Goodbye to the Messed-Up Expectations Portfolio

By Markets Fool.com

It's with a heavy heart that I pen these words. (OK, type them.)

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My responsibilities and demands upon my time at The Motley Fool (I now work on Stock Advisor andOptions, and I lead the Phoenix 1 portfolio for Supernova) have grown to the point where I can no longer give the attention to the Messed-Up Expectations portfolio that it deserves. Therefore, I've decided to shut it down.

But before I go, I'd like to share some of what I've learned and then leave you with some final numbers showing how the portfolio has done.

Lessons learned
I named the portfolio the Messed-Up Expectations portfolio based on thinking published by Michael Mauboussin in Expectations Investing. In that book, he took the traditional discounted cash flow model -- used to determine a company's intrinsic value given certain growth assumptions -- and turned it on its head, asking what growth assumptions justify the current share price. If those assumptions seem too low, then buy shares and let the company prove to the market that it was underpriced; if those assumptions are too high, sell shares (or don't buy them) and wait for reality to set in with a lower share price.

I found out, however, that this isn't enough by itself, at least not for me, when basing a portfolio on that idea. I also found it necessary to identify some catalyst that would lead the market to realize that it had made a mistake when it priced in a given level of growth.

The second thing I've learned is that buying a strong company when the market doesn't like it can be a fantastic strategy. This, of course, is the epitome of a messed-up expectation. Probably obvious, but a lot of people don't do that.

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For instance, when I purchased hard-disk drive maker Western Digital , analysts weren't too enthused with the company given the supply glut of HDDs in the market. During an earnings conference call at the time, one analyst said, "I think it is admirable to try to change the dynamics of the industry, but I am curious what you guys think you can do." The share price was in the low $30 range in early 2011, down from the $40 range a year earlier. My purchases in January and September 2011 have all tripled since then.

This was also demonstrated by my purchase of department store chainDillard's in December 2011 when the market thought the U.S. would slip into a second recession (after having just come out of the Great Recession) and consumers wouldn't shop again. Well, the U.S. didn't, and consumers did. That purchase has tripled, while the one I made the following June has doubled.

Of course, sometimes the market dislikes a company for a solid reason, too, leading to results that aren't doubles or triples, to say the least. For instance, I bought Bridgepoint Education when the for-profit education industry was under threat of stronger government regulation, only to have graduation rates, accreditation issues, and high student loan balances keep both the industry and the company in the doldrums over the years. My three purchases of this company (two in 2011, one in 2014) are down anywhere from 35% to 57%.

My two brushes with bankruptcy have also produced mixed results. While I successfully avoided riding drug maker Dendreon all the way into the ground (losing only 68% instead of 100%), my abandonment of grocery store SUPERVALU-- which I thought was on its way out (I was down an average of 60% for my three purchases) -- was trumped when it got some last-minute financing and staved off the vultures. The company's shares are now up an average of 74% from the time I bought, as it has managed a massive turnaround.

Ending numbers
Overall, however, I'm pretty pleased with the portfolio's performance. Here are some final results (all data as of market close on April 20, 2015).

  • Of the 95 total purchases made in four-and-a-half years, 59 (62%) are in the green and 44 (46%) are ahead of the S&P 500, tracked from the day of each purchase.
  • All purchases in total average a 59% return each, with a 14.7-percentage-point average outperformance against the S&P 500.
  • Of the 20 active company positions I'm ending with, 15 are in the green (an average of 82.3%) and five are in the red (an average of 20.3%).
  • I voluntarily sold six positions. I've mentioned Dendreon as a good call. Western Refining and Dean Foods are up 6.1% and 0.3%, respectively, since I sold them, so we'll call those good moves as well. And I'll count NamTai Electronics in this list as it has completely left the chip business since I sold. Oshkosh and SUPERVALU have moved up strongly since I sold.
  • I've had two companies purchased out from under me: Ceradyne and PowerOne. Both of these were purchased by others, but I ended up with gains on each.
  • My biggest winner is Netflix , at a 391.5% total return for the position (including my last purchase at $481 a share).
  • I've already named the other two multibaggers, Western Digital (128.7% total) and Dillard's (174.6% total). The remaining winners range from Core Laboratories at 7.6% to Apple at 88.2%.
  • The losers range from Mobileye at -2% to Bridgepoint at -45.8%.
  • Going year by year and measuring time-weighted rate of return, my worst year was 2011 (-16.3% vs. 2.1% for the S&P 500), followed by 2014 (-0.7% vs. 13.7%).
  • My best years were 2013 (60.2% vs. 32.4%) and 2012 (22.7% vs. 16%), and so far this year, the portfolio is up 13% vs. 2.6% for the broad market.
  • Finally, the portfolio's TWRR is 89.6% (15.4% compounded annually) since inception, just 4 percentage points behind the S&P 500.

That first year's result of 18 points behind the market put the portfolio into a hole at the start, but I'm proud that I've managed to pretty much erase that (and at one point was over 9 percentage points ahead of the S&P 500).

My final "final thoughts"
I'd just like to say "thank you" to The Motley Fool for entrusting some of the company's money to my care, and I'm pleased to say I'm returning more than I was given. (It's nervous-making to manage some of your employer's money!)

I'd also like to say "thank you" to those of you who have followed this portfolio and who contributed to the many great discussions on the MUE discussion board over the years. I hope you've enjoyed following along and learning with me. I know I've enjoyed having you along for the ride.

And with that, I'll bid you auf wiedersehen.

The article Goodbye to the Messed-Up Expectations Portfolio originally appeared on Fool.com.

Jim Mueller owns shares of Core Laboratories, Mobileye, Netflix, and Western Digital. Jim Mueller has the following options: short June 2015 $405 calls on Netflix and short June 2015 $170 puts on Core Laboratories. The Motley Fool recommends Apple, Core Laboratories, and Netflix. The Motley Fool owns shares of Apple, Bridgepoint Education, Core Laboratories, Dillard's, Mobileye, Netflix, and Western Digital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.