This (northern) summer, the team on The Value Perspective set about narrowing down the 55,000-odd listed companies in the world to half a dozen or so "must-own" stocks. Here's how.

A common misconception among both professional and private investors is, if you are not constantly buying and selling shares, you risk missing out on "opportunities" and so will underperform.

That is by no means necessarily true and yet on discovering the below-average frequency with which we buy and sell shares, here on The Value Perspective, people will often blurt out: "Then what do you do all day?" Well, here is a taste …

As the days grow colder and the nights longer, you may find yourselves thinking fondly back to all the fun things you got up to this summer.

Here on The Value Perspective, however, we are only now bringing to a close one of our favourite summer activities--our so-called "Summer Scramble," which sees the team whittling down the 55,000 or so listed companies in the world to a handful of "must-own" value stocks.

How do we do this?

The most efficient way to cut such a broad universe of businesses down to a more manageable number is by screening out those that do not meet certain key criteria.

Any business we own must be easy to buy and sell so our stipulation only those with a free float--that is, the amount of shares available to trade publicly within their own market--above $500 million make the cut quickly narrows the field to around 7,000 stocks.

The next hurdle these companies must pass is one of our preferred valuation metrics, known for short as the "EV/NOPAT". This divides a company's enterprise value by the 10-year average of its net operating profit after tax, which is a measure of profit that excludes the costs and tax benefits of debt financing. Any business boasting a ratio of 16 or less makes it through to the next round.

By now, the initial 55,000 or so companies are down to around 600 and you can see the geographical spread of this year's Summer Scramble in the chart below.

By the time we have ensured the businesses are of a sufficient size and degree of liquidity--and that they have English language accounts and not too much debt on their balance sheets--a "priority" list of 190 or so are left standing.

This is where the hard work really begins for the team, with each member analysing one company per day over the next two or three months. During this time, the 190 will be narrowed down to 40 and then to a shortlist of 20--of which we may end up buying perhaps half a dozen mispriced deep-value companies with substantial upside on a medium to long-term view.

 

chart

For illustrative purposes only and should not be viewed as a recommendation to buy or sell

 

That means we expect to hold them over the next three to five years, on average, until the share price reflects what each business is truly worth--although we would sell them sooner should the wider market take less time to agree with our initial analysis.

The Summer Scramble is a huge project but one we believe will prove well worth it--and of course we save every bit of research to refer back to the next time we do it all again.

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Nick Kirrage is the lead portfolio manager for the Schroder Global Recovery Fund. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

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