Value Strategies

for
Conservative Investors
Canadian MoneySaver Conference
October 2003

Norm Rothery, PhD

www.stingyinvestor.com

Overview
<
<
<
<
<
<
<

<
<

Before investing
Why invest in stocks?
Controllable factors
<
Fees, taxes, and trading
Indexing: the default choice
Select index funds and ETFs
Markets from a value perspective
Value Strategies
<
Graham: Investing with a margin of safety
<
Dreman: Relative ratios
<
Dividends
<
Buffett
Some problems
Further reading

Slide 2 of 22 Norm Rothery 2003

Before Investing
Be debt free
<
<
<

No Credit Card Balances

No Loans
No Mortgages

Have a rainy weather fund

<

Stash 3-6 months of income in short term notes

<
High interest bank accounts
<
ING Direct
<
American Express
<
Short-term GICs
<
Frugal short-term income funds

<

Save for large ticket items

<
Homes
<
Cars
<
Tuition
<
Medical

Insurance
<

Make sure that you are fully covered

Slide 3 of 22 Norm Rothery 2003

Why invest in stocks?

U.S. Annual Returns adjusted for inflation and taxes
Period

Stocks

Bonds

T-Bills

Gold

5.9%

2.3%

2.1%

0.06%

1802-1870

7.0%

4.8%

5.1%

0.18%

1871-1925

6.6%

3.2%

2.7%

-0.82%

1926-1996

4.2%

-0.71%

-1.1%

0.63%

1802-1996

Source: David Dreman

Slide 4 of 22 Norm Rothery 2003

Controllable Factors: Fees

Slide 5 of 22 Norm Rothery 2003

Controllable Factors: Taxes and Trading

Investment compounded for 20 years with a 27% tax on gains
Annual Return
Before Tax

Annual
Turnover

Value of $1M
after 20 yrs

Annual Return
After Tax

15%

0%

16,366,500

15.0%

15%

3%

14,780,800

14.4%

15%

10%

12,386,300

13.4%

15%

30%

9,694,000

12.0%

15%

80%

8,136,600

11.1%

15%

100%

7,990,800

11.0%

Source: www.tweedy.com

Group

Annual Turnover

Single Men

85%

Married Men

75%

Married Women

53%

Single Women

51%

Phone Trading

~70%

Online Trading

~90%
Source: John Nofsinger

Slide 6 of 22 Norm Rothery 2003

Indexing: The default choice

<

Simply buy a basket of stocks that mimics an index.

Potential Advantages
<
low cost
<
broad diversification
<
tax efficiency through low turnover

Source: A Random Walk Down Wall Street

Potential Disadvantages
<
selecting a good index
<
high-fee index funds & ETFs
<
limited diversification from specialty indices
<
valuation

Slide 7 of 22 Norm Rothery 2003

Select Index Funds & ETFs

Canadian Index Funds & ETFs
iUnits S&P/TSX 60 (T:XIU)
iUnits S&P/TSX Composite (T:TTF)
TD Canadian Index eFund
iUnits 5Yr Government Bond (T:XGV)
iUnits 10Yr Government Bond (T:XGX)
TD Government Bond Index eFund

MER
0.17
0.25
0.31
0.25
0.25
0.48

U.S. Equity Index Funds & ETFs

VIPERs Total Stock Market (U:VTI)
S&P 500 (U:SPY)
S&P 500 (T:XSP)
TD U.S. Index eFund
TD U.S. RSP Index eFund

MER
0.15
0.11
0.30
0.33
0.48

U.S. Specialty ETFs

DJIA (U:DIA)
S&P 500 Growth (U:IVW)
S&P 500 Value (U:IVE)
NASDAQ 100 (U:QQQ)
VIPERs Extended Market (U:VXF)
iShares Russell 1000 (U:IWB)
iShares Russell 2000 (U:IWM)

