Peter Mycroft Psaras'  Instablog

 I have always been told by friends that the markets usually go up on average 6 days for every 4 days they go down, so the long term buy and hold investor, if he waits long enough will do great.  Well as the table below shows, this is pure fiction and fantasy as the numbers show a different story.  From 1928-Present (20,340 trading days) the DJIA has gone up 50.68% of the time and down 49.32% of the time.  And as for the case for indexing, that is also a fantasy as a person who invested in the DJIA in 1928 and held to today, would have had an average annualized return of only 4.69% for those years.  If you factor in inflation, which has averaged 3.42% annually since 1913 to today, you are left with about a 1.27% real return on your money.

TOTAL DAYS		1928-2009	AVG ANNUAL % GAIN
10300	UP DAYS	50.68%	4.69%
10024	DOWN DAYS	49.32%
		1930-1940	AVG ANNUAL % GAIN
1200	UP DAYS	48.08%	-4.79%
1296	DOWN DAYS	51.92%
		1940-1950	AVG ANNUAL % GAIN
1191	UP DAYS	47.64%	2.85%
1309	DOWN DAYS	52.36%
		1950-1960	AVG ANNUAL % GAIN
1337	UP DAYS	53.25%	13.06%
1174	DOWN DAYS	46.75%
		1960-1970	AVG ANNUAL % GAIN
1259	UP DAYS	50.58%	1.66%
1230	DOWN DAYS	49.42%
		1970-1980	AVG ANNUAL % GAIN
1234	UP DAYS	48.85%	0.35%
1292	DOWN DAYS	51.15%
		1980-1990	AVG ANNUAL % GAIN
1312	UP DAYS	51.90%	12.31%
1216	DOWN DAYS	48.10%
		1990-2000	AVG ANNUAL % GAIN
1346	UP DAYS	53.24%	15.12%
1182	DOWN DAYS	46.76%
		2000-Present	AVG ANNUAL % GAIN
1252	UP DAYS	51.42%	-1.82%
1183	DOWN DAYS	48.58%

So what's the answer then if Indexing doesn't work?  The secret is Price to Free Cash Flow.  In 2007 I completed a 58 year back test of the DJIA, which concluded that if a person invested only in stocks that had a price to free cash flow of 15 or less, they would have done great. Here is the backtest;

 www.mycroftresearch.com/uploads/Backtest_1950-2007_Mycroft_Research_LLC.pdf

 
Now that backtest did not factor in taxes paid when one bought and sold each year, but even if half of your money was taken out for taxes you still would have done great.  I then took price to free cash flow and added a second criteria, which improved my performance substantially and that is to look for quality stocks that consistently return 20%+ free cash flow return on invested capital (FROIC).  Being an Investment advisor as well as an equity analyst, I am not in the habit of giving my stock picks away for free (those are reserved for my clients) but if you research hard enough you can find some real winners.  The formula I have come up with is to buy stocks at 15 times(or less) their price to free cash flow and sell them when they hit 30 times or when their free cash flow return on invested capital goes lower than 10% after I have bought them originally at over 20%.

 I am not a short term trader or long term investor. I am a right time investor who lets the stocks tell me when to buy them and when to sell them.  In closing I should atleast give you one example of a stock that has worked out well for my clients.  The company is Coach (COH) . I have been trying to buy Coach for years but it always traded above 15 times its free cash flow.  In 2009 though the world became a beautiful place as the inefficient market allow the stock to fall into the low teens in price and traded at a low of about $11.41 a share.  Anyone who bought the stock at that price would have paid 7 times its free cash flow per share.  The company today closed at $35.19 so your gain would have been huge just six months later.

YEAR	PRICE TO FREE CASH FLOW	FREE CASH FLOW RETURN ON INVESTED CAPITAL
2000	27.62	17%
2001	30.44	37%
2002	43.32	26%
2003	58.98	27%
2004	45.48	30%
2005	35.85	34%
2006	37.36	36%
2007	19.48	31%
2008	10.49	44%
2009	7.98	37%

 As for its free cash flow return on invested capital (FROIC) it comes in at 37%. What does this mean? A FROIC of 37% simply means that they make 37 cents in free cash flow for every $1 of total capital they invest.  In the end its all about the numbers as one can not argue with the facts that they generate, just like one can not deny the performance of Warren Buffett vs. the DJIA Index.  "Numbers don't lie, only people do"!  So next time you talk with your advisor or broker ask them "what is the average price to free cash flow of my portfolio or what is the FROIC of this or that stock?  If they can't tell you, or even worse don't know what those things mean, then it's time to find a new advisor or learn to do it yourself.

Disclosure; Long COH

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