Recommendations Report 2017

Dear member,

When our editor-in-chief John Addis founded Intelligent Investor back in 1998, it had the same ambitions and purpose as it has today.

In 2001, a new research team set us on the value investing path and current Senior Analyst James Greenhalgh joined the following year. Current Research Director James Carlisle arrived in 2003 and Deputy Head of Research Gaurav Sodhi in 2009. Senior analysts Alex Hughes, Graham Witcomb and Jon Mills all joined the team more recently.

All have first-rate analytical skills but there's one crucial test that every new analyst has to pass. They have to really get value investing – not in the superficial way but in a ‘read a ton of books and fly to Omaha for the Berkshire Hathaway AGM kind of way'.

Not that we classify ourselves as Buffett-style purists. Our reading also includes Charlie Munger, Ben Graham, David Dodd, Phil Fisher, Seth Klarman, Howard Marks and a host of others. The practice of value investing is less about the teachings of any one individual and more about the difference between price and value – specifically, how to get more of the latter in return for the former. There are different ways of going about this – but many more ways of not going about it.

Much of what you'll hear from the mainstream media and financial community about betas, capital asset pricing models, moving averages and retracements are dangerous distractions. Successful value investing means disregarding the white noise of daily market commentary and sticking to basic principles. We've been doing it for a long time and we're living proof it works.

Our latest numbers show an average annual return of 14.1% for our buy recommendations over the past 16 years.

Our latest numbers, which have been independently verified by Ernst & Young (in 2017 we switched auditors from Grant Thornton, who verified the numbers annually over the previous nine years), show an average annual return of 14.1% for our buy recommendations over the past 16 years. That compares with 9.1% for the ASX 200 Total Return Index (adjusted for franking) – meaning that Intelligent Investor's return was 5.0 percentage points higher.

That outperformance has huge implications. A $100,000 investment in the ASX 200 on 1 June 2001 would have produced $407,000 by 30 June 2017 (including dividends). Had members followed all our recommendations at the time we made them over the same period, that sum would be $836,000 – a difference of $429,000.

Now here's the caveat: replicating the recommendations in this and previous reports is impossible. Members simply cannot follow every buy and sell recommendation and the comparison assumes you don't have to sell any stocks to buy the ones we recommend.

So while this report is a transparent, independently verified tool for evaluating every recommendation we've ever made, as a proxy for our overall stock-picking skills it falls a little short.

Our portfolios are a more reliable and accurate real-life comparison and also show a respectable outperformance.

Table 2, which shows the performance of our Equity Income and Equity Growth portfolios, which commenced in 2001 and became investable via separately managed accounts on 1 Jul 15, is a more realistic guide. Our portfolios operate under the same constraints as your own investments and are a more reliable and accurate real-life comparison. Happily, they also show a respectable outperformance.

The internal rate of return methodology used in this report is unchanged from last year. The report covers a financial rather than calendar year-end and returns include franking credits, a valuable component of returns. Ourbenchmark, the ASX 200 Total Return Index has been similarly adjusted to make a like-for-like comparison.

Lastly, Strong Buy, Long Term Buy and Buy recommendations are rolled into one ‘Buy' category, which while slightly reducing our historic performance and the number of recommendations reported, makes the report easier to digest.

I hope you find this year's Recommendations Report interesting. Please let us know any thoughts you might have via the Q&A service on our website or by calling on 1800 620 414.

Yours sincerely,

James Carlisle
Research Director
Intelligent Investor Share Advisor

Background

Reporting performance is a vexed issue. We all know that past performance alone is not a reliable indicator of future returns but, over the long term, what else can one use?

That's one part of the equation. The other concerns transparency. We want to clearly communicate why we make the decisions we do and present our record for all to see. Through the 500-plus articles we publish each year, the website is a vast and accurate historical record of our activity. With this detailed, independently verified account of all our recommendations, there really is nowhere for us to hide.

Analyse the business

Our approach to analysing stocks is well documented. We review the business model behind each company to assess the stock's underlying value. If the current market price is substantially below our valuation, we'll recommend it. If not, we won't.

Our Buy recommendations, which form the bulk of our reviews and represent the type of stocks in most members' portfolios, have trounced the market, returning 15.2% a year between June 2001 and June 2017. That compares favourably with the ASX 200 Total Return Index's 9.1% return over the same period.

Our performance over the past 16 years speaks for itself. The annual return from our two positive types of recommendations (excluding 16 IPO ‘subscribe' recommendations, which provided an average annual return of 7.7%) was 14.1%. Given the tech wreck, SARS, and the global financial crisis (GFC), that's more than respectable.

That said, it's unrealistic to think any member would act on every single recommendation, which is why our Equity Income and Equity Growth portfolios (returning 12.5% and 9.4% a year respectively since inception) offer a better insight into how a ‘real world' portfolio would have performed.

Methodology

This is our tenth independently verified performance report and it's worth quickly repeating why we changed how returns are calculated in the 2011 report (for a full explanation please see the 2013 Recommendations Report).

The previous method was quite simple. Dividends received during the life of a recommendation were added to the price at which the stock was sold. This figure was then divided by the purchase price to establish the total return, from which the compound annual return was calculated. This was done for each change in positive recommendation. The overall performance figure was the arithmetic average of all those individual returns.

Trouble is, the reported performance using this method could be quite different to the actual outcome you might get from actually following our recommendations. How so?

The previous methodology ignored the time value of dividends. A $1 dividend received in 2002 is clearly worth more than a $1 dividend received today, but the previous method didn't distinguish between the two. The simple average doesn't take into account the duration of investment, which is not an accurate reflection of reality.

So in 2011 we switched to calculating performance using an internal rate of return (IRR) methodology, described in detail in How to calculate portfolio returns. An IRR accounts for the amount of money you have invested and the compounding of gains or losses over time.