Not tracking your portfolio results is like using a fairground mirror to fool yourself into believing you’re thinner than you really are. It makes it easier to distort reality and pretend that everything is hunky-dory. No indisputable facts, no reason to dispel the fairy story.

I prefer reality to make-believe. But tracking your portfolio on a spreadsheet is laborious and every other method seems to be flawed in one way or another.

So I’ve outsourced the whole job to financial data provider, Morningstar.

Its free Portfolio Manager tool does the heavy lifting – tracking the rise and fall of your assets as faithfully as the tides track the moon.

Below you can see what Morningstar’s portfolio tracker looks like – in this case tracking Monevator’s model passive portfolio.

Quite the looker, ain’t it?

This Snapshot shows your holdings arrayed on the left, followed by market prices and overall market value. Your current asset allocation is covered off by % weight.

However the more powerful screens lie on the right of the menu bar…

Performance

This section speaks truth with the directness of a toddler. There’s a lot going on but it’s the annualised return numbers (circled) that I’m really interested in.

These are the numbers that will ultimately determine the fate of my plan. The retirement calculators tell me I need 4% real return per year. I can take the annualised figure given here and subtract inflation, taxes and platform fees to discover my real return.

The good news is that fund fees are already accounted for.

Gain / Loss

This is the place for truth-seekers who want a warts ‘n’ all picture rendered in pounds and pence.

Every holding you’ve ever owned is archived here with the losses memorialised in red. At the bottom (off screen here) you can see exactly how much you’ve made or lost, in raw £s, since year dot.

Fundamental

The Fundamental screen helps you to diversify and to check that nothing loony tunes is happening with valuations.

The style boxes (circled in red) are Morningstar shorthand for the make up of your holdings.

The equity boxes show the average size of your securities and whether they’re tilted towards firms with value or growth characteristics.

The little selection of security squares we have here shows that Monevator’s Slow & Steady passive portfolio is concentrated in large cap equities. The blend designation means that our fund’s holdings tilt neither towards value nor growth.

Ideally we’d diversify into some funds with a small cap value bias but there aren’t any suitable candidates available for our purposes.

The bond style box reveals the credit quality and interest rate sensitivity of our holdings. You can find a fuller explanation in this Morningstar guide.

The P/E Forward column is our canary in the coalmine when it comes to stock market value.

The forward price to earnings (P/E) ratio offered by Morningstar is a guesstimate based on historical projections and analysts’ reports.

It’s a flawed measure but it’s the easiest way for small investors to get some handle on valuations at the fund level:

• Developed world stock market P/E ratios below 15 or so probably indicate that equities are on the cheap side. We can be optimistic about expected returns in these conditions.

• P/E ratios above 20 indicate assets are possibly over-valued and so expected returns have a good chance of being miserable in the future.

P/E ratios have been found to explain only about 40% of future returns, so this is a dicey game to play at best, but you can be more confident about buying when P/E ratios are low.

Time to make tracks

You can track up to five portfolios for free and the portfolio manager can alert you to an equity / bond allocation that needs rebalancing, if you tell it to.

Trustnet have a similar tool which I used for a while but eventually abandoned in favour of Morningstar.

New investors with only a few holdings may get by with the portfolio tracker provided by their broker, but I’d recommend using Morningstar as well:

• It’s a good idea to have an independent record of your holdings.

• Morningstar’s tools are more powerful than most brokers’.

• One day you’ll probably want to diversify among brokers. Morningstar’s portfolio tracker will offer an invaluable unified account of your treasure, whereas retrospectively recreating years of trades will be an insurmountable ache in the sacks.

A portfolio tracker is an invaluable record of your progress, and with the Morningstar version all you need do is keep it abreast of your trades.

The hard part is resisting looking at it all the goddamn time.

Take it steady,

The Accumulator

Good reads from around the Web.

The past few years have seen many British investing blogs come and go. I’ve always tried to send a few readers to the more promising ones, but only a handful ever made it to their one-year anniversary.

One recent arrival that I hope goes the distance is Under The Money Tree.

