The Buckingham Report

Paraphrasing an Associated Press account of the race, "Jockey Calvin Borel followed his instincts to the biggest victory of his career, moving Street Sense from next-to-last like an accelerating locomotive to win the Kentucky Derby. As the field turned for home, the colt blew past one horse after another on the rail, then went wide to squeeze past Hard Spun, his final challenger."

While the winning jockey's nickname of 'Bo-rail' has been earned by his desire to hug the race-track fence (he says, "It's the shortest way around the track."), Mr. Borel's willingness to change course and 'go wide' as the opportunity was presented allowed Street Sense to win the Derby.

We think folks on Wall Street could use a little of Mr. Borel's Street Sense as we have never understood the financial industry's willingness to be boxed in. It is our contention that limiting investment possibilities by market capitalization or traditional value-versus-growth distinctions only serves to limit returns. If small-cap stocks have had a great run, it's time to start looking at mid- and large-cap companies. If a $100 million semiconductor stock with a cash-rich balance sheet is inexpensive, we have no anti-tech bias that’s going to preclude us from buying it. If a $100 billion financial behemoth with a single-digit P/E is on sale, we’re buying. Bargains are bargains, and we’ll be there to take advantage of them.

We believe that our style-agnostic mindset affords greater opportunity to deliver top-of-table returns over the long term. For example, the TPS Versus All Value/Growth chart shows that $1 invested at the end of 1976 would have grown to $24.07 if it was kept in Growth Stocks, according to data from Morningstar (which purchased Ibbotson Associates, the original source of the data, not too long ago). Showing a little better return, if that same $1 was invested in Value Stocks, it would be worth $45.14 at the end of 2006.

Click to Expand Image
Were one to have had the benefit of 20/20 hindsight and been able to switch at the beginning of each year into either the Value Stocks or Growth Stocks category, depending on which would see the best return in the ensuing 12 months, the $1 would have grown to $99.03. Happily, had the $1 been invested in our unrestricted, go-anywhere strategy, as represented by Al Frank's three-decades-old TPS Portfolio, it would be worth $350.10!

Taking the analysis one step further in the TPS Versus Style chart, we again see what is possible when a manager's hands are not tied by arbitrary market-capitalization or style-box restrictions. Again utilizing Morningstar data, we see that the same $1 invested at the end of 1976 would be worth anywhere from $22.59 in the Large Growth classification to $143.82 in Small Value. Were one truly able to time the best of these six classifications each and every year, the $1 would have grown to $898.91, illustrating what is possible with the freedom to invest as the manager best sees fit.

 
Click to Expand Image
While it is true that TPS Portfolio's $350.10 tally trailed the Best of the Style Indices, we must point out that we know of no investor that has been able to pick the best style box each and every year. Don't believe me? Consider that Warren Buffett, widely thought to be one of the greatest investors of our time, has been able to grow the per-share book value of Berkshire Hathaway by 22.7% per annum. As depicted in our TPS Portfolio Versus Buffett chart and using a starting index value of 1, Berkshire's book-value would have an index value of 464.51 at the end of 2006. This compares to an index value of 33.52 for the S&P 500 over the same time span.

Click to Expand Image
With the S&P 500's return since the end of 1976 working out to an annualized 12.4% while TPS Portfolio has enjoyed a 21.6% annualized rate of return, we aren't too unhappy that the Oracle of Omaha has a slight lead at the quarter pole of the performance derby!

Disclosures 

TPS Portfolio – Does not contain pooled investments and is not available for direct investment. The portfolio adheres to the investment principles and philosophies as put forth in The Prudent Speculator. The current composition of the portfolio can be found by logging on to the subscription portion of our website at alfrank.com. The TPS portfolio is leveraged and real and if leverage is not used, a client or subscriber’s total returns could be materially different. The portfolio contains domestic equities that are managed with a view towards capital appreciation, and may hold stocks that range in capitalization from micro-cap to large-cap.

Historical Performance - TPS Portfolio has been in existence since 3/10/77 and has been active throughout numerous market environments.

Future Performance - Past performance may not be indicative of future results. Therefore, you should not assume that the future performance of any specific investment or investment strategy will be profitable or equal to corresponding past performance levels.

