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Dow Jones Industrial Companies – (B)(N) There and Done That

June 6, 2012

The following Table 1 shows which companies in the Dow Jones Industrial Index we either bought or held (B) or sold or avoided altogether (N) and that each such decision was in effect for the entire quarter (three months) between early 2009 and the end of 2011 (three years). The extension into January, February and March 2012 is also correct and will remain that pending new information as the year unfolds.

Table 1:  (B) Buy or Hold – (N) Sell or Avoid

For example, we bought Alcoa Inc in early 2009 and held it for the next fifteen months, selling (“selling” – please see below) the entire holding in the second quarter of 2010 (marked (N)) and re-acquiring it three months later in the third quarter of 2010, and finally selling it again during the second quarter of 2011 (marked (B)) and the beginning of the third quarter (N); we have, moreover, not bought it since and don’t hold it now.

In general, we don’t really care at what price the stock was bought although typically buy decisions are made early in the quarter in which the company is first indicated (B) and sell prices are determined in the quarter preceding an (N) as in a (B)- to (N)-transition; sell decisions (and profit taking) are generally more complicated than buy decisions and are explained in the Appendix.

Our Stock Price Table (Table 2) is in the Appendix and we also discuss the exact logic of our buy/sell decisions; the same logic applies to any and all the companies and does not depend on any special knowledge about the companies or even what they do.

This portfolio returned 56% over three years or 16% per year (compounded) plus dividends which added another 2%-3% per year to our returns; transaction costs were for fifty-one buy decisions including twenty-six in the first quarter of 2009 and thirty-seven sell decisions in subsequent quarters in each of which the entire holding of one or more of the companies was sold because (and only because) of a (B)- to (N)-transition or change.

During that time the Dow Jones Industrial Index gained 39% or 12% per year but the Index at various times (three times in three years) dropped 10%-15% in one quarter or less, and, of course, Index-oriented investors do not generally have any “free cash” unless they sell or redeem some of their holdings uniformly.

In contrast, our portfolio never lost money but for a decline of less than 1% in the second quarter of 2010 and again in the third quarter of 2011 and the cash position remained positive at all times.

The amount of cash available for re-investment (or other uses) approached the original investment during the last six months of 2011 – there were just no more opportunities for us in the Dow at that time and such monies could be allocated to buy more of what we have (fourteen to seventeen companies, currently) or used in other markets such as the TSX, NASDAQ, or S&P 500 companies in which we might have many new opportunities.


The table and our methods require some description which we’ll provide below but, first of all, and most importantly, nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock of any of these public companies at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability.

We can only tell you what we do and why we do it or have done it and we also know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now.


Table 2:  Stock Prices Effective By Quarter

For example, Alcoa Inc closed at $11 in December 2008 and, based on our analysis effective as of the end of 2008, was a (B) in the first quarter of 2009; we bought it at $7 (please refer to the Table 2) and then held it for most of the the next thirty months, finally selling our entire holding at $16 in the second quarter of 2011 because (and only because) of a transition from (B) in the second quarter of 2011 to (N) in the third quarter of 2011 (Table 1).

As already noted (but it doesn’t hurt to emphasize), the “timing” of the buy is unremarkable and, generally, we have no control or insight into what the stock price is or was or will be, even days in advance – nor does it really matter because the companies that we buy can be expected to be in our portfolio for long periods of time (typically, fifteen months) and a current “low price” or “high price” is only marginally relevant to that decision.

Any company that actually demonstrates an (N)- to (B)-transition – which is a “state change” rather than a mere “price change” – is eligible for inclusion in our portfolio (at any price) but those companies may also have different expected price and dividend behavior that could become a factor in our objectives for portfolio management and what we might buy and how we might “sell” it, although that is not the case in Table 1 which simply records the calculated (B)- or (N)-state of the companies at that time.

The “sell decision” is more complicated because we could take reasonable profits while still holding a residual balance in the stock; for example, we bought Alcoa at $7 and might have sold half of our holding at $13 or $16 six months later and also established a zero cost base for the residual.

