Value investing ‘better’ for individuals
I thought I should write about one more investment celebrity before I go on to my last two legendary masters, William J. O’Neil and Warrant Buffet. He is also an equally exceptional money manager but is not given relative prominence as the others.
One possible reason he was not accorded the same exposure was his partiality to small cap but “high-expectation growth stock” companies.
The stock prices of small cap companies are usually very volatile. Their market performance usually depends on expectations and expectations can change in a heartbeat. For these reasons, small cap stocks become prone to speculation unlike the low-risk and value-oriented stocks big cap stocks. In this regard, small cap stocks can make sharp price swings that could lead to dramatic gains or losses.
Our man is also an advocate of value investing. “He even went on so far as to say that a value style of investing” was not just good but “might be better for individuals.” This makes his claim an interesting study for our purpose.
This celebrity is Gary Pilgrim. He is the manager of PBGH Growth Fund. As told, “as of the mid-1996, PBGH Growth Fund posted average annual returns of 32 percent for the past five years and 22 percent for the past 10 years.”
To further demonstrate his performance record, it was explained that if one invested $10,000 in the fund in 1986, this would have been worth $73,000 10 years later.
Comparatively, if the same amount was invested in the S&P 500, it would have been “worth only $37,000,” or 49.32 percent less than PBGH’s record.
Additionally, the money “would have been worth $200,000” if the $10,000 initial investment was left in the fund up to the bull market peak of 2000.
But the bull market turned sour toward the end of 2000, all the way to 2002. The PBGH Growth fund fell hard.
To Gary Pilgrim, this was bound to happen. In an interview in 1999, “he predicted that his style of growth investing would one day get out of favor and that PBGH would have two or three years of awful returns” (as the market turned bear in 2000, 2001 and 2002).
Elements of good growth stocks
Since Gary Pilgrim had a predisposition to find value from small cap companies based on their potential to beat earnings forecasts, he was described to have developed an “aggressive systematic approach.”
His system involved the examination of the “earnings momentum” of target companies. To do this, he used a computer system to determine growth rankings.
He starts by picking up “those that have increased their earnings by 20 or more for two quarters. Then, he ranks them according to how much earnings they realized in excess of estimates.
The criteria he uses to rank the targets are based on what he called the “upward revisions in earnings estimates and positive earnings surprises.” Accordingly, these two elements account for 60 percent of his ranking system.
This approach removes any element of emotional interpretation. “The numbers are there or they aren’t,” he explained. “It effectively insulates you from the trap of the good story management tells about their company,” he added.
More precisely, Pilgrim looks into the “rate of acceleration or deceleration” of earnings. Like the previously featured value investors, he also “digs deep into company balance sheets for high profit margins and low debt.”
But unlike the traditional value investor who uses the intrinsic value of a stock to determine whether its prevailing market price is at a bargain or not, Pilgrim “ignores valuation” in that sense.
He said, “valuation has no role in a growth portfolio. It’s a waste of time to wonder if companies I like are overvalued or undervalued. A P/E of 40 doesn’t mean anything unless you look at the underlying growth characteristics of the stock. You’ll find the high-P/E stocks are all selling at numbers commensurate with their growth rates.”
As observed, this is where Pilgrim is found to be like O’Neil. Both believe that “in the stock market, you get what you pay for.”
On value investing
Following the value-growth investing concept we have been pursuing, Pilgrim’s style also fits into place. He finds value in the earnings growth of small cap companies.
Pilgrim, however, believes it is dangerous for an average investor to pursue “earnings momentum,” which is basically anchored on calculated guesses or expectations. This style, according to him, requires “a fast finger to get out of the wrong stocks and into the right ones, when wrong.”
Therefore, individual investors are better off with the traditional value investing concept to concentrate on mature companies and “buying on the cheap.” You can easily see when their prices are relatively low. But like in his earnings momentum concept, he has these reminders to individual investors: to “read regular earnings report; look at earnings growth from quarter to quarter to determine acceleration or deceleration, and get hold of analysts’ estimates.”
These estimates are readily available from stockbrokerage houses or the information desk of companies themselves. He further advises retail investors to “set up parameters” to limit the percentage of their portfolio to any given stock. Any stock should not take up more than 8 percent.
He also insists that one should “buy more of what’s rising and stop buying what’s falling.” Before buying back—a stock or into the market—one must reevaluate existing circumstances.
Also, “don’t necessarily sell” when the price of a stock is down. “Look at the fundamentals” and ask the question if it really is a bad stock or a good stock with a great buying opportunity?
Lastly, “stay true to your strategy. Every investor experiences good and bad times. Don’t change everything when times are bad.”
Bottom line spin
Up to the weekend, worldwide economic and geopolitical conditions remained hinged on what would happen next in Syria; developments on who would be “Barak Obama’s nominee to succeed Ben Bernanke as Fed chief” and the possibility of “another showdown between Obama and congressional Republicans over the federal debt.”
These and developments in the economies of India, Indonesia and China will certainly have impact on the local market’s outlook in the coming days. They could further bring down the market.