MER
0.17
0.18
0.18
0.20
0.20
0.15
0.20

International Equity Index Funds & ETFs

MSCI EAFE (T:XIN)
MSCI EAFE (U:EFA)
TD International Index eFund
TD International RSP Index eFund
iShares S&P/TOPIX 150 (U:ITF)
iShares S&P Europe 350 (U:IEV)
iShares Emerging Markets (U:EEM)

MER
0.35
0.35
0.48
0.48
0.50
0.60
0.75

Slide 8 of 22 Norm Rothery 2003

Valuation

Slide 9 of 22 Norm Rothery 2003

Valuation

Slide 10 of 22 Norm Rothery 2003

Select Value Strategies

Benjamin Graham: The Father of Value Investing
<
<
<
<

Margin of Safety
Assets on the cheap
Stable growth
Low debt with a high earnings yield.

David Dreman: Relative Ratios

<
<
<
<

Price-to-Earnings
Price-to-Book
Price-to-Cash Flow
High Dividend Yield

Dividend Yield
Warren Buffett
<
<
<
<

Strong Companies
Concentration
Margin of Safety
Qualitative

Slide 11 of 22 Norm Rothery 2003

Benjamin Graham Margin of Safety

There are instances where a common stock may be
considered sound because it enjoys a margin of safety as
large as that of a good bond. This will occur, for example,
when a company has outstanding only common stock that
under depression conditions is selling for less than the
amount of bonds that could safely be issued against its
property and earning power. That was the position of a
host of strongly financed industrial companies at the low
price levels of 1932-33. In such instances the investor can
obtain the margin of safety associated with a bond, plus all
the chances of larger income and principal appreciation
inherent in a common stock
-The Intelligent Investor (4th ed) pg 278
Factors
<
<
<

Price much less than Working Capital

Strong balance sheet
Profits and expected profits

Problems
<
<
<

Scarcity of such stocks

Hidden liabilities
Poor outlook

Slide 12 of 22 Norm Rothery 2003

Benjamin Graham Defensive Investors

Guidelines for Defensive Investors
<
<
<
<
<
<
<
<

Price-to-Earnings Ratio less than 15

Price-to-Book Ratio less than 1.5
Book Value over 0
Current Ratio over 2
Earnings growth of 33% over 10 years
Uninterrupted dividends over 20 years
Some earnings in each of the past 10 years
Annual revenue of more than $100 Million (1950)
The Intelligent Investor 4th Ed, pgs 184-185

My Approximation
<
<
<
<
<
<
<
<

Price-to-Earnings Ratio less than 15

Price-to-Book Ratio less than 1.5
Book Value per share more than 0.01
Current Ratio more than 2
Annual EPS Growth (5 Yr Avg) > 2.9186%.
5 Year Dividend Growth more than 0%
5 Year P/E Low more than 0.01
1 Year Revenue more than $400 Million
- See November 2003 Canadian MoneySaver

Slide 13 of 22 Norm Rothery 2003

Benjamin Graham Defensive Investors

Performance of previous Graham Picks (October 3 2003)
Stock

Initial Price
Current Price
2000 Graham Stocks (12/12/2000)
AAR Corp (AIR)
$11.94
$9.70
Haverty Furniture (HVT)
$10.06
$20.76
La-z-boy (LZB)
$15.88
$23.20
Rollins Truck (RLC)
Bought in 2001
Reliance Steel (RS)
$25.13
$23.00
Tredegar Corp (TG)
$15.56
$15.70
Thor Industries (THO)
$19.69
$60.70
Wabash National (WNC)
$7.81
$16.75
Watsco (WSO)
$11.35
$19.65
Average Gain
S&P500 (SPY)
2001 Graham Stocks (10/29/2001)
Centex (CTX)
$39.45
$83.71
Domtar (DTC)
$8.19
$11.38
Haverty Furniture (HVT)
$12.80
$20.76
M.D.C. Holdings (MDC)
$27.35
$59.11
Pulte Homes (PHM)
$33.83
$71.42
Average Gain
S&P500 (SPY)
2002 Graham Stocks (10/27/2002)
Centex (CTX)
$43.38
$83.71
Pulte Homes (PHM)
$46.17
$71.42
D.R. Horton (DHI)
$20.16
$36.12
Woodward Governor Company
$36.62
$45.97
(WGOV)
M.D.C. Holdings (MDC)
$37.91
$59.11
Standard Pacific (SPF)
$25.10
$40.39
Seaboard (SEB)
$207.00
$229.50
Universal Forest Products (UFPI)
$18.34
$26.93
Haverty Furniture (HVT)
$11.75
$20.76
Watsco, Inc. (WSO)
$14.25
$19.65
Average Gain
S&P500 (SPY)
Source: quote.yahoo.com, *Adjusted for splits
<

