BI > JULY 2004

We'd Rather Switch Than Fight

Lessons in Continuous Equity Analysis

This is one of my favorite times of year. Sure, the joys of spring and early summer have a lot to do with it, but the real reason is the growth that I get to personally witness while reviewing club portfolios and visiting our chapters and investment clubs. It's also a time to think about bolstering the health of our portfolio gardens by carefully considering decisions that can continuously improve the overall portfolio quality and expected returns.

Is it possible -- when taken in the context of portfolio design -- that it can be prudent to sell a high-quality company? Does it make sense to seek replacements of equal or higher quality with higher expected returns?

The Continuous Search For Excellence

All of us make mistakes. Conditions do change. One of my colleagues often points out how few of the companies from In Search of Excellence, the 1980s work by Tom Peters, still have high investment grades. I've seen too many examples in which NAIC-based portfolio caretaking has delivered powerful results. The most recent example came during a visit with an investment club in Auburn Hills, Mich. It's the tale of what happened to a certain $800.

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The club invested $800 in Home Depot during January 1996. During the next five years this $800 investment increased in value to $4,400. At a club meeting in late 2000, the club weighed the prospects for Home Depot and decided to sell the shares and invest the proceeds in Lowe's. Legend has it that one of the members became so emotional over the decision that he stopped attending meetings. The value of the new Lowe's investment continued to grow to $10,990 by April 2004 -- meaning that the original $800 had grown at a compound annual rate of 37.6 percent since 1996.

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Continuous Analysis -- Continuously Better

There are days when I lament the title of our powerful tool, the NAIC Stock Selection Guide. Although it's clearly a great shopping guide, it's really so much more than that. We hear too many stories of investors and clubs thinking you do an "original" SSG at the time of purchase and file it away like some sort of time capsule.

Our SSG is a powerful tool and is best used in a process of continuous analysis. The two images on this page illustrate the SSG results (quality or investment grade and expected return) over a five-year period ending in early 2001. I think of this as a continuous summary of quarterly SSG results for the two companies. Note the higher expected returns for Lowe's during late 2000. The club made the switch during October 2000.

Times were good for Home Depot shareholders during the late 1990s and the club was rewarded. The $800 investment grew to become $4,400 in late 2000. What would have happened to the $4,400 if the partners had resisted the switch? The Home Depot stake would now be worth $2,896. Rumor has it that the prodigal member is considering a return to the club.

Mark Robertson is director of online resources and senior contributing editor for BetterInvesting. He serves as a member of BetterInvesting Magazine's Editorial Advisory & Securities Review Committee. Mark can be reached at Robertson_Mark@comcast.net.