A
pleasant consequence of time in the market
From
supplement to core holding
Diversifying
assets within an asset class
Supplements
as a hedge
Staying
current
Stock-by-stock
discussion of MCD, MSFT, INTC, UL,
HON, HCH, F, WTR, NNN, plus UTX, BCE, ABBV, EMB, KMI, GG, PAAS,
EMR, BBL
One of the more pleasant consequences of owning
stocks and equity mutual funds is that they generate money. That money can be
used to expand positions or it can be spent. This posting talks about one of
the uses for funds generated along the way. Specifically, it talks about expanding
and supplementing a core stock portfolio. As with the previous posting, it
discusses actual examples in an attempt to provide information that's useful to
others pursuing the same ambition.
Unlike the core 10 holdings this portfolio has not
been restricted to hundred percent stocks. In fact, much of it was in a 401(k)
which constrained investment options to mutual funds. However, over time it has
increasingly come to hold additional core holdings. It was not necessary to
keep this portfolio 100% in equities as long as it was supplemented by the
larger Widows’ and Orphans’ Portfolio.
One reason for supplementing a core portfolio is to
hold a position that hedges against specific risks associated with one of the
core holding. In the presentation of the original 10 stock portfolio some
alternatives were mentioned. Those alternatives often provide a hedge against
the failure of a primary holding. However, another reason for adding to the
core portfolio is even more important. Over time new phenomenon emerge as do
new industries. Firms in those industries or reflecting the phenomena may
belong in an updated core portfolio.
Another reason to expand the portfolio is that any
portfolio that focuses on the objectives outlined for the 10 stock portfolio
creates concentration risk. Many of the stocks that fit into a portfolio
pursuing those objectives have certain common traits. For example, they may all
be large-cap stocks, but they may also overlook certain industries. Two good
examples are real estate and pipelines. Real estate and pipelines weren’t
always separate industries. There was a time when it made sense for them to be
a part of companies like those in the core portfolio. In fact, at the time the
portfolio was initially constructed, the companies included substantial real
estate and pipeline holdings. Changes in our tax codes encouraged their
segregation into a different class of corporations. Further, as the portfolio
grows, international exposure becomes increasingly justified in order to hedge
the risks associated with having all investments in only one market. In the
last financial crisis, diversification across markets internationally wasn't a
very good hedge, but that was unusual.
As a risk management approach, a fixed dollar amount
of investment in any one stock was discussed. As the value of the entire portfolio
grows, more and more stocks will get to that dollar limit. Further, it may be
desirable to move funds held in mutual funds because of 401(k) restrictions
into individual equities. Some mutual funds may want to be retained in order to
get exposure to areas like international equities or small-cap stocks. However,
it may be easier to achieve the objectives of the investor by moving equity
exposure from some mutual funds to individual stocks that meet a particular
criteria.
This posting will discuss both the how and the why
of supplementing the 10 stock portfolio. Stocks that were added to the core
will be identified by an *. In each case, there will be a presentation of the
investment thesis. Some of the stocks were initially purchased as a supplement,
and then they became core holdings. The discussion will explain why that
occurred.
Expanding
the core holdings
*McDonald's
(MCD) - Yum Brands (YUM) is an alternative. The investment
thesis: Originally coverage of this
industry was included with Pepsi. Therefore, once Yum Brands was spun off, an
alternative was appropriate as a supplement for the portfolio. It would add a
service industry that has proven durable. However, since the Widows’ and
Orphans’ Portfolio already contained a fairly diverse set of industries, adding
back the fast food representative was not urgent.
When it did seem appropriate to add this industry, a
position in McDonald's was judged to be the better approach. It was based upon
two extremely important factors. McDonald's brand seems stronger and their real
estate holdings resulted in a much more conservative balance sheet. A previous
posting, “McDonald's Two Businesses, One Strategy,” enumerated a number of
other reasons why McDonald's appeared to be the appropriate selection for the
portfolio.