Performance Calculations – The performance results are calculated by actual total return, including effects of dividends reinvestments, margin leverage and net of margin interest charges, trading costs and subscription costs.

Comparison to Performance Indicators

Indices are not available for direct investment.

S&P 500 - An index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Companies included in the index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor's. The S&P 500 is a market-value weighted index - each stock's weight in the index is proportionate to its market value.

Small Value – A portfolio of stocks constructed by first selecting deciles 6-8 of the NYSE universe. Once these breakpoints are established, similar-sized AMEX and NASDAQ companies are assigned to the corresponding portfolios. The companies are then ranked by book-to-price, creating a growth portfolio (high B/P) where the total market capitalization of the growth and value indices are equal to each portfolio. (Style index)

Mid Value – A portfolio of stocks constructed by first selecting deciles 3-5 of the NYSE universe. Once these breakpoints are established, similar-sized AMEX and NASDAQ companies are assigned to the corresponding portfolios. The companies are then ranked by book-to-price, creating a value portfolio (high B/P) where the total market capitalization of the growth and value indices are equal within each portfolio. (Style index)

Large Value - A portfolio of stocks constructed by first selecting deciles 1-2 of the NYSE universe. Once these breakpoints are established, similar-sized AMEX and NASDAQ companies are assigned to the corresponding portfolios. The companies are then ranked by book-to-price, creating a growth portfolio (high B/P) where the total market capitalization of the growth and value indices are equal to each portfolio. (Style index)

Small Growth - A portfolio of stocks constructed by first selecting deciles 6-8 of the NYSE universe. Once these breakpoints are established, similar-sized AMEX and NASDAQ companies are assigned to the corresponding portfolios. The companies are then ranked by book-to-price, creating a growth portfolio (low B/P) where the total market capitalization of the growth and value indices are equal to each portfolio. (Style index)

Mid Growth – A portfolio of stocks constructed by first selecting deciles 3-5 of the NYSE universe. Once these breakpoints are established, similar-sized AMEX and NASDAQ companies are assigned to the corresponding portfolios. The companies are then ranked by book-to-price, creating a value portfolio (low B/P) where the total market capitalization of the growth and value indices are equal within each portfolio. (Style index)

Large Growth - A portfolio of stocks constructed by first selecting deciles 1-2 of the NYSE universe. Once these breakpoints are established, similar-sized AMEX and NASDAQ companies are assigned to the corresponding portfolios. The companies are then ranked by book-to-price, creating a growth portfolio (low B/P) where the total market capitalization of the growth and value indices are equal to each portfolio. (Style index)

All Value Stocks – A portfolio of stocks constructed using the lagged market capitalization-weighted returns of the large-, mid-, and small-cap value series.

All Growth Stocks - A portfolio of stocks constructed using the lagged market capitalization-weighted returns of the large-, mid-, and small-cap growth series.

Best of Styles Indices – The performance number is used solely for illustrative purposes, as performance is nearly impossible to duplicate.

Berkshire Hathaway – The annualized return was calculated by taking the annual percentage change in per-share book value of Berkshire Hathaway corporate performance from 1976 to 2006.

Decile – One of 10 portfolios formed by ranking a set of securities by some criteria and dividing them into 10 equally populated subsets. The New York Stock Exchange market capitalization deciles are formed by ranking the stocks traded on the Exchange by their market capitalization.

Book Value - The net asset value of a company, calculated by total assets intangible assets (patents, goodwill) and liabilities.

About Al Frank Asset Management

Al Frank Asset Management, Inc. (Al Frank) is an Investment Adviser, registered with the Securities & Exchange Commission, is editor of The Prudent Speculator (TPS) newsletter, editor and publisher of The Prudent Speculator TechValue Report (TVR) newsletter, and is the Investment Adviser for individually managed accounts and two value-oriented no-load proprietary equity mutual funds.

Al Frank is committed to assisting our customers build wealth. We strive to be a leading resource for value-based investor information in the financial community, where we combine our simple, time-tested philosophy of buying under valued securities for their long-term appreciation with our experience, hard work, and intensive research to give you actionable investment information that can be used on a daily basis.