Summary: We are introducing four new model portfolios covering growth stocks, income stocks, listed investment companies and international stocks. The portfolio weightings reflect our level of conviction on the stocks, relative to risk. We are focused on stock picking, rather than market timing.
Key take-out: The models are an extension of the share recommendations we already provide. We aim to ensure our best performers outweigh the rest.
Key beneficiaries: General investors. Category: Shares.
The launch of our model portfolios is a natural extension of Eureka Report's expansion into the area of direct stock picking by our team of in-house analysts. We have been running our direct stock recommendations for two years today! We started on July 1, 2013, so we have had plenty of time to finesse our methodology to make sure you make money.
We are kicking off the model portfolios – which you can see at any time by looking at our model portfolios tab at the top of the page at www.eurekareport.com.au – with two working models and a plan to launch two more in the very near future.
Our first two models with be a growth model portfolio of local small to medium cap stocks run by Simon Dumaresq and an international stocks portfolio to be run by Clay Carter. In the weeks ahead we will launch an income stock portfolio and a listed investment company portfolio to be run by Mitchell Sneddon who has joined us from Clime Ltd.
Here's a guide to each of the model portfolios.
- managing editor James Kirby
Eureka Growth First model portfolio
Our “growth first” model portfolio is a high conviction portfolio where we aim to achieve long term outperformance against the ASX200 index.
Updates to the model will be presented weekly and include the stock weightings, performance and any changes.
We are targeting 10-20 stocks in the portfolio – beginning with 10 stocks – and we will alter weightings according to our level of conviction with the stock relative to risk.
The portfolio will be mostly small to mid-cap stocks and as such has the potential to be more volatile than an index tracking model. As our companies have to meet thorough selection criteria, the reward for taking on this higher volatility should be stronger medium-term growth.
It is important to note that just because a stock is more volatile does not necessary mean there is more company risk. Having said this, the model will be very focused on mitigating unnecessary risk.
Although the model will not be tracking index sector weightings we will make sure we don’t have too much exposure to any one sector (maximum 25 per cent).
The model will focus on stock picking rather than market timing. As such we will always have at least 50 percent of the portfolio invested in the market. The level of cash will come down to the opportunities we can find at the right price.
Initially we are 60 per cent invested with 40 per cent cash, but we will be looking to increase the proportion invested as further opportunities arise.
Stock selection criteria
The model’s main criteria for selecting quality companies, includes those with robust financials that have a competitive advantage in a positive industry structure, with capable management and trading at a discount to valuation.
We ideally look for an industry that is growing, and find companies that have a competitive advantage within that industry.
Given the level of disruption from new technology, we are not just looking at the industry structure today, but also considering future threats and opportunities.
In terms of the financials, we are looking for companies that are not overly geared and can generate the required level of cash flow to meet the re-investment requirements.
In forecasting growth we need to have a high level of confidence around the major revenue and cost drivers, and to what extent they are within management’s control.
We then need to consider what we would pay for this growth. We don’t have one valuation technique that we use for all situations. Instead we use the most appropriate method for that particular company/sector.
For example a discounted cash flow valuation is not suitable for a high growth company that only has visibility of earnings for the next two to three years.
We don’t prioritise dividends, but if a company can meet its re-investment requirements and still have the ability to pay out a dividend then that is a bonus.
In assessing management, their track record is critical. That is, did management do what they said they would do? We are always communicating with management and making an assessment on their strategy and ability to execute it.
Benefits of a growth portfolio
The model is an extension of the ASX share recommendations we have provided at Eureka Report over the past 18 months.
Some of the better performers in this time have included AMA Group (AMA), Capitol Health (CAJ), Vita Group (VTG), Empired (EPD) and Netcomm (NTC).
But we haven’t got them all right, and our objective is to ensure our best performers far outweigh the detractors, and take a medium- to long-term view with this process.