That still left the problem of when to buy. The
initial small position hardly constituted a core position. However, an
opportunity to load up on the stock surfaced fairly recently. The posting
referenced above discussed a number of management missteps taken by the
previous Chief Executive Officer. They can be summarized as not understanding
what business he was in. The behavior of management during that time can best
be described as floundering. They consider breaking out the real estate
holdings and focused on competing with the wrong competitors.
Consequently, the stock pulled back from about $100
a share and languished at about $90 per-share long enough to allow an
accumulation of the stock. When a stock that's been increasing in value pauses
and pulls back, it's time to investigate why. It was clear that the management
was not capitalizing on the strength of their brand or the power of their
business model. Nevertheless, the
strength of the brand was still there as was the power of their business model.
It required buying a stock of a company that had strengths that were being
overlooked because of mismanagement.
In many respects, it was analogous to the situation
described in connection with Johnson & Johnson and which may exist
currently with respect to Pepsi. It is a very good illustration of why the buy
part of a buy-and-hold strategy is so difficult.
Disclosure: I own MCD and do not
intend to purchase more shares as long as I retain my current limit on the
dollar value of dividend flows from any single stock. Nevertheless,
I would recommend it to anyone who wants to hold a stock for 20 or 30 years and
to build a position by reinvesting dividends. However, I would not recommend it
as an initial position in the portfolio with fewer than 15 stocks. At
current prices, I would emphasize the need to start with a small initial
holding.
*Microsoft
(MSFT) – The investment thesis: Any core portfolio should include representatives of the technology
industry. However, for many years all of the technology industry could be
classified as speculative growth stocks. Once Microsoft began paying a dividend
it became a candidate for status as a core holding. It has a very strong
balance sheet, seems committed to dividend growth, and has strong brands even
if they are threatened by technological change.
However, as mentioned in the original presentation
of the Widows’ and Orphans ' Portfolio, the original position was small and
taken based on a judgment about price (low $20s on a pullback). Mismanagement
under the previous Chief Executive Officer provided some opportunities for
small additional purchases (on pullback into the mid $20s). There wasn't any
expectation that there would be huge gains from those purchases. After 3 1/2
years the stock was only in the mid-$30s. However, the dividend had been consistently
raised, and clearly there had been efforts to develop new products, many of
them total flops.
At about the time the Chief Executive Officer was
changed, the market was behaving as if there would never be another sale of the
PC, and Microsoft would never generate a new product. The market was overlooking the assets of Microsoft because of its
previous mismanagement. The company still had a dominant position in a
viable market. That position was based upon a strong brand which they could
leverage into new markets. They still had tremendous software development
capabilities. They also had ample resources to invest into the development of
new products.
It seemed there was justification for doubling the
position by investing more than the total that had been put into the stock as
of that point. Once the initial signs that the new
manager’s strategy was working started to appear, the position could be doubled
again and considered a core holding.
Microsoft needed to demonstrate that it could recover from major setbacks such as
the missteps of the previous manager. Once that was accomplished, it was
legitimate to consider it a core holding. One should never forget the
Buffet admonition to invest in companies that could prosper even if run by an idiot
because sooner or later they will be.
Because of the need for some technology representation
in the portfolio, Microsoft had been on the watch list for some time. In fact,
small positions were bought and sold a couple of times. The same is true of a
couple of other technology companies. There is no discussion of those early
efforts to establish a position in the technology industry because none met my
criteria for a conviction buy or the intent of a long-term hold. They were all
trades from the start. There are plenty of examples of mistakes in that
experience, but generally they are mistakes in trying to make shorter-term
trades without a strong conviction about the durability of the company. That's
one of the reasons that this and other postings have advocated not taking a position unless it can be
taken with the intention of holding it for the long-term. It's also why the
initial presentation of the portfolio included the comment: “In tech I’m not a
good source for ideas.”
The
approach of putting the company on the watch list and being patient about
purchases allows one to build a portfolio without starting with an in-depth
knowledge of every industry. Microsoft had been on
the watch list for a long time before the initial purchase, and even when the
accumulation began, it was done in steps. To the extent any damage was done by
other trading activities in the technology industry, it was from ignoring that
simple rule of waiting for a long-run opportunity.