Written by a mid-30s finance professional who wants to escape the City while he’s still young enough to laugh at those cooped-up there, Under the Money Tree only posts weekly, but like Monevator his posts are longer, and his writing is of a high quality

This week’s article is on how much income your portfolio will produce. It takes this well-worn theme for a new spin with some handy tables that let you easily see how much capital you’ll need to fund your idea of a lavish (or otherwise) retirement.

I also like his idea of working out how much capital you’ll need in order to generate sufficient income to pay for specific expenses, post-retirement:

Of course such a table shouldn’t be taken as gospel. It’s more a motivational tool than something to carve into the brickwork above your PC.

I’m young enough to have paid bills before mobiles and broadband were invented, and I’m sure there will be other currently unimaginable bills that will need to paid when I retire. (The weekly delivery of special material for my domestic 3D printer, perhaps?)

Other bills may go away. Car insurance could plummet in an era of self-driving cars, for instance.

[continue reading…]

The dream of a growth investor is to discover the next Apple or Coca-Cola just as it’s getting started.

One or two such investments can make your fortune. Exactly how to find them is the $6 million question!

In the blue corner, we have the efficient market theorists who say it’s a doomed endeavor, and that you’re better off putting money into an index fund.

Most money managers fail to beat the market. What hope have you got?

In the red corner, we have investing legends like Peter Lynch, Jim Slater, and Philip Fisher, who did beat the market through growth investing and who outlined how in various books.

As always I’d suggest most people should stick to passive investing. Despite what the financial industry tries to tell us, you don’t need to risk picking shares or to invest in expensive managed funds in order to achieve what you need to from investing.

However for those of us who do find stock picking irresistible, growth can be especially enticing – despite the steep odds against success.

Today’s great growth companies are tomorrow’s global giants

There’s little doubt that growth investing is statistically even less likely to beat the market than value investing. Value at least has some evidence of market beating metrics on its side.

Weighing up a growth company is hard – and it’s even harder if the company isn’t yet making much profit.

However that’s not sufficient reason alone to deride a young growth company as “insanely overvalued” or even “worthless”, as commentators are wont to do.

Investing in such a company may well be incredibly risky and it may well look seriously expensive. That might make a share uninvestable for you. And the truth is most growth stocks would be best avoided, as the majority fizzle out long before they deliver on their promise.

Nevertheless all giant companies began life as small ventures, and most of them started without profits.

With hindsight, we can see that far from worthless they were actually bargains for much of their existence, and they could have made us rich – if only we’d been able to tell the very few winners from the many pretenders along the way.

Growth investing is all about the future

The number one thing to grasp about growth investing is that it’s about looking forwards, not backwards.

Whereas a traditional value investor tries to pay a low price for today’s assets and cash flows – and usually demands a discount to be safe – a growth investor aims to pay a fair price for cash flows that he or she expects to come in the future.

Because the future is unknowable, this involves a fair bit of guesswork and heuristics, which is one reason why growth investors sound much woolier than value investors.

To my mind the important aspects of growth investing include:

• Deciding on the story – Most good growth stocks have a narrative that captures the imagination as well as guiding profit expansion. It might be anything from revolutionary computer software to a new take on fast food, but it must underwrite the investing case and evolve as the company grows. Growth investors particularly like first movers who look capable of dominating their space.

• Understanding the business – Value investing in its purest form is just about the numbers. Growth investors must understand the business opportunity if they’re to evaluate its long-term potential, its progress, and how much other investors are paying for an entry ticket.

• Small size, massive opportunity – “Elephants don’t gallop”, said Jim Slater. Microsoft is a fine company – perhaps it will double in size in the next few years – but with a market cap of over $320 billion it’s not going to become ten times bigger anytime soon. But a £25 million company can double in size every year or so, provided its opportunity is big enough to sustain its growth.

• Disruptive company – Often (but not always) an excellent growth company is doing something new, which changes an entire market. Think Google in the early years or McDonalds with its franchise-based approach to restaurants, or Tesla and its premium electric cars.

• Great leadership – New companies are much less stable than mature ones, and that’s especially true in new or fast-changing sectors. Many people could have a stab at running M&S and achieve okay results for shareholders. Very few could do the same at Amazon.