A challenge with the share recommendations we have provided can be the communication process. For example does a hold recommendation mean you should really hold? Or does it mean the stock is no longer one of the best opportunities that should be in your portfolio?
With the “growth first” portfolio we are looking to remove that uncertainty by making the appropriate changes to the portfolio and tracking the performance.
Portfolio characteristics: Small to mid-cap ASX stocks, solid balance sheets, growth profile, and a discount to valuation.
Position sizes: Risk weighted to stock conviction
Equity/cash allocation: At least 50 per cent invested at all times
Diversification: Not index weighted, but maximum of 25 per cent of portfolio exposed to any one sector.
Overall risk: Medium-high
Eureka Growth First model portfolio
Eureka Income First model portfolio
Our view is that good companies are neither all growth nor all income, but most are primarily one or the other. “Income first” stocks need to be looked at slightly differently to “growth first” stocks which you can find in our growth portfolio.
Before the current period of ultra-low interest rates began, picking the stocks for an income portfolio was a relatively simple process: Find the highest yielding stocks that also have the most defensive earnings profile.
The challenge with this approach now is that the extreme demand for “yield stocks” has meant that many of the former so-called “defensive yield” stocks are over-priced.
Further, management teams know that the easiest way to support their share price is increase their dividend payout ratio. If they have done this instead of re-investing in the business then it is likely to lead to one of two outcomes. Either the payout ratio (the percentage of profits paid out as dividends) will prove to be unsustainable or earnings growth in future years will take a hit.
Our “income first” model is going to find high yielding stocks that are also not over-valued and have a sustainable dividend. Earnings growth which usually translates to capital growth will also be a handy bonus.
The way to assess the sustainability of the yield is to firstly understand the company operations at a high enough level to make assessments on its forecast growth, cash flow and capital requirements.
We can then decide what a sustainable payout ratio is, and what chances there are for future dividend growth.
A final important consideration is franking, where we look for fully franked dividends. A further consideration that can be missed is a company’s franking balance. When a company records profits without paying out dividends it builds up the franking balance.
Given the potential regulatory changes to franking, many companies with high franking balances are implementing measures to return this value to shareholders.
We are not prepared to make a forecast as to when bond yields will increase, but we are mindful that they are near record lows. It would only take a small normalisation of bond yields to have a large impact on the market as the hunt for yield is certainly a crowded trade. It is our view that there are steps that can be taken to protect yourself from this and still achieve a decent income.
We will track the performance of both the capital return and yield with the objective of delivering a reasonable premium to the available cash rate, and protecting capital.
To help you in the hunt for yield, we will provide education and further expand on strategies to identify income stocks. You will see our approach to finding businesses that pay high, sustainable yields, along with our “pick” of companies that meet this objective.
Eureka Listed Investment Companies model portfolio
Every week I will be providing you with my insights into the expanding universe of listed investment companies and week by week I will build a model portfolio with a handful of LICs that tick the right boxes and stand out as the best of breed.
Historically, unless you are a client of the bigger broking houses (and even then the information is a little stale and inaccurate) it has been difficult to obtain up to date LIC research. One reason for the lack of coverage could be due to the little brokerage they offer the broker. LICs are passive investments not for churning.
I personally favour LICs for my own investing and I believe many Eureka readers do too. Working full time I don’t have the time to be spending the hours necessary to pick stocks in a concentrated portfolio. Also the more I learn and talk to analysts the more I realise what I don’t know. These people are paid to dissect stocks. They live and breathe the market. For me to think I could outperform them over the long run by squeezing in research when I have time is downright foolish. Yes, from time to time I will outperform but over the long run I know who will come out on top.
With LICs I still have control. I don’t have to argue with anyone or provide “feedback” to get my hard earned cash back in my pocket. Finally I can still take advantage of market sentiment. The good thing about LICs is they tell you what they are worth but for some reason you can still buy $1 for $0.90 and vice versa by taking advantage of the premiums and discounts to NTA. Discounts and premiums are not always black and white though, some will always trade at a premium and some will rarely bridge the share price to NTA gap and we need to be aware of this.
