Q: What is the Alpha objective of the DowJones/Select and the S&P500/Select portfolios?
A: The performance objective of Beacon Street Capital for each of its equity products is to add 2%+ of return in excess of the benchmark return per annum on average, net of fees, over rolling 3-5 year periods. Historically we have exceeded this objective (please see the performance page and click on "statistics" for each product for the most recent five-year averages for alpha).
Q: What are the Tracking Error, Information Ratio, and Beta of the DowJones/Select and the S&P500/Select portfolios?
A: Beacon Street Capital actively manages its portfolios. As such we assume risk, and potentially add value, by generating excess returns over the benchmark Index through stock selection and related buy/sell indicators. The "value added" produces the Information Ratio, which provides an estimate of the additional return added or subtracted by the manager for each 1 percent of risk added by the manager. The Information Ratio grows in proportion to the manager's ability; therefore, a high ratio, with 1.00 being excellent, implies a higher degree of manager skill (please see the performance page and click on "statistics" for each product for current Information Ratio and other data).
Q: How do you make sell decisions?
A: One major advantage of having a quantitative based stock selection process is that it also provides an objective basis for selling a stock. Sales occur when internal growth potential turns negative. Therefore, identifying opportunities to sell is the mirror image of the long position selection process. Since price is not a consideration, traditional profit taking is not practiced. In fact, using targeted price levels as an exit strategy most often results in selling a stock too early or holding a stock too long. Instead, we are able to cut our losses early and let our profits run by staying with a stock only as long as its growth potential remains positive. This creates big winners that contribute significantly to the performance of the portfolio, and few and smaller losers whose negative impact is not as significant to the overall portfolio.
Q: What is the significance of price in your buy/sell decisions?
A: The price of a company's stock is based on the company's growth potential and the quality of that growth potential relative to the risk. For example, companies with no debt typically have higher P/E ratios because risk is lower and investors do not require as great a premium. The same company with higher growth potential will have an even higher P/E ratio if that growth potential is well defined. So share prices are determined by expected cash generation - earning an acceptable rate-of-return - from growth potential, and not from reported earnings or the current book value of assets. Quantifying growth potential and using it as a proxy for changes in future earnings and value trumps prices as a determinant of value. It also trumps Wall Street research and traditional methods of investment analysis such as business valuation, long-term earnings expectations, market changes and macro economic factors.
Q: How often do you calculate growth potential?
A: We calculate growth potential each quarter from the data included in the 10-Q's and 10-K's filed with the SEC by each company in our universe. Buy/Sell decisions are made when those reports are issued.
Q: How do you approach sector diversification?
A: Our investment strategy includes a built-in sector rotation as market leadership follows stocks with positive changes in their growth potential. While this may create a more concentrated portfolio with a heavier weighting toward one or more sectors, through both bull and bear market cycles that have occurred since 1992, no one industry or sector has dominated our portfolios.
Q: How many stocks do you cover?
A: Our initial screen reduces our universe to approximately 250 stocks for which we calculate growth potential each quarter. Of those stocks, 35-75 will comprise the S&P500/Select portfolios and 4-16 will comprise the DowJones/Select portfolios, depending on the state of the underlying economy which generates the business opportunities for growth potential.
Q: What is your turnover for each portfolio?
A: Turnover for each of our products is relatively low and predicated on changes in growth potential for each stock. Over the past five years the turnover rate has ranged between 28% and 100%, being highest at the peak of bull markets as more stocks are sold, and the lowest at the trough of bear markets as new stocks are added.
Q: Do you use Wall Street research or third party data?
A: Beacon Street Capital uses no outside research or third-party sources of information. We gather financial data directly from quarterly filings to the SEC by the companies in our universe.
Q: Why will this philosophy be successful in the future?
A: This philosophy does not deal with price data, which preoccupies "modern finance." Dividend discount models and discounted cash flow analysis have critical conceptual and practical deficiencies because they rely on assumptions about the future and are uninformative about value. On the other hand, accounting procedures aggregate a large amount of information into summary numbers which have value measures from which future earnings flow, and therefore offer an opportunity to benefit from market pricing anomalies. Consequently, a strategy built around an accounting-based algorithm that provides superior information content as to future earnings will continue to be successful as long as Generally Accepted Accounting Principals (GAAP) are used in financial reporting.
Q: Have there been any changes to the investment process over the past five years?
A: Our process is based on a quantitative accounting-based algorithm developed in 1992 and is specific to each company we follow. As long as accounting principals do not change, the algorithm will not change. However, we have altered the initial screening parameters to adjust for lower long-term interest rates by lowering our return-on-equity and cash-return-on-equity to reflect the general trend of interest rates in the market.
Q: Explain how your philosophy/process might give rise to variations in performance through different stages of market cycles. Has this changed in the last five years?
A: Our portfolio selection process is a unique and disciplined approach to stock selection. Our process will typically under perform our benchmark indices when we experience a rapidly rising market after an extended bearish period, which was the case in 2003. The great advance in the U.S. equity markets for 2003 was concentrated in stocks of companies which often had no earnings and which also had no quantifiable growth potential. This indicated to us the vast majority of investors were assuming unsound risks, hoping to maximize gains with stocks of companies that were financially weak in hopes of their gaining financial strength if the economy continued to improve. They had attempted this twice before, once in March, 2001, when the S&P500 Index was at 1100 and again in September, 2001, when it was at 985. It was a successful strategy in 2003, although some of the largest gainers had negative earnings and negative internal growth potential. These are the types of stocks our quantitative approach causes us to avoid because they carry much greater risk and are profitable only if purchased at precisely the right time rather than for the correct fundamental reasons. We did not, and will not, change our discipline to accommodate the market.