• Stellar sales growth – Surging sales validates the growth opportunity, provides cashflow for reinvestment, and in time enables a good company to overcome its ongoing expenses and capital expenditures to generate a profit. Think 20-50% annual sales growth over more than several years.

• Gross operating margin – A very high gross margin tells you that a company doesn’t have to spend much to create the product its customers consume. What’s high varies by sector – Twitter has very different input costs to Tesla – but as a rule, a high gross margin can give you more confidence that your growth company will at some point achieve escape velocity.

• An emphasis on expectations – Growth investors are much more reliant on analyst’s forecasts than value investors, and will treat profit forecasts 2-3 years into the future as credible. This is inherently risky.

• High return on capital employed – It’s easy to grow by issuing lots of shares to expand, or by taking on more and more debt. Good growth companies make money for shareholders.

On the other hand, growth investors don’t much care about:

• P/E ratios – These can be sky-high for young companies, but that doesn’t mean the companies are a crock. If a company has a massive opportunity to grow sales and future cashflows, it makes sense for it to reinvest most or all of the cash generated back into the business before any earnings hit the bottom line. Look at sales growth and gross margins instead, and check where the company is spending to see if it’s investing for the future.

• Re-ratings – Usually when I invest I want to discover an unpopular share on a low-ish P/E that gets re-rated to a higher P/E when perception changes. Such a re-rating hugely increases the gains from any underlying earnings growth. But great growth companies are seldom cheap on this basis, and if they are then something may have gone wrong with the story. I know of growth investors who for this reason only buy expensive shares!

• Dividends and buybacks – Most growth companies need all the cash they can get to recruit staff, build more capacity, push into new markets, promote their products, and so on. It makes no sense for a company capable of compounding money at 20% or more a year to return capital to shareholders.

Don’t be fooled! Many small cap companies look like growth stocks now and then, but the growth soon moderates. Any manager worth his salt can spin a good story. Cyclical companies grow for a few years but then sales plunge. Most companies with small profits and large outlays are probably just bad investments, as opposed to laying the foundations of a mighty empire.

Even if you do find a good growth stock, be aware that managing fast growth is very difficult. Companies often expand too quickly and run out of cash, or conversely they move too slowly and lose the early initiative.

There are scaling problems, too. It’s hard to turn a small company built around a charismatic entrepreneur into even a medium-sized one without losing the magic. (I’ve been at such companies and observed the growing pains first hand).

Should your company get through all that, then there’s the difficulty of knowing when to jump off the ride.

No company can grow forever – even Apple seems to have run out of road. Any let up in growth will be punished hard if the shares are highly-rated.

Growth, value or both?

Having started my investing life as a strict value investor, I’ve become a bit more interested in growth over the years.

Perhaps it’s because the market has typically been pretty richly priced – 2008-2010 aside – so the value opportunities have often been in especially awful companies.

But it’s also the influence of books and articles I’ve read, particularly the shareholder letters of Warren Buffett and his various biographies.

Buffett doesn’t subscribe to the pure definition of growth investing, saying growth and value are two sides of the same coin.

And that’s about where my investing philosophy is, too. I can rarely bring myself to pay for shares on sky-high P/E ratios, let alone loss-making companies promising “jam tomorrow”. I will defend them, but it’s hard to invest in them.

Still, all things being equal I’d prefer to buy a decent business growing at 15-20% a year at a fair price than a low P/E business that’s stagnant but cheap.

This sets me against the UK investing great Antony Bolton. In a review of Bolton’s Investing Against the Tide, Richard Beddard quotes Bolton as saying:

I realise that PEG ratios are more the domain of the growth rather than the value investor but I’m afraid I can see little logic in the argument that a business at five times earnings growth at 5% a year, one at ten times earnings growing at 10% or one at 20 times earnings growing at 20%, which all have the same PEG, are equally attractive.

I would go for the five times earnings growing at 5% every day.

Bolton is a value investor through and through, and I think he’s more mindful of risk here, as opposed to maximizing his potential return.

Low P/E companies are (if you know what you’re doing) far less risky than high P/E companies, because there’s not much hope baked into their price.

But risk aside, there is a strong logic to betting on growth, which is that fast-growing companies can deliver stronger returns due to the power of compounding.