The aim of my LIC portfolio will be to outperform the market with a relatively passive investment approach. I won’t be looking to trade these positions as that would defeat the purpose of a long-term investment vehicle but if a position has been bid up and is excessively priced compared to its historical average share price to NTA it will be lightened and eventually exited.
Here are the characteristics of LICs that will make the grade:
1. Steady consistent returns against their set benchmark. I want to avoid LICs that have returns propped up by one good year out of five.
2. Experience in the management team. I want to see LICs that have a depth of experience in their team to avoid 'key person risk'.
3. We will be looking to see through current trends and purchase LICs that are trading at a discount to their NTA due to negative sentiment. If a LIC has a proven history of outperformance and historically has traded on NTA or above more often than not but is being sold down due to short term performance we will see this as an opportunity.
4. Finally I personally tend to favour managers who can hold cash. If the management team behind the LIC does not see opportunity or sees dark clouds on the horizon I want them to have the ability to raise cash to suitable levels instead of having their hands tied by a mandate that says they must be fully invested.
Combining the above selection criteria my strategy will be to have a variety of investment styles and asset classes (including international exposure) within the portfolio to suit the current market conditions.
The benefit of the LIC model portfolio is that you will be able to take from it what you will. You could follow it to the letter and run a 100 per cent LIC portfolio or you could use it as a cornerstone to your current portfolio and still pick individual stocks around it that other members of the Eureka team write about.
Eureka International model portfolio
For the last decade and a half, I have been a high conviction portfolio manager, holding between 25 and 40 companies in a global portfolio. According to a Mercer survey of global investment managers who manage funds for Australian investors, I was ranked sixth out of 100 managers over the five-year period to October 31, 2013, generating some 4.7 per cent p.a. over the index.
Attribution analysis points to stock selection as the dominant factor in my outperformance. In other words, I held larger positions of the right stocks. Holding far fewer stocks if you are a dedicated stock picker has always made sense to me.
Holding and keeping track of even 25 stocks would be impractical for most Eureka Report subscribers, so I am proposing a high-conviction, actively managed 10 stock portfolio constructed from some of the companies I have been recommending to subscribers since last July.
This portfolio is constructed with a view that these 10 stocks are to be bought now. Don’t try and be a market “timer”. The innumerable factors that influence the markets on a daily basis are beyond even the understanding of algorithm-fed super computers. Anyone who thinks they can predict short-term market movements is a deluded fool. The factors that influence individual companies, such as news flow, sentiment, earnings etc are more easily understood and readily available to individual investors, so let’s use them.
I intend to actively manage and monitor this portfolio on a daily basis. The investment ideas that are presented weekly in Eureka Report will not necessarily be placed in either portfolio but will instead form part of an investable ideas universe. From time to time, I will recommend selling certain portfolio stocks and buying others.
If pressed, most portfolio managers would admit that the easiest decision to make is the “buy” decision and the hardest is the “sell” decision. My rule of thumb is to sell if I sense a company’s fundamentals are deteriorating and the projections of earnings and profitability are unlikely to be met over the medium term. With concentrated portfolios you also need to add fresh ideas from time to time so a stock might be sold if it has appreciated far beyond expectations or seems to lack any meaningful catalyst over the short to medium term. This discipline forces a portfolio manager to only hold what he or she considers are the “best of the best”.
Eureka International model portfolio
Portfolio Characteristics: Larger market capitalisations, solid balance sheets, growth rates well in excess of market, reasonable valuations. The large companies dominate their space: smaller companies have a distinct disruptive edge.
Position sizes: Risk weighted as to stock volatility
Fully invested at all times.
Diversification: Good for a concentrated portfolio, with a nice spread of industries from technology, automotive, energy, media, and pharmaceuticals. 30 per cent of the portfolio is non-US.
Overall risk: Medium