Gain
-15.8%
112.4%
52.7%
82.0%
-5.9%
3.5%
*517.7%
116.1%
102.6%
107.3%
-22.2%
112.8%
43.0%
65.3%
*164.1%
111.8%
99.4%
-1.4%
93.3%
55.0%
80.4%
28.1%
*72.5%
62.2%
12.3%
47.3%
78.7%
38.7%
56.8%
16.3%

This Year: Pulte Homes (PHM) & Ameron Int (AMN)

Slide 14 of 22 Norm Rothery 2003

Benjamin Graham Earnings Yield

Average annual % gain or loss from 1937 - 1969
Period

10 lowest
P/Es

10 highest
P/Es

30 DJIA
Stocks

1937-42

-2.2%

-10.0%

-6.3%

1943-47

17.3%

8.3%

14.9%

1948-52

16.4%

4.6%

9.9%

1953-57

20.9%

10.0%

13.7%

1958-62

10.2%

-3.3%

3.6%

1963-69

8.0%

4.6%

4.0%

Average

11.8%

2.4%

4.6%
Source: Benjamin Graham

A low price-to-earnings approach also worked from 1970-1997

Quintile

low
1

Return

19.0%

17.4%

14.6%

high
5

market

13.1%

12.3%

15.3%

Source: David Dreman

Grahams Earnings Yield Approach

<
Earnings Yield > twice that of AAA Corporate Bonds
<
Maximum P/E Ratio of 10
<
Equity / Total Assets more than 50%
<
From 1926-1976 yielded 2 times the returns of the DJIA
The Rediscovered Benjamin Graham, pg 259

Slide 15 of 22 Norm Rothery 2003

David Dreman: Ratio Analysis

Price-to-Earnings from 1970-1997
Quintile

low
1

Return

19.0%

17.4%

14.6%

high
5

market

13.1%

12.3%

15.3%

market

Price-to-Cash Flow from 1970-1997

Quintile

low
1

high
5

Return

18.0%

16.6%

15.8%

13.7%

11.2%

15.1%

market

Price-to-Book from 1970-1997

Quintile

low
1

high
5

Return

18.8%

16.3%

14.6%

13.7%

12.0%

15.1%

market
14.9%

Dividend Yield from 1970-1997

Quintile

high
1

low
5

Return

16.1%

17.5%

15.1%

13.8%

12.2%

Source: Contrarian Investment Strategies: The Next Generation

Slide 16 of 22 Norm Rothery 2003

David Dreman: Industry Ratio Analysis

Industry-Relative Price-to-Earnings from 1970-1997
Quintile

low
1

Return

17.7%

16.7%

16.1%

high
5

market

13.7%

12.2%

15.3%

Industry-Relative Dividend Yield from 1970-1997

Quintile

high
1

Return

17.0%

16.0%

14.9%

low
5

market

14.1%

12.7%

14.9%

No need to rush
P/E buy-and-hold annual returns (1970-1996)
Quintile

2 Years

3 Years

5 Years

8 Years

1 (low)

18.7%

18.1%

18.7%

18.4%

16.9%

16.5%

17.1%

17.5%

15.3%

15.2%

15.5%

16.2%

13.5%

13.7%

14.4%

15.3%

5 (high)

