How to measure portfolio return

At the blog AnotherValueInvestor there is currently a miniseries on how to calculate your own portfolio return. I would therefore like to give my view on how to calculate the annual compounded return for your portfolio. This is fairly easy to do with a spreadsheet program like Excel, Numbers or Google Docs Spreadsheet. For my own tracking I have used Excel since late 2000.

First start with identifying the exact dates and amounts for all your deposits and withdrawals from your stock accounts. Then do the following in your spreadsheet program:

Create two input fields (orange fields at the top first column in the figure below):
[A] today's date. If using Excel, use the TODAY() function
[B] the estimated portfolio return (denoted as 'CAGR to reach current value of portfolio'). Start e.g. with 10% as a reasonable starting value

Create at least four columns (six if you want to compare yourself with any index) with the following contents:
[1] Date (enter the date for the deposit or withdrawal to your account)
[2] Amount of deposit or withdrawal
[3] Calculate the number of years since the deposit or withdrawal (there are several simple functions in e.g. Excel to calculate this) using the input [A] above and column [1]
[4] Calculate the compounded value of your deposit or withdrawal [2] today given the estimated portfolio return [B] and time [3] since this deposit or withdrawal. The formula is    = [2] * ( ( 1 + [B] ) ^ [3] ).  "Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it." Albert Einstein

Create also at least one output field (grey fields at the top first column in the figure below):
[C] Current value of portfolio. In this field you summarize the whole [4] column. With everything now set, the output figure [C] should become equal to your current portfolio value (check in your stock account what it is on the [A] date) once you have the right [B] value input. Either test yourself (5-10 tries will normally make you come very close), or use a built in function like 'Goal Seek' in Excel.

Kids, I would like you to remember that my primary target regarding portfolio return is to measure that the compounded return over time is at least 10%* (read this previous post regarding having an absolute return target). However, it can still be relevant to compare to the most relevant practical alternative that I could entrust our capital to. That would most likely be an index fund that would try to closely follow the SIXRX index (such as Handelsbanken Sverigefond Index or SEB Sverige Indexfond).

Hence, for comparison, I have added in the SIXRX index. Find the index value for each relevant date and add them into a fifth column [5]. Then calculate in the sixth column [6] the current value of the deposit or withdrawal by dividing today's closing SIXRX index [D] (see the top right orange input field) with [5] and multiply with the deposit or withdrawal value [2]. Sum up all values in column [6] to calculate the value of the portfolio if you had invested in SIXRX [E]. Then use the [B] input again to match the [C] output with [E] and you will find the annual compounded interest that the SIXRX would have given you.

This model is simple to update every time you make a new deposit or withdrawal, just add a line and make sure the sums are correct in the 'grey output fields'. Using this model I can see that currently my portfolio have had an annual compounded return of 11,85% which is above my 10% absolute return target and 2,01%-points better than SIXRX.

Figure. Excerpt of simple model to calculate annual compounded return on your investment portfolio.

Using this model it is also very easy to see how much a withdrawal a long time ago have cost me. For instance, the withdrawal in May 2001 of 146 kSEK would have been worth 646 kSEK today in nominal terms before tax (while inflation has been about 17% during the same period). These things are always good to reflect upon...

Anyway kids, your portfolio is growing at a slightly higher pace (17,25%) mainly due to the fact that it is still more concentrated to fewer large (and so far successful) investments. So far it has also well outperformed SIXRX with about 5%-points.

* measured pre tax regarding capital gains tax in normal VP-account, after tax for ISK-account and after all transaction costs

Neurosearch - a different 'investment' case

There is a company Neurosearch listed on the Danish stock exchange that is now potentially very interesting to invest in. This is normally not the type of company that I invest in as this is clearly a 'cigar-butt' type of investment with the feature that this cigar either has no fire in it at all (and it will only cause me to feel ill for having picked it up) or that the last puff will be very rewarding.