Sell decisions are also typically enforced by an automatic stop/loss that is executed by our broker and which we calculate in a simple way based on the current stock price (while still in (B)) and our estimate of the downside that might be expected and due only to volatility.

The same calculation can be used to buy reasonable long-dated puts in order to protect the price and keep the company in our portfolio regardless of the future stock prices, particularly those that we might deem affected only by volatility.

Our primary goal in portfolio management is not opportunism but systematic and pragmatic risk aversion using the simple and essentially free mechanisms of the market.

It is, first of all, nearly unheard of that a portfolio of equities (The Perpetual Bond, so named for good reasons) can be crafted systematically to outperform the Dow – yet we have 16% per year versus 12% per year in the Dow over a three year period.

And we understand completely how that was done and how we can expect to continue to do it in the future – for decades if we like, being constantly in the market and seldom out of it.

Our portfolio began with a cash investment of $1,153,000 in early 2009 and we simply bought blocks of 1,000 shares in each of the twenty-nine companies designated (B) in Table 1 at the prices in Table 2, and it is now (March 2012) a portfolio of seventeen companies in the Dow worth $1,130,000 at the current prices and a cash account of $689,000 which is presently unallocated.

An investor with nerves of steel and no need for cash could simply have bought all thirty companies in the Dow for a similar cash outlay of $1.2 million in early 2009 and would now have a portfolio worth – randomly, so to speak – $1.7 million but still no cash other than dividends worth approximately $25,000 per year, a large part of which we would also be earning in The Perpetual Bond and adding to our cash hoard in addition to the capital gains which we could draw down at any time (100% Liquidity) if we wish.

Every investor has their own view of the market and which equities they are motivated to buy and sell; we have nothing to say about that and there is a vast industry of investment technology, data, opinions, and news services that – by our choice – we have nothing to do with and pay no attention to, particularly forward looking prognostications.

We do not, in fact, use any forecast information at all.

Our method is based on the simple observation that investors are not in the market in order to lose their money but expect to maintain and even increase their real capital by obtaining a hopeful return that exceeds inflation, whether Consumer Price Inflation or Producer Price Inflation, nor do we care what those numbers are because we have no influence or insight into the future; we merely expect that the companies themselves will do what they can to deal with the factors of production and sales, and to stay in business, and that retail investing is essentially a passive activity akin to gambling in the absence of a provably proactive discipline of risk aversion.

In our view, an “investment” is simply (just and only) a deliberated purchase of risk and as for any other purchase, there is a “price of risk” that we may provably discover from the market itself (which sets the price); a company gets a (B)-rating from us if and only if the current and prevailing stock price (despite volatility) appears to be above the price of risk (Table 3 below) and an (N)-rating otherwise.

Volatility is a useful tool (and the subject of a forthcoming Letter from the RiskWerk) but we must note that “Volatility is not risk; it is volatility” (John von Neumann 1943) and that the systematic and widespread substitution of volatility for risk has rendered most of modern portfolio and risk management theory and practice not only provably useless (or meaningless), but dangerous (Harry Markowitz,  The early history of portfolio theory: 1600-1960, Financial Analysts Journal, Jul/Aug 1999).

Table 3: Risk Prices Effective By Quarter

These data (Table 1 through 3) are available from the author in a CSV-format for each of the major markets – the Dows (Industrials, Transports and Utilities), the S&P TSX Companies, the S&P 500 and the NASDAQ 100.

For example, for the three years from early 2009 through 2011,

The Perpetual Bond (B)®
The Dow Jones Industrials – 16% per year (plus dividends)
The S&P TSX Companies – 18% per year (plus dividends)
The S&P 500 Companies – 23% per year (plus dividends)
The NASDAQ 100 Companies – 37% per year (plus dividends)

The Perpetual Bond (B)®
“Alpha-smart with 100% Capital Safety and 100% Liquidity”™

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