Now that the first half of the year is behind us, I have one more model to rebalance. The Enterprise Value Growth and Income model has been one of the steadiest performers among the models I track, with only five down years over the past 15 years. The model rebalances every six months, and back-to-back negative performance over the six-month period only has happened three times in 15 years. We just experienced the third time as the model had negative returns the past two periods and is down about 10% over the past year.
For the first six months of the year, the EV Growth and Income model has declined about 4.17%. Energy, consumer discretionary and insurance stocks have been the biggest culprits behind the decline so far in 2016. The gainers in the first six months were for-profit education stocks such as Graham Holdings (GHM) and Capella Education (CPLA), along with small banks.
The model looks for U.S. companies in excess of $100 million in market capitalization that are profitable, pay a dividend between 1% and 7% and have Piotroksi F-scores over five. Purchases are limited to those with the 50 lowest enterprise value to EBIT ratios. In no case will the model pay over an EV/EBIT ratio over six. The result gives us a manageable portfolio of cheap dividend-paying stocks with a margin of safety in the financial statements.
While the model has been lagging of late, over the long run it has been a very smooth performer that consistently beats the market. Brief periods of underperformance in the past have been followed by long runs of outperformance, so hopefully that the case this time as well.
The first thing I noticed about the rebalance is that there are not 50 qualifying stocks. The model found just 43 names, so it will hold about 14% cash for the six-month period. That is an unusual condition and gives us a hint of how overpriced the broader market actually is right now.
Community banks once again are the dominant industry group, with 20% of the portfolio in smaller banks. I like that as it is my favorite sector, and while not immune to turmoil smaller banks should suffer little if any fallout from geopolitical developments such as the current Brexit mess. Community banks have made up the bulk of my portfolio for a few years now and I am pleased to see that they remain a big part of the Enterprise Value Growth and Income portfolio.
Railroad-related companies are well-represented in the portfolio. American Railcars (ARII), Greenbrier (GBX), FreightCar America (RAIL) and Trinity Industries (TRN) all make it into the portfolio. Airlines also make a strong showing, with Alaska Air (ALK), American Airlines (AAL) and Delta Air Lines (DAL) finding their way into the portfolio.
This is more of a large-cap portfolio than my models unusually produce, with an average market cap of $8.4 billion. The five largest stocks in the current portfolio are Anthem (ANTM), Prudential (PRU), Baxter International (BAX), Delta and Valero (VLO) . The five smallest are Franklin Financial (FRAF), Auburn National (AUNB), Timberland Bancshares (TSBK), Riverview Bancorp (RVSB) and Midsouth Bancorp (MSL).
It is an interesting mix of industries and market caps. The portfolio is very cheap based on the EV/EBIT ratio, with an average ratio of just 4.36. For comparative purposes, the S&P 500 average right now is over 15. The average yield of the stocks in the portfolio is 2.77% compared to the index's 2.07% right now. The fundamentals and prospects of our portfolio companies are pretty good, with an average F-score of 6.
Using a quantitative approach to manage your portfolio can help take all the whats, ifs and maybes out of the investment process. This is especially useful in times such as these when you are hit with differing opinions on macro subjects and risks. It takes some discipline as no one approach outperforms all the time and there will be times of underperformance, but I have continued high expectations for an investment model that is based on low valuations and financial strength.