11.9%

11.3%

11.8%

12.8%

Market

15.3%

15.0%

15.6%

16.2%

Source: Contrarian Investment Strategies: The Next Generation

Slide 17 of 22 Norm Rothery 2003

Dividend Based Approaches

<

High Dividend Yield

Dividend Yield from 1970-1997

Quintile

high
1

Return

16.1%

17.5%

15.1%

low
5

market

13.8%

12.2%

14.9%

Source: David Dreman

[Attend David Stanleys Presentation for more info]

<

Relative Dividend Yield

<
Compare yield to historic highs/lows
<
Compare yield to an appropriate index

<

Dividend Growth
<
High yield compared to similar payout ratios
<
Stick to low dividend payout ratios
<
Current and expected profits
<
Little debt

<

Distressed Dividends

Slide 18 of 22 Norm Rothery 2003

Warren Buffett
We believe that our formula the purchase at sensible prices of
businesses that have good underlying economics and are run by
honest and able people is certain to produce reasonable
success.
< Strong companies at fair prices
An investor should act as though he had a lifetime decision card
with just twenty punches on it. With every investment decision his
card is punched, and he has one fewer available for the rest of his
life.
< Concentration
There is simply no precision to the process - and if you think so,
you are kidding yourself. There should be such a margin of safety
that you dont need to carry it out to three decimal places.
< Margin of safety
The qualitative is harder to teach and understand, so why not just
focus on the quantitative? ... It makes more sense to buy a
wonderful business at a fair price.
< Difficult to emulate

Slide 19 of 22 Norm Rothery 2003

Potential problems with value investing

<

Value stocks can be psychologically unappealing

<
Hard to boast about your newest picks
<
Unlikely to hear good things in the news
<
People may criticise your ugly ducklings
<
Holding for long periods is seen as slothful

<

Taxes may be higher

<
Higher turnover
<
High dividend payments may not be as tax
efficient as capital gains.

<

Commissions may be higher

<
low volume stocks tend to have higher
spreads and buying large positions may
impact the market.

<

Value is often seen as an unrealized risk factor

<

Cheap stocks can get cheaper before recovering

<

Cheap stocks can just get cheaper

Slide 20 of 22 Norm Rothery 2003

Cheap stocks can get cheaper

<

While value stocks may outperform the market,

they may lose ground in a meltdown

<

The markets are still very expensive on a

historical basis and remain dangerous

Slide 21 of 22 Norm Rothery 2003

Value Strategies for Conservative Investors

Norman Rothery

Value Oriented Books

Security Analysis
The Intelligent Investor
The Rediscovered Benjamin Graham
Value Investing Made Easy
Contrarian Investment Strategies
What Works on Wall Street
Relative Dividend Yield
Beating the Dow
Buffett: The Making of an American...
Value Investing

by Graham & Dodd

by Benjamin Graham
by Janet Lowe
by Janet Lowe
by David Dreman
by James P. OShaugnessy
by Anthony Spare
by OHiggins & Downes
by Roger Lowenstein
by Martin Whitman

007141228X
0060555661
0471244724
0070388644
0684813505
0070482462
0471327050
006098404X
0385484917
0471398101

Web Resources
www.stingyinvestor.com
www.frugalfunds.com
Overheads
www.stingyinvestor.com/SI/articles/talks.shtml
Free Email Newsletters
www.stingyinvestor.com/cgi-bin/email.cgi
The Stingy News Weekly
The Graham Report
The Foolish TSE
The Value Ratio Report
The Value 60
Subscription Based Newsletters
For Stocks: The Rothery Report
For Funds: Frugal Funds
Id be happy to mail you a free copy of either newsletter.
Contact Info
info@stingyinvestor.com
www.stingyinvestor.com
16 Queens Drive, Toronto ON, M9N 2H4

Slide 22 of 22 Norm Rothery 2003