Why This Pro Is Satisfied Matching the Market

The Motley Fool Pro's real-money portfolio opened in October 2008. Nearly two-and-a-quarter years on, and the portfolio is roughly even with the S&P 500's 40% gain. Despite this, Pro advisor Jeff Fischer is satisfied with the portfolio's performance (although no professional money manager is ever truly satisfied). How can that be? Isn't every portfolio manager's goal to beat the market?

Not your standard portfolio
Let's get things straight. Although the S&P 500's return is displayed on its portfolio tracking page, Pro's primary goal isn't to beat the index (positive relative returns). Rather, it's to achieve absolute returns, i.e. positive returns in any stock market environment. If Pro can do this, beating the S&P 500 should take care of itself. Let me explain why.

When you evaluate an investment manager or an investing strategy, it's short-sighted to look at the return figures only. It's more important to understand how those returns were achieved. In the case of Pro, returns have kept pace with the S&P 500, but Jeff achieved this with just 60% of the S&P 500's volatility.

Wait until the bear shows its teeth again
Why does lower volatility matter? In a bull market -- which is what we've experienced since April 2009 -- it doesn't: Everyone loves volatility when prices are going up! In a bear market/correction, however, lower volatility gives you the peace of mind and confidence to stay with your stock picks until they pan out instead of closing your positions prematurely.

A portfolio that matches the index's performance in bull markets and outperforms during bear markets/corrections will end up smashing the index over the long term. I think we could witness the second component of that equation as early as this year if this overheated market suffers a correction.

Stocks: Focus on quality and valuation
How does Pro avoid capital losses and achieve absolute returns? And how can you follow its lead in your own portfolio? Let's take a look.

The target allocation for stocks in the Pro portfolio is 70%; they are the bedrock of the portfolio. As such, Jeff focuses on businesses with a defensible competitive position and that produce ample cash flows; these are the companies that will compound value over extended periods of time. When you combine that focus with a careful buying discipline that requires that every purchase be made at a discount to a stock's fair value, your odds of experiencing capital loss shrink dramatically.

Here are two examples of that process straight from the Pro portfolio:

Intel: A gorilla in a tamer jungle
Intel (Nasdaq: INTC) has long been the dominant franchise in the cyclical chip market, which traditionally suffers from a "boom-bust" cycle of performance improvements, investment to increase capacity and, ultimately, oversupply. However, Pro believes Wall Street has not cottoned on to the fact that the quality of Intel's franchise is actually improving as the industry matures, reducing the volatility in this cycle.

Intel is the second-largest position in the Pro portfolio, and the team continues to rate the stock a "Buy First." At an enterprise value of less than five times EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization), some sort of revaluation in the shares appears inevitable.

Medtronic: A leader with the drive of an underdog
Pro also rates Medtronic (NYSE: MDT) a "Buy First" stock. The leader in five of six key medical device markets, there is little doubt concerning the quality of the business. Medtronic isn't resting on its laurels, either; the company invests more in R&D than three of its main competitors combined in order to maintain its leadership.

As far as valuation goes, the shares currently trade at $37.50, offering investors a wide discount to Pro's estimate of their fair value (high $40s).

5 more ideas for further research
If you're looking for other stock ideas that might be consistent with this low-risk approach to investing, the following names are at the top of their industries with respect to their return on capital and at the bottom in terms of their valuation (on the basis of their forward price-to-earnings multiple). Furthermore, they each have one or more distinct competitive advantages:

Buying high-quality businesses at a discount to their fair value is Pro's primary strategy to avoid capital losses, but Jeff also employs several more advanced investing techniques to generate additional income, reduce the portfolio's volatility, and provide downside protection. If you're interested in learning more about these strategies, drop your email in the box below, and we'll send you Jeff's free report, 5 Pro Strategies for 2011, along with an individual invitation to join Pro, which is open to new members for the first time since June.