In summary, this company is in practice under 'liquidation' and have come very far in that process. The number of employees were two at end of 2013. The asset side is now (for all practical purposes) only compromised by cash and cash equivalent (of 87 MDKK) and the liabilities side (for all practical purposes) of equity only in the corresponding value. All other assets have been written down to a zero value. The company has 24,554 million shares.

With a annual burn rate of 10 MDKK (as announced by management) during the ongoing 'liquidation' and litigation process, the share price at end of July should be about 3,30 DKK if just valuing the company by its cash assets.

The key issue until now has been the trial regarding share manipulation in 2010. Today the verdict came and the ruling was that the company was found guilty of share price manipulation contrary to the rules of the Danish Securities Trading Act. The company was ordered to pay a fine of 5 MDKK.
The company now has two weeks to decide whether to appeal the District Court judgment to the Danish High Court. Hence the current asset value of the company at the moment after this verdict should be (in my opinion) somewhere around 3,10 DKK / share (excluding 'option value' described below).

The interesting thing is that there is a big upside in this company as all other assets have been written down to zero value in the books during the 'liquidation' process. Without going into details on the minor items (e.g. potential milestone payments of 55 MDKK relating to the development of Huntexil^®), the large item remaining is the deferred tax asset that could potentially be sold (most likely through selling the whole company). Some of the details regarding the deferred tax assets are as follows:

In the latest financial update (April 30th, 2014) the following is mentioned:
"In addition, NeuroSearch calculated the value as of 31 December 2013 of its unrecognised tax losses carried forward at approximately DKK 1.8 billion, and deductible temporary differences at approximately DKK 0.5 billion, or a total of DKK 2.3 billion. Under certain conditions, the unrecognised tax assets may be exploited in full or in part by a potential buyer of NeuroSearch."
And in the Annual Report 2013 (p30): "As of 31 December 2013, the Group had tax loss es carried forward totalling approximately DKK 1,800 million which can be carried forward indefinitely. In addition, the Group had deductible temporary differences (net) of approximately DKK 473 million, totalling DKK 2,273 million. The carrying amount of unrecognised deferred tax assets was approximately DKK 500 million for the Group at a tax rate of 22%" 

To summarize; these 'hidden assets' have a gross value of about 20 DKK per share. I do not believe that in case of a transaction this full value would come to the benefit of the current shareholders, but rather a smaller but still substantial part of this.


Based on this I see a downside (with very high likelihood) but limited to some 5-10% in the upcoming year. At the same time I see a potential upside (with much more limited likelihood) of 100%++ in the same timeframe. For me, this is the type of 'lottery ticket' I like to buy (intrinsic value is somewhere between 3-23 DKK per share). Therefore I currently hold a smaller position in the stock. The stock closed at 3,25 DKK today.

HNWI status - July 2014

Below is a summary of my best understanding of the investable assets (in SEK) for some bloggers as of end of July 2014.  For some of the bloggers the data is a few months old as there has been no update.

NB: HNWIs are defined as those having investable assets of US$1 million or more, excluding primary residence, collectibles, consumables and consumer durables.

Exchange rate as of July 31st, 2014: 6,90 SEK/USD

I was still able to make it above the 1 MUSD mark by having investable assets of over
7 000 000 SEK as per end of July 2014.

How to generate income and what is an asset

Kids, one of the books that you should read very early on in preparing for investing is the 'Rich Dad Poor Dad'-series by Robert T. Kiyosaki. There are a number of books written by him and they are all fairly easy to read. As always, with anything you read or hear, you need to be critical and have your own thinking and opinions about the material. But you should always also open your mind to new and interesting ideas and not shut them out before thinking about them critically.

For me there have been two key take-aways from reading these books; a) one about how to think about different structural options to generate income and b) one about what is an asset and what is not.

A) Regarding the structural options to generate income, Kiyosaki introduces a concept of a 'CASHFLOW Quadrant', which basically lists four type of ways to generate income.

