Introducing our growth stock portfolio

This new model portfolio is designed to deliver at least 10% p.a. compound over the next three to five years.

PORTFOLIO POINT: This new growth stock portfolio aims to deliver returns of at least 10% p.a. compound over the next three to five years.

Today I am introducing my growth stock portfolio especially for Eureka Report readers, which has been designed using my value-based investing methodology. I have also compiled a model income stock portfolio, which I will present next week. This column will provide an update every Friday, alternating between growth and income portfolios, and will explain any changes to their composition.

"It is not the strongest of the species, nor the most intelligent that survives. It is the one that is most adaptable to change." - Charles. R. Darwin (1887)

Why value-based investing is sensible and indexing is not

There is much in the above observation by Charles Darwin that describes the success, or lack of it, of listed Australian companies. It gives us an insight into the flaws in the investment process undertaken by major institutions and fund managers. It puts into context the current debate as to the asset allocation of many superannuation funds; in particular, the notion that a superannuation investor, aged above 60, should have a different asset allocation to one aged under 60 (a notion that ignores risk or value).

Given that human beings are both highly intelligent and clearly adaptable, why are so many companies incapable of responding to or preparing for the immense changes confronting economies and markets? This observation is true of both investees and investors.

It is not necessarily the fault of size. However, the diseconomies of scale in managing capital are evident when a large investment fund is not managed with intelligence and is not adaptable to change.

The largest public company investor in the world is the most successful. For decades, Berkshire Hathaway has undertaken an investment process and strategy that is oblivious to indexing and market fads, and ignores traditional dogmatic asset allocation, through value-based investing.

It is the combination of this technique with the capacity to be patient that has delivered exceptional long-term returns for Berkshire shareholders. It is the identification of companies (investment opportunities) that will deliver a growing stream of earnings that is the key to compounding investment capital over time.

This philosophy has defined Clime’s approach to investing. Developed on the concept of core value investing principles and using MyClime, our stock valuation and research platform, I have identified a portfolio of 12 listed companies from the largest 300 stocks by market capitalisation. This is aimed at delivering growth and maintaining capital in volatile market situations.

The Clime Model Growth Portfolio aims to deliver returns of at least 10% p.a. compound over the next three to five years.

The portfolio is not weighted; that is, each holding is assumed to have an equal weighting in the portfolio. I aim to hold each stock in the portfolio for as long as possible. Portfolio switches will be limited, but will occur if a holding substantially exceeds my assessment of value or another quality stock becomes available at a significant discount.

Readers should note that the portfolio does not attempt to time the market in its initial construction.

-Clime Model Growth Portfolio (prices as at April 19)
Company
Code
Purchase Price
Market Price
June 2012 Value
Margin of Safety
Grossed Up Yield
BHP Billiton
BHP
$35.50
$35.50
$54.31
52.99%
4.14%
Commonwealth Bank of Australia
CBA
$50.78
$50.78
$58.97
16.13%
8.89%
Westpac Banking Corporation
WBC
$22.02
$22.02
$27.57
25.20%
9.67%
Blackmores
BKL
$27.55
$27.55
$28.85
4.72%
6.43%
Woolworths
WOW
$25.85
$25.85
$31.53
21.97%
6.69%
Iress Market Technology
IRE
$6.75
$6.75
$7.28
7.85%
7.69%
The Reject Shop
TRS
$12.04
$12.04
$14.51
20.51%
3.68%
Brickworks
BKW
$10.45
$10.45
$12.33
17.99%
5.60%
McMillan Shakespeare
MMS
$11.01
$11.01
$11.42
3.72%
4.80%
Mineral Resources
MIN
$11.77
$11.77
$14.00
18.95%
4.98%
Rio Tinto
RIO
$66.60
$66.60
$84.61
27.04%
2.55%
OrotonGroup
ORL
$8.64
$8.64
$9.48
9.72%
8.27%
 
Purchase date close of business April 19 2012

Companies identified at this point are:

1. Regarded as higher-quality companies in terms of their return on equity and financial attributes; and

2. Presented in the current market at a discount to the MyClime assessment of their intrinsic value in one year’s time.

The fundamentals I looked for to identify the above companies are as follows:

1. Consistent and sustainable profitability, measured by Normalised Return on Equity (NROE). A sustainable NROE in excess of 20% usually gets my attention.

2. Cash flow from operations approximating NPAT over time. This ensures that the reported profit is free from accounting trickery. Further, I am attracted to businesses that self-fund, which means the cash from operations covers current operations, growth plans and dividend payments. This indicates the business is financed by its customers, not its shareholders or bankers.

3. Little or no acquired goodwill and debt on the balance sheet.

4. Franked dividends. As an owner, I like to receive a portion of my earnings in the form of franked dividends.

5. Good management. I only purchase companies where I trust the stewards of my capital, the CEOs, to sensibly allocate my capital. I look for businesses that think like owners.

6. Financial Strength. Using the Clime Quality Rating (CQR), I can stress-test the profit and loss account, the balance sheet and the cash flow statements.

7. Businesses with a competitive advantage. I look for businesses in which I see a compelling reason as to why their customers use or want their product or service. I like companies that will grow with the economy and with population growth.

8. Margin of safety. As every business is unique, I demand a different margin of safety for each given business based on its competitive strength. For robust businesses that have the ability to generate strong returns through cycles, I demand less; for cyclical businesses with less competitive strength, I demand more.

Next week, I will identify an income model portfolio and will then revisit both portfolios in alternating weeks.

Clime Asset Management and MyClime are part of Clime Investment Management, an independent Australian fund manager specialising in value investing. Using MyClime, the Clime Australian Value Fund delivered 89.91%* to its clients to March 31 2012. Register here for a free two-week membership to MyClime.

(* Past performance is no guarantee of future returns)

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