Monday, August 1, 2011

Investment Guidelines - Version 1

Objective

The first objective is to invest in companies that will generate a higher dividend yield than the current ten-year Treasury yield, with a second objective for capital appreciation so the annual return for the portfolio outperforms the total return of the S&P 500.

Investments will be primarily made in U.S.-based companies that are considered either large-cap or mid-cap.

Strategy

The primary strategy is to acquire shares of companies that are considered undervalued using a discounted cash flow (DCF) model.  Companies must pay a sustainable dividend and the company must demonstrate a history of increasing dividends.  Fundamental analysis for the company will be performed and the firm must demonstrate a durable competitive advantage.

Initial positions will be established by:

1.       Company must demonstrate a durable competitive advantage.
2.       If a company demonstrates a durable competitive advantage, shares must currently be trading below the intrinsic value with a risk-adjusted margin of safety. 

Ideally, positions will be held indefinitely to avoid transaction costs (i.e. taxes).  Once shares of the company reach their intrinsic value, analysis will be performed to see if any fundamental factor has changed to force a sale of the position and to see if the intrinsic value of the company is higher than originally calculated.  If the fundamentals remain intact, the position will continually be held.  If the fundamentals do not remain intact, the position will be sold.

Allocation

The portfolio will be primarily held in equities and cash.  Portfolio can be invested in up to 90% equities at any given time.  Cash may not exceed 90% at any given time.

Positions will not be allowed to exceed 10% of the total portfolio value at the time of purchase.

Company selection

Fundamental analysis will be completed before any position is added to the portfolio.  This includes:

1.       Analysis to determine does the company demonstrate a durable competitive advantage as indicated by the income statement, balance sheet, and cash flow statement
2.       The purchase price must be less than the current trading price and include a risk-adjusted margin of safety.  The risk adjusted margin of safety will be calculated as follows:

Margin of safety                   30%
x business risk                      1.00   (constraints 0.8<x<1.2)
x financial risk                      1.00   (constraints 0.8<x<1.2)
Risk-adjusted margin of safety

3. Any investment must have a yield higher than the current yield of the ten-year Treasury

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