This is the editorial of our monthly Quant Value Investment Newsletter published on 1 October 2024.
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More information about the newsletter can be found here: This is how we select ideas for the Quant Value investment newsletter
This month you can read why keeping the volatility of your returns low is the key to growing your wealth.
But first the portfolio updates.
Portfolio Changes
Europe – Buy Five – Sell One
Five European recommendations this month as the index is above its 200-day simple moving average.
The first is a cheap €1.5bn Milan-listed Dutch cement manufacturer trading at Price to Earnings ratio of 7.3, Price to Free Cash Flow of 9.2, EV to EBIT of 6.1, EV to Free Cash Flow of 8.9, trading at a Price to Book ratio of 1.0 and it pays a dividend of 3.1%.
The second is a very undervalued €661m German manufacturer of power tools and electrical garden equipment, trading at Price to Earnings ratio of 7.4, Price to Free Cash Flow of 2.7, EV to EBIT of 5.2, EV to Free Cash Flow of 2.9, Price to Book of 1.1 with a dividend yield of 5.0%.
The third is a fast growing €179m Italian trade fair organiser trading at Price to Earnings ratio of 7.8, Price to Free Cash Flow of 5.9, EV to EBIT of 6.6, EV to Free Cash Flow of 8.8, Price to Book of 1.5 with a dividend yield of 2.4%.
The fourth is a dirt cheap NOK11.3bn (€963m) Norwegian chemical shipping company trading at Price to Earnings ratio of 4.1, Price to Free Cash Flow of 3.8, EV to EBIT of 6.0, EV to Free Cash Flow of 7.1, trading at a Price to Book ratio of 1.2. And it pays an attractive dividend of 9.3%.
The fifth and last is a fast growing €696m Greek port operator trading at Price to Earnings ratio of 10.3, Price to Free Cash Flow of 10.5, EV to EBIT of 5.6, EV to Free Cash Flow of 8.9, Price to Book of 2.0 with a dividend yield of 4.8%.
Stop Loss - Sell Supreme Plc at a loss of -21.3%
North America – Nothing to do
No new recommendation this month as the companies we found elsewhere in the world fit the newsletter’s investment strategy a lot better.
Asia – Buy One – Hold Three – Sell One
One recommendation this month as the index is above its 200-day simple moving average.
It is a growing, debt free JPY 16.6bn (€105m) Japanese information services and security systems company trading at Price to Earnings ratio of 9.3, Price to Free Cash Flow of 9.8, EV to EBIT of 2.8, EV to Free Cash Flow of 4.7, Price to Book of 1.4 with a dividend yield of 2.8%.
Hold Three
Continue to hold the below companies as they still meet the portfolio’s selection criteria.
- APT Satellite Holdings Limited +21.1% (recommended in October 2021)
- E J Holdings Inc. +53.8% (recommended in October 2021)
- Chiyoda Integre Co.,Ltd. +31.6% (recommended in October 2023)
Sell Pasco After Tender Offer Announcement
Sell Pasco with a profit of 13.6%
On 5 September 2024, SECOM Co., Ltd, Pasco’s parent company, along with Itochu Corporation initiated a tender offer for all remaining shares of Pasco.
The purpose of the offer is to acquire 100% of Pasco’s shares and take the company private.
I recommend that you sell your shares as the current prise is only slightly below the tender price of JPY 2,140 per share.
The offer commenced on 6 September 2024 and ends on 22 October 2024.
Crash Portfolio – Nothing to do
No new Crash Portfolio ideas as markets have recovered.
To date all 15 Crash Portfolio ideas, recommended between August 2022 and May 2023, are up an average of 38.4%!
Why Low Volatility Gives You Higher Returns
Imagine you invest $10,000 in the stock market.
- In one scenario your investment grows steadily at 5% per year.
- In another it grows by 50% one year and drops 33% the next.
After two years, which scenario do you think would leave you better off? It might seem like the bigger gains in the second scenario would give you more money ($1,005.00), but steady growth ($1,102.50) performed better and is much more powerful over time.
That’s because large swings in value, or volatility, hurt your returns more than you think.
This month I want to share something with you that took me a while to fully understand. Keeping the volatility of your investment returns low is the key to growing your wealth. In other words, why reducing roller-coaster returns in your portfolio gives you higher results in the long run.
What is Volatility and Why Does It Matter?
Volatility measures how much an investment’s value fluctuates over time. Think of it like the waves in the ocean.
When an investment is highly volatile, it makes frequent large up and down moves, big waves. This might sound exciting, but it makes it harder for your money to grow steadily.
Let’s take a simple example. Imagine two investments:
• One grows 10% every year, and
• The other grows 30% one year but drops 10% the next.
If you invested $1,000, after two years, the first investment would grow like this:
Year 1: $1,000 x 1.10 = $1,100
Year 2: $1,100 x 1.10 = $1,210
The second investment, even though it has a big 30% gain, would look like this:
Year 1: $1,000 x 1.30 = $1,300
Year 2: $1,300 x 0.90 = $1,170
In the second scenario, the average return over two years is 10% ((30% - 10%) / 2), but the result is worse than the steady 10% return. This is the negative effect of volatility in action: large swings drag your returns down.
Key Point: Even with the same average return, volatility reduces your overall growth. This makes steady returns more beneficial.
The Volatility Drag: How It Lowers Your Returns
One of the hidden dangers of volatility is something called “volatility drag.” It means that the more your investment bounces up and down, the lower your long-term growth will be, even if the average return looks good.
Let’s look at another example to understand how this works.
