Custom Index Funds - March 2021 Update
Since May 2020, we’ve been having a friendly competition between a few popular valuation ratios. It all started as a battle between dividend yield and shareholder yield. I built a 30-stock portfolio with the highest ranked stocks in each sector according to five different valuation metrics.
If you want to see the entire portfolio (including all the holdings), using this link to M1 Finance. Heads up: if you click this link and end up signing up for M1, you will get a $30 bonus (and so will I).
We’re basically creating our own index fund with these strategies and plan to hold them indefinitely (with adding new positions later). The portfolios all beat the S&P 500 in 2020 and that continued with impressive returns to start 2021.
For more information on how these portfolios are constructed, read November 2020’s breakdown and then come back. If you're already familiar, then below is the progress of the portfolio since inception.
Each month, I post an update on how each fund has been doing. We're attempting to see, in real time, which valuation metric will 'rule them all'? Here are the different valuation ratios we're looking at:
The Valuation Ratios Used
Buffett yield is a custom metric that I designed to attempt to approximate the approximate yield that an owner would recieve if he or she were to buy the entire business and pay off all its debts. To calculate it, I use 10-year average free cash flow / enterprise value.
Dividend yield is a common metric used by value investors and, obviously, dividend investors seeking current income. Its also, in my opinion, a grossly overrated metric. To calculate it, I use the trailing 12-month dividend per share / price per share.
EBIT/EV Yield has some impressive research behind it. It's similar to my 'Buffett yield' concept, except (1) it uses income statement numbers rather than cash flow and (2) it utilizes a single year, whereas my 'Buffett yield' calculates an average over 10 years. This metric is far better than P/E ratio both logically and in historical backtests. The calculation is: Highest operating income (EBIT) / enterprise value (EV).
Shareholder yield is one of my personal favorite metrics. It assumes that a company buying back stock is beneficial for shareholders, whereas issuing equity (dilution) is bad for shareholders. Adding whatever is bought back to dividends tells us how much cash flow the company is giving back to shareholders. The calculation is the total dividends paid + total buybacks (or negative if equity issuance) / market cap.
So, how have they performed so far through early March?
2021 Performance 
Forward P/E ratio: +22.0%
EBIT/EV yield: +19.7%
Dividend yield: +18.6%
Buffett yield: +17.7%
Shareholder yield: +12.1%
Equal weighted S&P 500 (RSP) +7.0%
S&P 500 (SPY): +3.3%
2020 Performance 
Shareholder yield: +49%
EBIT/EV yield: +44.5%
Forward P/E ratio: +43.8%
Buffett yield: +43.4%
Dividend yield: 39.5%
Equal weighted S&P 500 (RSP) +39.2%
S&P 500 (SPY): +33.5%
The first, and most obvious, is that these valuation portfolios have been absolutely crushing it. I can't say I expected that to happen, especially to the degree that it has. It's also been pervasive across all of the strategies - not just one or two.
Second, shareholder yield has clearly taken a step back since the start of 2021. The 'reopen trade' has been back on, so some of the higher quality names (such that shareholder yield generally contains) have underperformed.
Third, the equal weighted S&P 500 has outperformed the S&P 500 (market cap weighted). This confirms the otherwise obvious trend of small/mid-cap stocks outperforming since the market bottomed in March. That has continued and accelerated since the start of the new year.
Fourth, the winners are carrying the entire portfolio. That's obvious if you look into each of the portfolios.
New Strategies Coming Soon
As we move ahead into 2021, we’ll see how these portfolios continue to perform. I was planning to update them 12 months from the initial rebalance, but have since reconsidered. I'll discuss more on that later and the rationale behind my new move.
There also may be some new strategies for 2021 that I’ll be rolling out over the next few months. For now, though, that will have to wait. We had our third baby on February 19th, so I've been slow to respond to YouTube comments, emails, and - clearly - slow to get new content out (both here and videos). Thanks for your patience and continued support! 🙂
DISCLAIMER: This is for educational purposes only and is not investment advice. It is not a recommendation to buy or sell any security. The author owns every stock mentioned above. All opinions are my own.
 From January 4, 2021 through March 3, 2021. Source: M1 Finance 'Valuation Ratio Derby' From May 4, 2020 through December 31, 2020. Source: M1 Finance 'Valuation Ratio Derby'