Is John Dorfman’s Robot Portfolio worth your money?

Everyone knows the story of the monkey (which represents the passive investor) who beat the active investment manager, a story that has been repeated many times throughout history. But, it’s well known that most investment managers lose to the indices, so the more interesting question is whether the monkey is able to beat the market.

In other words, is there an automatic or passive investment strategy that is based only on a fixed set of criteria without further in-depth analysis of each security individually, that can achieve higher returns above the index return over time?

There are many benefits to such a quantitative investment strategy: you don’t have to spend a lot of time analyzing companies, you don’t have to try predicting market behavior, and you can also deal with market volatility more easily.

If you’re a proponent of the efficient market theory, you probably won’t believe such a magic formula. But, if you believe, like me, to the proven statistics that stocks with lower-than-average multipliers ​​produce excess returns, there is no reason why you should not believe in the ability of such quantitative strategies to beat them.

Indeed, over the years, dozens of such formulas have been proposed, starting with Benjamin Graham’s Net-Net stocks from 90 years ago to Joel Greenblatt’s magic formula introduced in 2004. All these strategies are based on a similar principle of selecting a basket of quality companies whose shares seem to be cheap based on low multipliers like Price to Earnings, Price to Book Value and sometimes more advanced multipliers, hold it for one year, and than sell and replace it with new winning stocks. It’s that simple.

The Robot Strategy

One of my favorite strategies is the Robot Portfolio suggested by the fund manager and Bloomberg’s columnists, John Dorfman. Dorfman’s robot portfolio selects the 10 stocks of large profitable and non-leveraged companies with the lowest Price to Earnings multiplier, holding them for a year and then replacing them with 10 new robot stocks.

Over the past 21 years since launched in 1999, the robot portfolio has delivered an impressive 12.26% average annual return, well above the S&P 500 return over the same period, 6.55%. The robot didn’t beat the market every year and obviously had some negative years; it went down by 61% in 2008, -31% in 2007, and even lost 11.2% in 2019 when the US market went up by almost 30%. Still, it yielded a cumulative return of 1,034% since 1999 compared to the S&P 500 with only 379%. This is a huge excess return that makes this strategy very interesting.

How the robot stocks are chosen?

The robot screening starts by selecting US-traded companies with a market capitalization higher than $500 million. Now, it takes only those that had positive net profit in the last 12 months and has long-term debt lower than their Equity (book value). Finally, it chooses the 10 cheapest stocks by taking the ones with the lowest price/earnings ratio.

The 2020 robot portfolio

The robot portfolio that Dorfan has recently published for 2020 is full of traditional energy stocks. Nowadays, when the world tries to go green, the polluting energy companies are unpopular, thus traded at very low valuations. It could be justified if the alternative energy companies can supply all the electricity needs in the near future by themselves. Unfortunately, producing energy by burning coal and oil will probably be required for at least the next decade so it’s possible that energy stocks went down too sharply and could be a profitable contrarian investment idea.

In my opinion, this is not the case, and most energy stocks will perform very poorly in the near future, but no-one knows what will happen in the longer term. In any case, when buying the robot portfolio you don’t use any further analysis or commentary, just buy the cheapest P/E stocks.

The energy stocks that Dorfam choose to the robot portfolio are: 

  1. Southwestern Energy Co. (SWN), with a price/earnings ratio of 1.2.
  2. Warrior Met Coal (HCC) with a P/E of 1.7.
  3. Berry Petroleum (BRY), with a multiple of 3.
  4. Murphy Oil (MUR), at 3.4.
  5. Alliance Resource Partners LP (ARLP), 3.6.
  6. Arch Coal (ARCH), 4.0.

The other 4 robot stocks that close the portfolio are also very interesting companies:

  1. The cheapest insurance company – Brighthouse Financial (BHS), with a P/E ratio of 2.6.
  2. United States Steel (X), which returned to profitability in recent years, but still trade at low P/E of 3.
  3. Ligand Pharmaceuticals (LGND) with a P/E of 3.7, mainly because investors don’t trust the numbers in its financial statements.
  4. Live Ramp Holdings (RAMP), which sells relatively popular software for advertisers to organize information about their customers.

Obviously, all these companies have problems, otherwise, they weren’t traded at such depressed multipliers. This is exactly why the success of investing in the robot strategy requires buying all the 10 stocks together, without further analysis, and hold them patiently for one year. It might look scary, but this is the only way to go if you’re a quantitative investor that doesn’t like to work hard and want the potential to beat the indices.

In the LongRunPlan we present all the US companies that pass these criteria (we limit the P/E to 15) and update the list every day, so you can choose your robot stocks whenever you like.

The Robot stock list includes very interesting companies currently, and you’re invited to take a look at this link

quantitative strategies

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