If your portfolio was quoted on the stock exchange, would you buy it?
If your portfolio was a business, quoted on the stock exchange, would you buy it? Warren Buffett's portfolio, Berkshire Hathaway, is quoted on the stock exchange, but nevertheless he applied his mind to this topic some years ago.
To answer the question, he added the total earnings and dividends generated by each holding, and compared these to the total value of the portfolio. He coined the term 'look-through' to describe this approach to portfolio management, and it can reveal some surprising truths about your investments.
What does it look like?
A simple example would look something like this:
| Company | Price (p) | Quantity (shares) | Value (£) | EPS (p) | Earnings (£) | P/E ratio |
|---|
| AstraZeneca (LSE: AZN) | 2,843 | 200 | 5,686 | 366.0 | 732 | 7.8 |
| BAT (LSE: BATS) | 1,938 | 200 | 3,876 | 136.0 | 272 | 14.3 |
| Diageo (LSE: DGE) | 1,055 | 250 | 2,638 | 68.0 | 170 | 15.5 |
| Phytopharm (LSE: PYM) | 12 | 30,000 | 3,600 | -2.8 | -840 | -4.3 |
| Portfolio | | | 15,800 | | 334 | 47.3 |
The owner of this portfolio might think he has a fairly conservative core holding, with a little speculative punt in the form of Phytopharm (LSE: PYM) tacked on for some excitement. Would he be surprised to find he that, in aggregate, his portfolio has a price/earnings ratio (P/E) more appropriate to a high-risk strategy?
These situations can sneak up on us, as the relative weightings in a portfolio change over time, and as companies miss or exceed forecasts. Buffett's "look-through" helps us to spot these situations, so we can then decide what, if anything, to do about them.
Practicalities
In practice, this spreadsheet would be extended to include a similar calculation for dividends, and to incorporate any other information you consider relevant. I use results for the last year, and any forecasts for current and future years. From this I can calculate the expected portfolio earnings growth, and portfolio PEG. The spreadsheet also provides a good structure for holding summary qualitative data, and anything I else I regard as relevant, when reviewing my holdings.
Some measures are more suited than others to this approach, so don't forget to use common sense. For example, I wouldn't consider something like dividend cover to be appropriate to a look-through, as the companies are acting independently and a loss or cash-flow problem in one company will not affect the dividend paid out by another.
You'll notice also that it makes no sense to take an average, or weighted average, of the P/Es; instead you need to look at total portfolio earnings and value, and do the calculation on these.
While I still make buy and sell decisions based on the merits of each individual share, I also like to have a feeling for my overall portfolio and how it compares to the market -- I'm aiming to beat the market, after all, otherwise I'd buy a tracker. For that reason, I regard the "look-through" as one of the more useful tools in our investing toolbox.
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