Disclosure: I own MSFT and
do not intend to purchase more shares as long as I retain my current limit on
the dollar value of dividend flows from any single stock. Nevertheless, I would
recommend it to anyone who wants to hold a stock for 20 or 30 years and build a
position by reinvesting dividends. At current prices, I
would emphasize the need to start with a small initial holding.
*Intel
(INTC) – The investment thesis: Intel is a capital goods producer in a very capital intensive industry.
It has very long cycles, but it has established a strong brand in its core
market. It has tremendous technological expertise as well as intellectual
capital. Historically the company has also demonstrated an ability to adapt to
changes in the technology market into which it sells.
There
are a couple of misperceptions about Intel that can be used to time purchases.
The first is that the company can't adapt to changes in the marketplace. One
only needs to read Andrew Grove’s book, ONLY THE PARANOID SURVIVE: HOW TO
EXPLOIT THE CRISIS POINTS THAT CHALLENGE EVERY COMPANY, in order to realize
that failure to respond to market challenges has not been the company’s
history. If I were to fault the narrative in that book, it would be that it leaves
the impression that the type of adjustment being described occurs quickly.
Intel is in a capital-intensive industry where change requires time and
investment.
The more recent example was the assumption that
Intel could only produce processors for microcomputers. Rather, it is pivoting
to processors for data centers without sacrificing its current position in the
PC market. It's undoubtedly doing research on other potential markets, but it
is a capital-intensive industry, and they have to be sensitive to the need to
control ROI. The market’s obsession with PC sales when assessing Intel created
a recent opportunity. In 2012 the company’s stock was being priced as if there
would never be another sale of a PC, and Intel would never find another market
to serve. At that point it was so extreme that it justified violating the rule
of starting small. It is one of the few instances that justified initiating a
position with a statement buy at $19.50.
The second misperception is that Intel is a growth
story or a broken growth story. It is neither and never has been. It's a highly
cyclical capital goods company. The
reason that the statement buy could be used to initiate the position was that
Intel had been on a watch list for a long time. During the time while it was on
the watch list, it was possible to trade the stock to capitalize on the growth
story/broken growth story phenomena.
Trading
the growth story/broken growth story phenomena involves fairly long holding
periods and fairly long periods of not owning the stock.
As noted, it is a capital-intensive industry with long cycles. While it is in
either phase of being perceived as a growth company or as a broken growth
company, it is very hard to profitably trade the stock. To illustrate, Intel's
ability to maintain and grow its dividend even during the period when many
analysts were treating it as a dying company demonstrated a commitment and
capability that justified viewing Intel as a core holding. Since then, it's
been possible to make very few opportunistic buys based on price pullbacks, but
there haven't been any opportunities to make another conviction buy.
Disclosure: I own INTC and do not intend to purchase
more shares as long as I retain my current limit on the dollar value of
dividend flows from any single stock. Nevertheless, I would recommend it to
anyone who wants to hold a stock for 20 or 30 years and build a position by
reinvesting dividends. At current prices, I would emphasize the need to start
with a small initial holding, and then add to the position opportunistically based
on price.
*Unilever
(UL)
The investment thesis: The Company has
strong brands, a conservative balance sheet, and a long history of dividends.
It was originally held as a supplemental consumer non-durables stock that
provided direct international exposure.
Unilever was on the watch list before the need for
international exposure justified purchasing it as a supplemental. It initially
went on the watch list when it acquired the brands of a company called Corn
Products International. Corn Products International had been a longtime hold as
a core holding. It had provided the portfolio with exposure to two industries.
One was corn sweeteners and the other was branded food products. Corn Products
International broke itself up into two companies and Unilever bought the
branded consumer products groups. They were strong brands. That purchase put
Unilever on a watch list. When a company
buys another company that has already been assessed as it good fit in the
portfolio, it is time to put the acquiring company on a watch list.
