By Larry H. of intelligentinvestors.org
In my post last month I discussed a passive investing strategy that (if used with discipline) could result in phenomenal gains. Sticking with that theme I developed a strategy I call “Brand Index Investing.” This is a passive investing strategy that utilizes Interbrand’s “Best Global Brands” ranking system, finds the lowest priced stocks, and then trades based on that information. It is my belief that this strategy will beat the S&P 500 over the long-term.
Interbrand uses a proprietary ranking system based on a concept similar to EVA, they call it “economic profit,” multiplies that by the role of brand, and then each brand is discounted according to its brand strength. This whole methodology is discussed more thoroughly in their report so I will not dwell on it (http://www.brandwizard.com/Best_Global_Brands_2010_US.pdf). After putting these together Interbrand then arrives at brand value. In their top 4 sits Coca-Cola (on top), IBM, Microsoft, and Google. Sitting at #100 is Burberry. Their report also provides a short summary on each brand for those interested in learning more about each company.
My strategy uses this information, examines the top 50, sorts in terms of price-to-sales, then buys the top ten lowest p/s stocks while eliminating those that do not trade on US markets or trade as pink sheets. Every 3 years these stocks will then be sold and this strategy will be repeated. Taking this year’s list as of today’s date the top 10 (in order of lowest P/S to highest) are: Sony (p/s= 0.37), Ford, Toyota, Dell, Honda, Nokia, Hewlett-Packard, Phillips, Siemens, and General Electric (p/s= 1.16). This is a healthy lineup of companies and there are only a few of these that give me pause if I were actively investing and picking stocks on an individual basis.
There are a few reasons why I think this strategy will work. The price-to-sales strategy has already been proven by the likes of people such as Ken Fisher and James O’Shaughnessy (and there is well-documented proof of its usefulness over the long-haul). Next is what Warren Buffett calls “having a moat” (he often uses Coca-Cola as an example actually). Brands serve as moats which keeps competitors at bay. (See more about brand investing: http://www.washingtonpost.com/wp-dyn/content/article/2008/05/31/AR2008053100292.html). They also allow companies to charge higher prices and therefore obtain higher margins. Higher margins are moats in and of themselves against inflationary pressures. A company with a higher margin won’t feel the effect the same way as a lower margin company when inflation finds its way into the market. Although not all of the companies above are high-margin companies, their brands allow them to charge higher prices to keep their margins more consistent. Lastly, an objective strategy eliminates investor-bias and often times an investor is his own worst enemy.
The three-year time horizon was chosen mostly arbitrarily based on my experience. A company with a moat has staying power and will not be irrelevant in future years. It may lose brand reputation or may in some way tarnish its image but it will not be wiped off the competitive landscape quickly. Three years also gives the market some time to realize the value of the stock. O’Shaughnessy used one year as his time horizon but he also used relative strength and price momentum to determine which stocks were “being noticed.” However, while trying to curb volatility his gains were lessened as more valuable stocks were thrown to the side for shorter term price appreciation. I prefer to stay with the cheapest of the cheap and give Mr. Market some time to realize his mistakes in order to get more bang for my buck. Additionally, Phil Fisher always advocated holding a stock for at least three years and through my experience I have found this to be sound advice.
I plan on tracking this strategy to see how it performs over a longer period of time as I think it will prove to be a valuable strategy. Later on I will post my results. If something should change, such as Interbrand closing up shop or something along those lines, I will have to modify the strategy. I think this strategy could even be modified to use dividend yield or any other value metric to determine which holdings go into this portfolio. Also, using this strategy just to pick out low-priced stocks with a moat and then actively screening companies based on your own skills could prove to be useful as well. Be creative. Something that may seem minor may prove to be dramatic. Just by adding relative strength to his strategy O’Shaughnessy was able to dramatically change his results.
Those who plan on using this strategy I advise to be careful as it has not been tested. Anyone who has access to back-testing programs and who is willing to look over Interbrand’s old reports to back-test this strategy please contact me at: firstname.lastname@example.org.
You can track this strategy here.