Six months (the half way mark)  are up since I started the challenge of a model portfolio I picked in five minutes, versus Austock’s list of preferred stocks (at 6th July 2011). My model portfolio is comfortably beating Austock’s preferred stocks by more than 5%, and also outperforming the ASX 200 Accumulation Index by 0.8%. Had you followed Austock’s recommendations, you’d now be facing an un-realised loss of $29,181, compared to a loss of $12,836 if you had followed my tips.

This is despite Zicom Group (ASX:ZGL) shares in my portfolio falling 60%+, including over 30% in one day last week.

Much of investing is an art and you won’t always get every stock pick right. What matters is that your winners more than make up for your losers. As you can see from the picture above, 16 out of 30 stocks in my portfolio are beating the index, while the Austock portfolio only has 11 stocks beating the index, or in other words, 19 of Austock’s picks out of 30 are NOT beating the market – so much for vaunted stock pickers.

I’ve attached a copy of the spreadsheet (224kb), so you check out all the gory details yourself.

Stock Markets have continued to fall in December due to the uncertainty around Europe and the US. I expect this to continue for some time it and could possibly be years before markets recover. Until Europe put in place a proper plan to resolve the issues it faces, markets will continue to be volatile and fall further.

I’ve also attached the spreadsheet (260kb) so you can see the individual stock performance of both portfolios.

The company said that sales in Europe have been affected by “Sovereign debt issues and fears of a global recession, impacting consumer spending patterns significantly”. Europe is also being affected by bad weather due to limited snowfalls.

Sales in Australia have been significantly affected by unseasonably cold summer weather, despite the November rate cut by the RBA.

Operational review

Billabong says it has “limited ability to reduce the relatively fixed cost base in the short term.” Despite that, the company plans to make reductions to its overheads. This would be the usual strategies of cutting staff, trying to manage expenses more closely and cutting out any unnecessary spending.

Strategic Review

Billabong also stated that it needs to strengthen its capital structure, due to the current environment and risks of further deterioration.

What could we expect?

The company stated “Raising equity is not the preferred path at this time as the company is reviewing other options”. Despite what the company says, Billabong only has three options. The company can raise equity capital, borrow more from their bankers or sell assets. I’m banking on the former. The company may be forced to offer shares at a big discount, so now is not the time to be buying Billabong shares.

With $613m of debt (as at 30^th June 2011) versus current market capital of 558m, it’s unlikely that its bankers will be happy to lend more without major structural changes or conditions. This could be a sale of some of its assets and non-core brands and may also involve a change to the company’s direct-to-consumer business model of retail stores and online businesses.

Whichever option is chosen, its going to take Billabong some time to recover, if ever.

Spotless Group Limited

So why the big difference between offer price and trading price? The main reason as I see it is that the market is not completely confident that the takeover will proceed. The market is pricing in the risk that PEP will walk away. My view is that they should walk away anyway. Should PEP walk away, Spotless’s share price is likely to crash to lower than $2.00 and possibly much lower. My view is that the potential return doesn’t mitigate the risk and the price differential is a trap.

Spotless is not a great company, and its performance over the last 10 years has been ordinary to say the least. Prior to the takeover, Spotless shares were trading under $2.00, and have fallen from just over $8 since 2001. It’s not hard to see why the share price has fallen that far when you analyse their financial statements over the past 13 years.

• Scored a MikeRating of 2.1 (out of 10) for its historical and current financial results
• Return On Equity (ROE) has been falling, and was 9.6% in 2011. Long term its averaging less than 12%
• Return on Assets (ROA) has been less than 10% since 2007
• Book Value Per Share (BVPS) has risen at less than 2% a year, less than inflation
• Earnings per share (EPS) in 2010 and 2011 were less than it was in 1998
• Net Profit have almost doubled, but so have the number of shares from 131m to 261m
• Profit margin is under 2% and has been for last 4 years. Long term average is 2%. That’s fine for a company like Woolworths (ASX:WOW) with $54Bn in Sales, not for Spotless.
• Free Cash Flow is low compared to Operating cash flow and was negative in 2011

I accidentally started watching the “Inside Job” the other night and was glued to the screen for two hours until the finish. The movie is a 2010 documentary on the Global Financial Crisis (GFC), but focuses on the CEOs of Wall Street investment banks and the US regulators and their actions.

Many of those directly involved with the GFC were invited to be interviewed for the movie, and not surprisingly, many of the lead actors in the GFC declined to be interviewed. I was amazed at how ridiculous some of those interviewed looked. The over-riding thought I had while watching the movie was this “this person being interviewed should have known better”. Many of the interviewees were professor’s and lecturers at famous US universities or had high levels of education, so you’d think they’d be highly knowledgeable and experts in their field. I suspect simple human greed led them to do the things they did more than anything else.