Most people in today's society live their lives mainly on the left-hand side of the quadrant, i.e. as employees or as self-employed (e.g. small-practice lawyer, doctor or similar). Even though it is possible to reach financial independence on the left-hand side, most people who have reached it have done it on the right-hand side (as business owner and/or as investor). Please however remember that there are also many failures on the right-hand side, not everyone who tries that side will succeed.

I strongly believe that you should try to find your the passion in your life from which you can also generate a healthy income to live off and to invest. This can be in any of the four quadrants. However, I also strongly believe that you should as early on as possible develop your skills as Investor to have your excess money work for you. This will give you financial independence at some point in time and give you many additional degrees of freedom in your life. Even if you do not think investing is fun, you should at least try to acquire knowledge of the basic concepts within investing, so that you at least can challenge and potentially judge the advisors that you want to have to help you with the investor quadrant.

Personally, I have spent most of my time after university in the E square, but for the last 15 years also allocated capital in the B quadrant. After reading 'Rich Dad Poor Dad' I have for the most of my career sought after job positions where I can combine E with B in order to get some of the financial upside of the B quadrant and also to get as much understanding of how successful people in the B quadrant think and operate and to learn things that I can also use in the I quadrant. I have, however, never been the majority shareholder and/or founder of a business, so in essence I have not really given that quadrant a proper go. In parallel, also for nearly 15 years, I have started to build my skills in the I quadrant. Most of the posts in this blog relate to the learnings and ideas I have about being an investor and those I want to pass onto you, no matter what you choose to do in life for a living.

B) The other key take-away is regarding what is an asset and what is not. Until my early 30's I was so 'brain-washed' from school and university with the concept of assets being such things as the apartment or the house where we live or even the car we own, i.e. things that have a market value. It was not until I read 'Rich Dad Poor Dad' that it struck me that an asset is 'anything that produces a positive cash flow'. Our house will only produce a negative cash flow as long as we use it to live in and the same goes for our car. Hence they are not assets, they are only 'liabilities' and have a huge alternative cost... The most practical example of this is that we today could sell our existing house and move to a much cheaper house somewhere on the countryside or a smaller town, become debt-free and have all the cash-flow from real assets that we need to live a comfortable life without needing to work. But with the current 'assets' (mainly our house) I still need to work as it consumes cash (rent payments, running costs and maintenance costs) and hence is NOT a true asset (that generates a positive cash-flow). A share in a company is however most often generating cash to the owner through dividends or share redemption programs and this is in my world a true asset.

As a final remark, I think one should focus most of the attention on how one can generate the most income rather than spending as little as possible. The reason is that it (at least for me in relative terms) is so much easier to spend little money, whereas the effort to increase income (through getting a higher-paying job, starting and driving a business or learning how to invest successfully over time) is much, much tougher. Naturally one should keep costs low, but it is only a (smaller) part of the key to achieve financial independence.

Kvaerner - additional investment

On Friday I did a small add-on investment in Kvaerner of 5000 shares at 10,70 NOK. This company will most likely not be part of a long-term portfolio as I have very hard to judge its short-, medium- and long-term business prospects. The operating cash-flow recently has been wildly negative with 274 MNOK in the first half-year of 2014. The management claims that the cash flow is fluctating in this business and that is even illustrated separately on p13 in the latest Q2 2014 presentation.

However, at the current price it is yielding very close to 12,0%. This company I value mainly on the valuation metric of EV / EBIT of 3,24 (at the purchase price of 10,7 NOK). The company has a negative NIB (Net Interest-Bearing debt) of about 489 MNOK (cash of 972 MNOK and interest-bearing debt of 483 MNOK). TTM EBIT I have calculated to 738 MNOK. With the negative NIB, it gives me some comfort to invest in this company, more with the approach of a 'cigar-butt' investment that gives me some cash back short-term.