Let’s consider a made-up company, Go-Go Growth PLC, in that range of scenarios outlined by Bolton.

We’ll assume GOGO is currently earning 10p per share.

The following table shows us what will happen to GOGO share price in Bolton’s scenarios after five years, under three different earnings growth scenarios (i.e. 5, 10, and 20% growth):

P/E	Initial price	5%	10%	20%
5	50p	64p	81p	124p
10	100p	128p	161p	249p
20	200p	255p	322p	498p

Note: Author’s calculations.

The three prices in bold (64p, 161p, and 498p) are the important ones to look at first. These show us where the share price would be after five years if the P/E multiples remained unchanged.

You can see that after five years, Bolton’s 5% grower on a P/E of 5 would be worth 64p, after its 10p per share earnings grew to just under 13p1. That’s a share price return of 28%.

In contrast, the P/E 10 share growing at 10% has risen to 161p for a gain of 61%, and the 20% grower has delivered a gain of 149%!

The faster the earnings growth, the higher the final return. Clearly, if all things stay equal it’s far better to own a fast-growing share, even if you have to pay a high price to get started.

Run this scenario over 10 years and the gains become even more divergent.

The P/E 5 share growing at 5% will be up 62% after 10 years, but the P/E 20 share growing at 20% will have delivered a gain of 519%.

But all things do not usually remain equal

In reality, you could invest for many years and never manage to find and hold one company that grows consistently at 20% a year for 10 years.

Certainly they are out there and they are easy to spot in hindsight. But they are not so easy to find in advance of their gains, even using the growth investor mindset I outlined above.

Much more commonly your 20% grower becomes a 10% grower, or worse. I have previously written about how such a change will rightly cause investors to reduce the P/E multiple on the shares. Such a ‘de-rating’ can devastate your returns.

Look again at the table above. In it we see that the P/E 20 company that grows at 10% a year for five years and remains on a P/E of 20 at the end of that period would be priced at 322p.

That’s a gain of 61%. Not a champagne moment for a growth investor, but probably better than cash in the bank.

However in reality investors would probably reduce the P/E closer to 10 for that 10% growth. In this case earnings will have grown to a little over 16p after five years of 10% growth, and on a P/E of 10 would imply a price of 161p.

Remember, you initially paid 200p! This means you’ve made a 19.5% loss as an investor, even though your company grew earnings at 60%.

That’s the risk of growth investing in a nutshell.

On the other hand, what if you were Bolton and you bought the 5% grower on a P/E of 5, but it actually grew at 10% a year?

Again, earnings have expanded by 60%. That surprises the market and makes the shares look cheap, even if their price kept pace to grow to 64p.

Investors might decide that 10% was the new likely sustainable growth rate for the company, and they might now pay a P/E 10 multiple for the shares.

In this scenario canny Bolton has benefited from buying cheap. At P/E 10 the shares are priced at 161p.

Remember, the cheap P/E 5 shares started at 50p, so that’s a 222% gain!

There are no rules about P/E ratios. Don’t imagine that 10% earnings growth should always command a P/E multiple of 10 or anything like that. These are just rules of thumb and convenient examples. In a bullish market P/E multiples will expand, and in a bear market they will contract. Companies also have their own bull and bear markets. At the end of the day, the P/E rating will also incorporate factors like confidence about management, the business franchise, the prospects, and many more. Debt is a massive factor, too, which is why you may need to look at enterprise values and EBITDA if you become a growth investor.

So is it best to play safe or to go gangbusters for growth?

Obviously there is no certain answer – if there was we wouldn’t be urging most people to employ passive investing strategies every week… 😉

At the end of the day it comes down to temperament. I think the best reason to be an active investor (perhaps the only good one) is because you enjoy it. Doing something you find agreeable is a more certain pay-off than the prospect of beating the market.

Some who are drawn to active investing will love looking to the bright shiny future promised by growth companies, and some are curmudgeons and tyre kickers who love bargains and will take to value.

To thine own self be true!

Note: I know I said this next growth investing post would be about valuing “worthless” growth companies. I still mean to get to that, but I got bogged down in complicated spreadsheets and want to present it as simply as I can. Watch this space.

1. Specifically: 5 x 12.76p = 64p [↩]