This movie provides a definite contrast with the “other” GFC movie “Too Big To Fail“, which came out in 2011. Now that I think about it, I wonder if Wall Street paid for “Too Big To Fail”, so it would show them in a better light?

What really amazed me was that hardly any action has been taken post GFC to stop it happening again. Not one person was ever charged with criminal offenses, not one person put in jail. The Banks that survived (Goldman Sachs, Bank of America, Wells Fargo etc) are now much larger, and mostly the same people who were leading them before and during the GFC, are still there. Many of those who left or were forced to leave, walked away with millions of dollars in severance packages, and that’s not counting the ridiculous amounts of money they were paid before and during the GFC.

What’s scary is that hardly anything has changed from before the GFC to after. Investment Bank practices haven’t changed, Regulators still don’t have full control over all financial instruments in the US and the ratings agencies still have too much power.

I can see where the 99% revolution’s anger comes from, after watching this movie. Corporate greed at its worst, regulators missing in action, with conflicting interests and the poor man in the street made to bear the brunt of the after effects.

I can thoroughly recommend this movie, for an in-depth look inside Wall Street Investment banks and the US regulatory authorities.

Stock markets have continued to be volatile. Some days the Australian market follows Wall Street, and on other days we seem to be forging our own path. The rise and fall of some stocks’ prices has been hard to fathom. For some companies, no news is good news and for others it seems to be bad. Just goes to show how the market is pulled this way and that by short-term factors, investors confidence and their psychology.

Europe’s and America’s debt issues are still a storm cloud hanging over investor’s heads, and there doesn’t seem to be any end in sight. It’s all doom and gloom.

During times like this its important to remember that investing is for the long-term, and these issues will pass…at some stage anyway. It’s also important to remember that it’s almost impossible to time the market, so there’s no point saying “should I sell now and maybe buy back in later when it reaches the bottom?”

Look at all your stocks and remember why you bought them. Are they still on target to meet your aim? And if so, are they cheap? You might want to consider buying more. If the stocks don’t look like meeting your goal, you might need to consider selling all or part of your holdings. Maybe you can also see better opportunities out there.

Personally, I’m sitting on all my stocks in my portfolio and SMSF, and biding my time. I’m happy with my current list of stocks and I’m confident that many of them will perform well in the future. I’m not in a position to be able to buy much more at the moment, otherwise I’d probably be shopping like there’s no tomorrow.

I’ve also attached the updated spreadsheet (135kb), so you can see the detailed performance of each portfolio.

I have issues with Roger’s valuation methodology in using Return On Equity(ROE) and Book value per share (BVPS) to calculate a value for a stock. I don’t believe Return On Equity is a true indicator of a company’s ‘worth’, as companies can use debt to increase ROE, but Roger’s valuation methodology doesn’t take debt into account. (I assume that his/Skaffold’s ratings do).

BVPS is a snapshot in time and an accounting valuation that includes intangibles, goodwill and other accounting methods that do not represent the true value of a company. As just one example, companies are allowed to determine their own values for some assets, which may or may not represent the true value; property assets may be valued at  the purchase price or an assessment of their current market value (which may not have been assessed for some years).

Skaffold shows up these issues by the fact that the top ten highest quality stocks are all listed investment companies, and almost all the top 20 quality rated companies are also listed investment companies. RHG Limited (ASX:RHG) is listed as an A1 stock with a 90% safety margin and a valuation of $4.00 in 1 year compared to the current price of 40 cents . That’s crazy for a stock who’s profits are declining year by year as it runs off its mortgage book, and the company won’t exist in a few years time.

Here’s a list of the other issues I have with Skaffold.

• There’s no insight into how it calculates a stock’s value (although you can get some idea from Roger’s book Value.Able)
• There’s no insight into how it calculates a company’s rating (A1 down to C5)
• There’s no commentary or recommendations from the Skaffold experts of what they think of a stock e.g. what’s management like, or which stocks are worth buying?
• Its written in Adobe Flash, so you can’t view it on an Ipad or Iphone. I can only imagine that was done to stop subscribers copying pages and data easily.

For myself, I’d much prefer to see the underlying data that goes into a valuation, and the inputs into a company rating. Hence the reason I’ve developed my own models, valuation methods and company rating mechanism. Samples can be seen as Excel attachments in some of my blogs on specific companies, and a FREE template here.