The Omnipresent Impact of the Bell Curve

The Omnipresent Impact of the Bell Curve

Outstanding portfolio performance on its first anniversary (This article originally appeared in Grainews on July 16th. The performance was as of May15th and while the numbers may have changed, the message is just as applicable today)

It is time to take a look at our Titanium Strength Model Portfolio. How did it perform? How did it compare to market indices? What other nuggets can we glean that might aid our understanding of portfolio management? What does a bell curve have to do with it?

Overall performance was 13.5%, pretty good in nominal terms and outstanding compared to market performance, which came in at 4.0% as a weighted average of the Canadian, US and UK markets, including dividends. The Canadian side had a price appreciation of 9.8% and dividend yield of 4.0% for total return of 13.8%. The international component had a price return of 6.7% and a dividend yield of 1.7% for a total return of 8.4% in USD terms. The Canadian dollar also depreciated making the gain 13.1% in CAD on the international side, and 13.5% overall.

Outcomes of disciplines that entail variability, like investing or farming, will be governed by the rules of a normal distribution curve, a.k.a. the bell curve. While overall performance was outstanding for the year, there is a distinct difference amongst companies. Disney and Pentair represent the outliers of the bell curve. The others companies came in closer to the average. This portfolio is too small to create a perfect bell curve, but is large enough to demonstrate the concept.

Stratification of individual company performance will always occur. Better portfolios will have better overall performance but will always have a laggard or two and a star or two, with most companies falling near the mean.

Many portfolio managers would sell Disney because of its great performance, thinking they should take profits. Many think if a stock moves up by 20% it should automatically be sold, succumbing to the misperception that you need to sell to make money. Other managers would sell Pentair as they “pull the weeds” from the portfolio. However, the only real reason to sell either company is if their business prospects had deteriorated significantly, or their valuation becomes unreasonable.

If we sold these two companies and picked two others the portfolio would still be governed by the bell curve, and a year from now we would likely have an outlier on both the good and bad side. What company will be next year’s star? Which will be the laggard? There is simply no way to predict this. The only prediction is that a well-structured portfolio of good companies will appreciate in value better than the market average of about ten percent per year.

With this demonstration I am hoping to illustrate the relative ease of investing in stocks and deriving adequate returns with minimal effort. It took me a long time to realize how simple it was, because virtually everything you read will tell you how difficult it is. Business schools teach students that it’s impossible to beat the market based on a theory called, “Efficient Market Hypothesis,” and most investors only derive half the returns of the market. I am hoping to pass along what I have learned through the years via my book, newsletter, blogs and Grainews articles so others can benefit to achieve better returns. Charlie Munger, Buffett’s right hand man for half a century once said, “More investors don’t copy our model because our model is too simple. Most people believe you can’t be an expert if it’s too simple.”

This illustrative portfolio is similar to the process I take with my newsletter, where I have TFSA and RRSP model portfolios, and an actual non-registered portfolio set up specifically for the newsletter showing subscribers exactly what I do when I do it. This actual account is up about 60% in 3.5 years and employs both stocks and options.

My two main frustrations with market newsletters is they tend to have a list of stocks rather than a well-structured portfolio, and they eliminate many losing companies from their list giving a false impression of a much higher winning record than reality. My newsletter portfolios are run like real portfolios. If I sell a company, the impact of that sale remains as I track whole portfolio performance.

During a 35+ year career in agriculture, Herman VanGenderen became an active investor in stocks and real estate. He writes a monthly newsletter and his book “Stocks for Fun and Profit: Adventures of an Amateur Investor” is available at internet book sites. Visit his website at www.you1stenterprises.com, or email him at you1st.stocks@gmail.com.

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