Suppose you have an investment that gains 50% in one year but loses 33% the next. You might think this evens out, but it doesn’t. If you start with $1,000, the numbers look like this:
Year 1: $1,000 x 1.50 = $1,500
Year 2: $1,500 x 0.67 = $1,005
Even though the average return over two years is 8.5% ((50% - 33%) / 2), your actual growth is only 0.5%.
This happens because losses have a bigger impact than gains of the same size. It takes more effort to recover from a loss than it does to benefit from a gain. That’s why volatile investments often underperform steady ones, even when their average returns are the same.
Why Low Volatility Equals Steadier Growth
Low volatility means more stable, consistent returns over time, which allows your money to grow steadily.
Let’s compare two investments again: one with consistent returns and one with volatile returns. Say you invest $10,000 in two portfolios. The first portfolio grows by 5% every year, while the second grows by 30% in the first year and then loses 20% in the second.
After two years, here’s how each investment would perform:
Steady portfolio (5% per year):
Year 1: $10,000 x 1.05 = $10,500
Year 2: $10,500 x 1.05 = $11,025
Volatile portfolio (30% in Year 1, -20% in Year 2):
Year 1: $10,000 x 1.30 = $13,000
Year 2: $13,000 x 0.80 = $10,400
Even though the average return in both cases is 5%, the steady portfolio leaves you with more money because the volatile portfolio’s losses drag your return down.
This is why low volatility equals better growth in the long run. When returns are more consistent, your investments compound more effectively, leading to greater wealth over time.
The Importance of Diversification and Rebalancing
One of the best ways to reduce volatility in your portfolio is through diversification. This means spreading your investments across different assets, like stocks, bonds, and cash, to lower the overall risk.
For example, if you put all your money in one stock, a big drop in that stock could hurt your entire portfolio. But if you invest in a mix of different stocks and bonds, the risk is spread out. When one investment goes down, another might go up, helping to stabilize your returns.
The second way to reduce volatility is through rebalancing which works like this. Suppose you start with a portfolio that is 50% stocks and 50% bonds. After one year, stocks perform well and grow to 60% of your portfolio, while bonds drop to 40%. To maintain your desired level of risk, you would rebalance by selling some stocks and buying more bonds, bringing your portfolio back to 50/50.
Rebalancing ensures that you “buy low and sell high” without making emotional decisions. It also helps keep your risk in check and your returns more stable.
The Long-Term Impact on Your Wealth
The real benefit of keeping volatility low is the long-term impact on your wealth. When your investments grow steadily, they compound more effectively over time.
And it is compounding is what allows your money to grow exponentially. This is because you earn returns not only on your original investment but also on the returns you’ve already made.
Volatility interrupts this process because large drops take longer to recover from, slowing down your progress.
Conclusion
Reducing the volatility of your investments is crucial for long-term success. Even if the average return looks good, large swings in value can drag your returns down and slow your progress.
By focusing on low-volatility investments, diversifying your portfolio, and rebalancing regularly, you can protect yourself from big losses and enjoy the benefits of steady, reliable growth.
Remember, investing isn’t about chasing the biggest returns. It’s about growing your money consistently over time while avoiding the damaging effects of volatility. By keeping your returns steady, you’ll build wealth more effectively and with much less stress.
How The Newsletter Keeps Volatility Low
In the newsletter we keep the volatility of your returns low by:
- Not buying when markets are falling
- Following a strict stop loss strategy
- Keeping individual investments small. Only 2% of your portfolio in each idea.
Reading Recommendations
Why Nothing Can Stop the US Fiscal Train
Lyn Alden wrote a great September 2024 newsletter called Why Nothing Stops This Fiscal Train. It explains why the U.S. will keep having high deficits and how that affects your investments.
Introduction:
The U.S. will have rising deficits due to problems with Social Security, healthcare, and growing debt.
Key Points:
- U.S. deficits will grow because Social Security and healthcare are not fixed.
- Government spending now affects inflation more than the central bank activities.
- Large debt and spending make it harder for the central bank to control inflation.
- Deficits will support asset prices but weaken the dollar, making gold a good option.
- Be cautious with bonds; focus on stocks, T-bills, and gold instead.
Summary:
With inflation rising due to government spending, it’s smart to focus on assets that protect you from a weaker dollar, like stocks, T-bills, and gold. Long-term bonds are risky in this environment.
Think about moving more of your money into assets that handle inflation well. Look for companies that can raise prices. Avoid long-term bonds and consider short-term T-bills or inflation-protected securities to protect your cash.
The Great Rotation Away from the USA
Brian Chingono from Verdad Capital has written a great article titled The Great Rotation, which discusses why a shift away from U.S.-dominated portfolios could benefit your returns. If you're relying too much on U.S. stocks, it's time to rethink your strategy, especially given today's market valuations.
Main points:
- U.S. stocks make up 70% of developed market indices, driven by high earnings from tech giants.
- Valuations in the U.S. are high, with a CAPE ratio of 36x, compared to lower valuations in Europe and Japan.
- Concentration in a few U.S. tech stocks add risk to U.S.-heavy portfolios.
- Expected returns in Europe (6.7%) and Japan (6.8%) outpace the U.S. (5.2%) over the next decade.
- Investors can benefit by rebalancing portfolios towards international markets.
Summary:
After a 15-year bull run, U.S. stocks now dominate global indices. However, with the U.S. CAPE ratio at 36x, returns are expected to be lower in the future, especially as international markets offer more attractive valuations.
Diversifying away from the hyper-concentration of U.S. tech stocks can boost returns and reduce risk. A balanced portfolio with 55% U.S. and 45% international stocks is a practical way to capture these opportunities.
Practical advice: If your portfolio is heavily weighted in U.S. stocks, consider adding exposure to Europe and Japan. Both markets offer cheaper valuations and better potential returns. Instead of relying on past winners, diversify to balance risk and growth potential.
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