John Neff: A Value Strategy

11/28/2014 9:00 am EST


John Reese

Founder and CEO, And Validea Capital Management

Most investors wouldn't give a fund described as "relatively prosaic, dull, conservative" a second glance. That, however, is exactly how John Neff described the Windsor Fund that he headed for more than three decades, explains John Reese, editor of Validea.

And, while his style may not have been flashy or eye-catching, the returns he generated for clients were dazzling, so dazzling that Neff's track record may be the greatest ever for a mutual fund manager.

By focusing on beaten down, unloved stocks, Neff was able to find value in places that most investors overlooked. Over his 31-year tenure (1964-1995), Windsor averaged a 13.7% annual return.

How did Neff do it? By focusing first and foremost on value and a key part of how he found value involved the Price/Earnings Ratio.

To Neff, however, the P/E wasn't always a lower-is-better ratio. If investors knew that a firm was a dog, they'd rightly avoid its stock. Because of that, he wrote that Windsor targeted stocks with P/E ratios between 40% and 60% of the market average.

He also wanted to see earnings growth, but here again it was not a case of more-is-better. A stock with too high a growth rate—more than 20%—could have trouble sustaining that growth.

He thus preferred to see growth between 7% and 20% per year, the kind of steady, unspectacular growth that could be sustained.

To make sure that his analysis captured dividend payments, Neff used the Total Return/PE ratio. This measure divides a stock's total return (that is, its EPS growth rate plus its dividend yield) by its P/E ratio.

He looked for stocks whose Total Return/PE ratios doubled either the market average or their industry average. Here are five of the stocks that currently earn a spot in our Neff-based model portfolio:

United Insurance Holdings Corp. (UIHC)
Home Loan Servicing Solutions (HLSS)
Starwood Property Trust (STWD)
Franklin Resources (BEN)
AXIS Capital Holdings Limited (AXS)

Our Neff-based model often treads into the most unloved parts of the market and is now heavily concentrated in the financial sector. Most of them are dirt-cheap thanks to lingering fears about the economy and financial sector.

By treading into such unloved areas, a value-focused strategy can languish for lengthy periods of time and the Neff-based portfolio has indeed struggled in recent years.

But Neff succeeded by staying disciplined, focusing on value, and having the patience to wait for others to recognize the value in his picks.

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