006/14/1312/9/13$284.5219.26%12.30%
SEP45.265$51.26$13.915/12/14n/a$52.843.70%4.68%
SLB40$113.91$0.007/15/14n/a$111.78-1.87%0.25%
SNY115.222$50.23$65.8410/11/13n/a$50.972.64%17.84%
SYNT20$80.20$0.004/30/147/23/14$89.8011.97%5.99%
TJX77$55.03$0.005/21/14n/a$52.55-4.50%5.04%
V7.013207.7441894$2.8041745n/a214.773.58%6.74%
VMI37.103150.6956311$15.5141722n/a149.64-0.42%7.14%

Overall, the year-end value of the portfolio (cash included) was $144,026 on a principal of $129,673, a total return of about 11.1%. As I have been contributing regularly to the portfolio over the past year, the average duration of each holding was 166 days; therefore, on an annualized basis, the portfolio would be projected to return 26.4%, with weighted standard deviation of 0.229%. For the period of 25 July, 2013 to 25 July, 2014, the SPY's performance was 19.22%, with a standard deviation of 0.163%.

The Sharpe Ratio for the portfolio (using the 10-year rate of 3.62% as the risk-free rate) was 99.9; applying the same metrics to the SPY yields a Sharpe ratio of 95.6 (a 4.28% advantage). Not only did I fail at rule #8, but this implies that only a very small amount of my outperformance could be explained by skill; the rest of it was luck and taking on excess risk. Moreover, it implies that for all of my work and reading, I've only generated about 720 basis points of alpha, which roughly translates into about a projected $9,300 based upon my principal, and about $8800 after a year's worth of trading costs are taken into account. I think I've sunk about 100 hours into reading and planning (this is a guess on my part). As an hourly wage, this is barely better than minimum wage. At this rate, I'd almost be better off waiting tables in my spare time and putting the money into SPY.

As disappointing as these findings are, I do take comfort in some findings. For one, the majority of my unfavorable trades so far - TJX, MA, and ESRX, for example - have seen underperformance due to what I believe are temporary price pressures, and may outperform in the days ahead. All my current holdings which have underperformed to date are trading at what I believe to be significant discounts to their fair value, and have significant economic moats that will sustain them for years to come. I don't think PG will go away, and the same goes for DE. MON is a relatively new purchase which is off its 52-week highs, but at the very worst is fairly priced for a long-term holding. And my opinion on Valmont is, for better or for worse, that the company remains significantly undervalued with several secular trends that favor its long-term growth.

For another, when I look back at other unfavorable trades, I see a pattern emerge: I sold too early GILD or out of a state of panic. I admittedly did not follow my own rule when I applied a small amount of cash to IPGP, and I need to do a better job of following the guidelines I've set for myself. Finally, I need to trade less, mostly by using larger aliquots of cash for any trades. Hopefully, that'll reduce my tendency to jump in and out of positions and trade emotionally, besides simply reducing my trading costs.

The major take-home point for me is this: that it's phenomenally hard for an amateur like me to beat the market. It is possible, and I think I've done a decent job in at least treading water. Ben Graham writes in The Intelligent Investor that physicians make the worst investors, and I tend to agree. But this one, at least, is slowly learning.

Disclosure: The author is long AMT, ATW, BAX, BBL, BLK, BRK.B, CLB, DE, EARN, EBAY, ECON, EMCG, ESRX, ETP, GEOS, HCP, IPGP, KO, MA, MCD, MOAT, MON, NOBL, NVO, ORCL, PCLN, PETM, PG, SEP, SLB, SNY, TJX, V, VMI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: It's Hard To Beat The Market: A Humbling Year-End Review