Thrifty 30, Nifty Thrifty – what’s the difference?

Playing the expectations game

From Steven by email:

Being a total newcomer to investing, can I ask why your portfolio of shares seems to be quite different from those in the  Money Observer portfolio, when the investing principles seem to be similar?

Thanks for your email, it’s given me an opportunity to think about what I’m doing!

I operate two model portfolios, the Thrifty 30, the main subject of this blog (you can also read about it in my Share Sleuth column for Money Observer magazine – I maintain an archive here), and the Nifty Thrifty on the Money Observer website (you can also read about it in Money Observer Magazine – here’s the archive). 

You are right, they operate on the same principle, that investing in sound companies at cheap prices is a relatively low risk, high reward method. It’s low risk because the companies are profitable (in most years) and financially strong (as opposed to loss-making and weak) and we are not paying too much for them. It’s high reward because there are two ways for the market value of such companies to rise, as they make more profit (money for investors), and as the market (investors in general) realises it’s underestimated them.

But there are three big differences between the portfolios:

1. There are no limits on the size of the companies in the Thrifty 30 but the Nifty Thrifty is limited to large companies, with market values over £500m. The Thrifty 30 is almost entirely smaller companies because there are many more of them and smaller companies tend to be undervalued.
2. Companies in the Thrifty 30 are hand-picked by me. I screen the market using a computer to identify likely candidates. I then investigate the most promising to verify the story the numbers tell me about profitability, financial strength and value. I may go back through ten year’s of financial reports and less often talk to the company itself. The Nifty Thrifty stops at the computer stage. I just add the shares ranked most highly by the computer. 
3. The Nifty Thrifty uses one method to identify good companies at cheap prices, equally weighting profitability (a sign of quality) and value. The Thrifty 30 embraces a wider spectrum of companies, including bargains, which might be better described as shares so cheap investors have given up on them.

As a result, the two portfolios have no holdings in common.

Perhaps the most common mistake newcomers make is assuming good companies make good investments, and struggling companies make bad investments.  The critical factor they omit in that model is price. Unless you buy and hold shares forever, the difference between the price you pay and the price you sell the shares for is likely to make up a significant proportion of your return as an investor (the rest coming from dividends).

The price of a share is determined by all investors’ expectations for that company, the more profit the market thinks the company will make in the future, the higher the price will be now. So buying companies with sound finances and businesses, but unremarkable prospects can be very rewarding simply because investor’s expectations are so low and the shares are so cheap.

In that sense, the Thrifty 30 is more tilted towards value than the Nifty Thrifty.

From a practical point of view, the Thrifty 30 is a lot of work, even if I didn’t have to write everything up it would take me a day a week or more to run it. The Nifty Thrifty would probably take half a day every three months.

Anticipating a supplementary question, I don’t know which is the better method. It depends whether my judgment adds enough to the the Thrifty 30 to make it worth the effort. Many argue judgment is fickle, and likely to reduce the performance of a portfolio, so in a sense by running two parallel portfolios I’m pitting man against machine.

Time will tell, we’ll know when we can compare the portfolios after five years or more.