Hence it gives me a decent return without having to risk too much money while building the dividend portfolio. The company itself states its dividend policy as follows: "The ambition is to pay semi-annual dividends with increases, in order to give a stable and predictable dividend growth, balancing out the underlying volatility of earnings". The next declared semi-annual dividend of 0,64 NOK will be paid out on October 24th. 

With this investment I expect some 270 kSEK in dividends (after tax) during 2015.

Betsson - my largest holding

My largest holding (measured as current value) is currently Betsson. I have owned the company during the more than three years (measured as weighted average) and the first investment was done about 4,5 years ago. On a few occasions the last 1,5 years I have sold smaller parts of my investment, but also added positions. Net divestment during the last 1,5 years is 850 shares.

During the time that I have now owned the company my CAGR (pretax, but incl. received dividends after-tax) is above 25%, which is far above my long-term investment return target of 10% p.a.

In the chart below I have plotted the EPS TTM (last twelve months) for Betsson as red bars and then the closing price as the blue line and the corresponding P/E TTM in the green line. The flat red line is the average P/E TTM (14,0) during the period (since Oct 8th 2007). The black arrows indicate when I have bought (upward-pointing arrow) and when I have sold (downward-pointing arrow). The length of the arrow correspond to the size of the transaction in number of shares. In the chart it is a hard to see that the EPS TTM is now close to 14 (13,88 to be exact, based on the recently released Q2 report).

As you can see from the chart above the first investment was made at a fairly high P/E (of about 15,5) in early 2010. One of the good things about following a company for a longer time, is that you start to get a better understanding for when it is cheap and when it is expensive. In mid 2011 I was even more confident that the company was attractively priced and added a fair position. Over the last 18 months I have started to take some money 'off the table' through a number of divestments. The main reason for this is that due to fairly high valuation at several points in time (P/E well above 14), I have judged it a good time to take some money 'off the table'.

What I like about this company is
- strong (although diminishing) ownership by physical persons
- consistent management; Pontus Lindwall (former CEO) now holds the Chairman position in the Board and works actively with strategic tasks
- fantastic ability to generate and distribute cash (through redemption of shares) to shareholders while growing the business
- market leading position (no 1 or no 2) in key markets
- seem to be able to acquire other smaller companies at interestingly low multiples to EBIT
- seem to (here I would, however, still not draw too far-reaching conclusions) learn how to integrate those acquired companies into existing operations to extract synergies
- seem to build in-house capabilities in many key areas (IT platform, payment solutions, data mining, proprietary games, marketing etc) to be successful in this business, while continuously pouring money into marketing
- 'pricing power' in the sense that this business should always - all else equal (i.e. mainly given a stable competitive situation) - be able to offset impact from inflation
- the option of successfully entering the Chinese market, which could potentially allow for massive growth over many years

There are also a number of key issues with the business, the main being that I do not see any clear moat (competitors popping up left and right as limited capital is needed to start up a business). If I had seen a clear moat, I would probably have poured all my money into this single company as it otherwise have nearly all characteristics that I like for a company that I want to own.

Today, I would most likely not add to the position unless P/E comes down to 14 or below before year-end this year. However, I do not believe I will sell either (at current price levels) as I think the company will be able to continue to grow its earnings in a pace that will give me some 8-9% total investment return over the next 10-20 years (given that they can hold an RoE at 32% or more and continue to reinvest the same share of their earnings into the business as they have done the last couple of years)

Ross Stores - additional investment made

Yesterday I did a smaller add-on investment to one of my existing investments. I bought 165 Ross Stores shares (ROST).

A short background to the investment is that I have owned HM since the market crash 2008 but due to the recent very high valuation of HM I have sold out part of the investment to buy some other companies. However, I like the simplicity and stability of HM and have therefore for some years been following another company that I think is somewhat similar to HM and that maybe could do the same trip as HM without necessarily competing too much with HM.

