PASADARM: A Time-Tested Value Investing Strategy


January 25, 2017

Don’t worry if you’re racking your brain for all the acronyms you know and are coming up short. When it comes to PASADARM, you are in the very large majority. Our founder, the late Al Frank, coined the term PASADARM to refer to his value investing strategy. Forty years later, we believe it still holds true.

PASADARM consists of 4 core principles for value investing:

  • Patience: What your mom told you to have as a kid is also important when it comes to your financial future. Patience is a naturally difficult concept, but it comes into play not only when holding an investment position within your portfolio until it reaches its target price, but also when you are determining whether or when to purchase a stock. Patience can keep you from making a rash decision.
  • Stock selection: This is exactly what it sounds like – do research and analysis to determine if the stock is undervalued  (using such metrics as price/earnings, price/sales, and price/book value). There is also a qualitative element that incorporates your personal knowledge of current events that may impact that company or industry. You want to shop for stocks the way you shop for groceries: try to find bargains.
  • Diversification:  Most people understand the concept of not putting all of your eggs in one basket. You hold a variety of different stocks so that if one underperforms, your whole portfolio should not suffer nearly as much as it would if you only had a few positions. Research from Stock Market Logic[1] indicates that diversification can help mitigate risk. Al’s rule of thumb was to have no more than 5% of a portfolio in any one equity.
  • Risk Management: This element was added to the acronym after the Crash of ’87, when Mr. Frank realized that the risk management principles built into selection, diversification and patience might not provide enough protection. There are many different types of risk. One is opportunity risk: the risk of investing an asset one way, which foregoes the potential opportunity that another investment could have provided. Another type is individual stock risk. This is typically associated with volatility within the market, which can have a positive or negative impact on your portfolio. The most important thing to remember is that portfolio risk management should include your total financial picture.

Are you still wondering what PASADARM stands for? It stands for Patience And Selection And Diversification And Risk Management. You might be asking, why add the “ands” to the acronym? Well, of course it makes the acronym pronounceable, which is helpful. Another reason is the “ands” are logically conjunctive, meaning that all elements are tied together and work together. So PASADARM not only names but also represents our core value investing strategy.

Now you may be asking if investing using this PASADARM approach could really work for you. Al Frank first employed this strategy back in 1977 with his Prudent Speculator newsletter. We continue to adhere to these concepts today with our value-based separately managed account strategies. As you can see below, a hypothetical investment of $100,000 in 1977 in our TPS Portfolio would be valued at over $69 million (as of 12/31/2016). The S&P 500, a commonly referenced benchmark for investors, would be valued at over $6 million.

pasadarm_graph

The PASADARM approach may seem simple. We believe it is simple if you have the time to do detailed research and the patience to hold onto the stocks long enough to optimally bear fruit despite headlines that stoke emotional reactions and overall market ups and downs. But you must fully commit to both. It is simple, but far from easy.

The Case for Value Investing

We believe that you pre-pay for expectations in growth stocks, whereas value stocks have already been discounted. This is why over the long-term, growth stocks have trailed value stocks, returning an annualized average of 9.4% while value stocks have returned an annualized average of 13.6% over the same time period.

Download The Case for Value Investing

Important Information:

Nothing presented herein is, or is intended to constitute, specific investment advice. Information provided reflects the views of AFAM Capital, Inc. (AFAM) as of a particular time. Such views are subject to change at any point, and AFAM shall not be obligated to provide notice of any change. While AFAM has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability or completeness of any third-party information presented herein. No guarantee of investment performance is being provided and no inference to the contrary should be made.

There is a risk of loss from an investment in securities. Past per­formance is not a guarantee of future performance.

TPS Portfolio is Al Frank’s actual investment portfolio. Though not presently leveraged, it has been so in the past. The use of leverage magnifies gains and losses and increases risk to a portfolio. The portfolio was comprised of 100% non-fee paying accounts until the portfolio was opened to other investors effective 12/31/15.

There are inherent limitations with hypothetical portfolio results as the securities are not actually purchased or sold. The results may not reflect the impact, if any, of material market conditions which could have had an impact on AFAM’s decision-making if the hypothetical portfolios were real. Hypothetical performance is shown for illustrative purposes only and should not be interpreted as an indication of performance of any AFAM portfolio.

For comparison purposes, the illustrated results are measured against the S&P 500 Index, a broad market index of the U.S. equity universe. The S&P 500 is includes the 500 leading companies and captures approximately 80% coverage of available market capitalization. It is not possible to invest directly in an index.

The U.S. Dollar is the currency used to express performance. Returns are presented net of applicable management fees, gross of withholding taxes on any dividends, interest or capital gains, and include the effects of trading costs and reinvestment of all income. Net of fee performance was calculated using actual applicable management fees charged to the client. Actual investment management fees will vary, beginning at 1.5% per annum. Our full management fee schedule is described in more detail in Form ADV Part 2A.

AFAM Capital, Inc. is a registered investment adviser. AFAM is editor of The Prudent Speculator newsletter and is the investment adviser to certain proprietary mutual funds and individually managed client accounts. Registration of an investment adviser does not imply any certain level of skill or training.

063-AFAM-2/15/2016

[1] Al Frank’s New The Prudent Speculator, p. 71, 1996. Adapted from Norman G. Fosback, Stock Market Logic , p. 254.

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