In early January, I talked about working on an approach to investing that had incredible long-term performance. This approach beat the market over the 15,10, 5, 3 and one-year time periods, and really only ran into any serious problems in the 2007 to 2009 time period. Even in the bear market of 2000 to 2003, it remained positive. The model is fully invested most of the time and the returns have been so consistent that I am currently looking to see how leverage might be used to enhance returns over an average market cycle. I know that leverage goes against the value-investing honor code, but if Al Frank can do it, so can I.
The model is not all that sophisticated. I simply screened each year for stocks with an enterprise-value-to-EBIT ratio (EV/EBIT) of less than 6% that were profitable and paid a dividend. I had an upside yield of 7% to avoid dividend traps and used $100 million as a market-cap floor. I took this list and only bought those with Piotroski F-scores of 5 or higher. I then bought the 50 stocks with the highest yield and held for a year.
We started tracking the portfolio on Jan. 7 -- and it went into free fall almost immediately. Before it stopped falling, we had a drawdown of about 13.5% by early February of this year. It was hardly the grand beginning I was hoping for with this portfolio, to say the least. Since then, however, the portfolio has come roaring back -- gaining about 18% off the lows -- and is now once again beating the overall market. The portfolio recovery has been broad based, with only one stock, American Railcar Industries (ARII), still showing a double-digit loss over the past month. Of the 50 stocks, 46 are higher since the portfolio bottomed, and the total return is 2.19% for the year -- well above the S&P 500's return of 0.25% and the Russell 2000's negative 2.67% return so far in 2016. That is an annualized return of 11.43%, which looks pretty good in the current low-return environment.
I ran the screen again this weekend, when I wasn't fielding calls from friends sobbing over their broken brackets. If it was possible to be long cheap whiskey and antidepressants in East Lansing, Michigan and Lexington, Kentucky, I suspect you could make a fortune over the next few days.
On the screen, I noted that a lot of the January portfolio remained intact -- with no significant changes in valuation, yield or F-scores. There were some changes worth discussing, however. A new portfolio of this growth-and-income approach would be a buyer of several community banks stocks, right now. As bank stocks have pulled back, and the small-bank baby has gone out the window with dirty brown bathwater of too-big-to fail-banks, many have traded back down to bargain levels based on EV/EBIT. I have little doubt that their inclusion will help enhance returns over the next year for anyone starting this approach today.
I also noticed the shares of B. Riley Financial (RILY) would be included in the portfolio. I like everything about this firm, and I am a big fan of their research. They do an excellent job of covering smaller-cap companies and deep-value and contrarian opportunities. They also have a solid reputation as an investment bank, with coverage of a wide range of industries. The stock trades with an EV/EBIT ratio of just 4.98% and yields 2.46% at the current price. B. Riley shares have an F-score of 7, so the firm is in solid financial condition and prospects are improving.
I have noted in previous articles that I like the staffing business, right now, as many of these companies are priced as if no one will ever need employees or look for a job again. Heidrick & Struggles International (HSII) is in the executive search and leadership consulting business, with offices all over the world. Business is actually pretty good for this company, and they have shown strong growth in revenue and earnings over the past year. In spite of that, the shares are off by more than 12% over the past year and trade with an EV/EBIT ratio of just 4.97%. At the current price the shares yield 2.2% and the F-score is 7.
The enterprise-value growth and income portfolio got off to a rocky start this year, but has recovered nicely. I will continue to update the original portfolio's performance as the year goes on -- and point out any new names that pop up in the screens.