Some 'soft' investment highlights that I like about ROST (you can read up briefly on the company for instance here or on their homepage):
- The company has proven itself over quite many years (about since mid 80's when it was IPOd), with a concept that now encompass over 1300 stores (Ross Dress for Less and dd's Discount) over large, but not all, parts of US. They seems to have a very well-defined concept that has been consistently expanding for more than 20 years
- What I personally like very much from an outside perspective (without knowing the persons) is that the recent succession is an internal manager. New CEO Barbara Renter has been with the company for 28 years and her most recent position has been Chief Merchandising Officer. Also some other promotions are for internal managers, and notably former CEO Michael Balmuth has become Chairman of the Board. I like consistency in management, and internal promotions of management. For me that is one of the strongest signs in a 'simple business-idea' company that the concept works, that the management believe in it and that they will not change the winning concept. Kids, you can read about this in the book 'Built to last' by Jim Collins and Jerry I. Porras.
- One weak point is that there is (to my understanding) not one single strong 'flesh-and-blood' owner. However, this is partly compensated with the fact that several key managers own about 10-30 MUSD of stock in the company, which I think is a large enough sum to really care about what you are doing as a manager. Please however also note that most managers seem to sell of a smaller sum consistently over time
- 20 years of consecutive dividend increase (although at only about 1,3% yield yesterday, dividend ratio (to EPS) has been below 20% historically)
- Number of outstanding shares is decreasing continuously. The management has driven a share buy-back strategy consistently over a long time period as a way to distribute the free cash flow back to shareholders.
- My outside view of the key issue and opportunity for this company is that it will have to prove that its concept will work outside the US within about five years (as growth opportunities in the US is starting to diminish). As their largest peer (TJX) has done this (although with some problems if I understand) in both Canada and parts of Europe, I believe ROST can also do it.

'Hard-facts' investment highlights:
I have looked back at key figures of EPS, equity per share, RoE, dividend per share, share of earnings as dividend, year-end share price, P/E ratio, number of shares and interest-bearing debt. In the table below you can see the key figures, for most of the metrics since 1997. I have calculated the seven and 14 year CAGR averages in growth for EPS, equity per share and dividend using three-year averages (i.e. comparing the period 2011-2013 with 2004-2006). RoE, dividend share of earning and P/E averages are normal averages, whereas share price is normal CAGR for the latest seven and 14 years respectively. In the row above ('Assumptions going forward') you can see my key assumptions on RoE (38% this year and declining to 30% in 2020), dividend share of earnings (at 20% this year and increasing up to 75% in 2023) and 'normalized' P/E ratio of 15 (as compared to 15,3 for the last seven years and 17,0 for the last 14 years). The share price of 62,23 USD correspond to the price of my latest purchase.

Interest-bearing debt is low at 150 MUSD and cash was 435 MUSD at year-end, giving a negative net interest-bearing debt, which is something I really prefer in my investments.

I will go into more details about my thinking on how this 'hard-facts analysis' works in a separate post. However, with the above assumptions (which I deem fairly realistic on the side of conservative),  I expect a investment CAGR (share price increase before tax and received dividends after-tax) of
a) 13,8% in a 3-year perspective
b) 11,9% in a 10-year perspective
c) 10,4% in a 20-year perspective
This is above my target return of 10% p.a.

The CAGR figures are calculated using the expected share price and dividend that you can see for the upcoming years, given that the assumptions about RoE, dividend share and P/E ratio hold.

One strange thing about this company is the following note in the latest 10-K on p11:
"There were 822 stockholders of record as of March 12, 2014 and the closing stock price on that date was $72.38 per share.".
A company of this size only having about 800 stockholders, can that really be true? Is there any reader with good knowledge about US stocks out there that could clarify this to me; could this really be the case for such a large company as ROST (a little bit less than 1/4 of HM as measured by market cap)?