After researching the company and following it for a
few years, it was apparent that it was a viable candidate for a portfolio with
the objectives of the Widows’ and Orphans’ Portfolio. As the portfolio grew, it became apparent that direct foreign exposure
would fit with the portfolio's objectives. At that point, a position in Unilever
was initiated with the intention of allowing dividend reinvestment to build the
holding.
Developments
in one of the existing portfolio positions can result in the need to expand on
what was originally a supplemental position. As Proctor and
Gamble struggled with its international operations, it created a need for a
core holding with a firmer international footing. Unilever filled that gap in
the portfolio’s holdings. While the primary reason for adding Unilever was
always portfolio fit, Unilever has also experienced some shakeups that refocused
the management on its core businesses.
One
can time purchases of Unilever based upon the relative rate of recovery of the
US economy versus the European economy. Although Unilever sells
to a much broader audience than Europe, European stock markets tend to move
based upon the outlook for the European economy. That phenomena is primarily
due to the attitudes of European investors rather than the underlying impact of
the European economy on all stocks listed on European markets.
Disclosure: I own UL and do not
intend to purchase more shares as long as I retain my current limit on the
dollar value of dividend flows from any single stock. Nevertheless, I would
recommend it to anyone who needs exposure to an international consumer
non-durables company and who wants to hold a stock for 20 or 30 years and build
a position by reinvesting dividends.
*Honeywell
(HON) - The investment thesis: An industrial conglomerate that provides coverage in a number of
industry areas, has a strong balance sheet, and has a history of paying rising
dividends.
Honeywell was originally purchased as a supplement
to GE and UTX. The objective was to extend the industry coverage. Extending industry coverage can reduce risk
by reducing the industry concentration. So, the reason for initially holding it was as a supplement that fit the
portfolio.
Because it supplies inputs into the aircraft industry, as do GE
and UTX, it was the other industries it serves that made it a useful
supplement. It has since sold off some of those other industries, and it is
currently rumored to be looking to purchase additional exposure to the airline
industry. The products it offers to the airline industry do not have much
overlap with General Electric or United Technologies, but the fact that all
three companies serve the airlines industry does present a concern.
However, as the execution risk associated with
General Electric increased due to mismanagement, it was appropriate to look for
an alternative industrial conglomerate to serve as a core holding. Underperformance of the core holding can be
a reason for diversifying the holding that serves a particular purpose in the
portfolio.
The original purchase as a supplement was made
during a period when a long upward trend in the price temporarily plateaued.
There was no change in the business or its growth prospects that justified the
pause in the price appreciation. It is
possible to make opportunistic purchases of stock in a company like Honeywell
when such unjustified pauses in price appreciation occur. Other purchases
were made to bring the portfolio weight of the total holdings of both General
Electric and Honeywell to a desirable level. In other words, they were totally
portfolio driven.
Disclosure: I own HON and do not intend to purchase
more shares as long as I retain my current limit on the dollar value of
dividend flows from any single stock. Nevertheless, I would recommend it to
anyone who wants to hold a stock for 20 or 30 years and build a position by
reinvesting dividends.
*Welltower
(HCH) The investment thesis: Provides exposure to the healthcare industry through something other
than pharmaceutical companies, is well-positioned to benefit from the aging of
the population, isn't overly exposed to regulatory risk related to health care,
and provides exposure to real estate through a REIT.
As a portfolio of stocks grows, the overall asset
mix of an investor shifts. Many investors have exposure to real estate through
homeownership. As they pay off their mortgage, their exposure increases because
of the greater equity in their home. However, homeownership represents a very
concentrated form of asset ownership. It's one type of real estate in one
single location. REITs provide a way to
supplement that exposure to real estate.
Further, once the mortgage is paid off, one is no
longer automatically increasing one's exposure to real estate. In addition, as
the portfolio of equities rises, the relative weight of non-real estate stocks
versus real estate is shifting. At some
point, it becomes advantageous to own REITs from an
asset-allocation perspective. Even within an equity
portfolio, there should be some exposure to REITs. In a portfolio with
the objectives of the Widows’ and Orphans’ Portfolio the fact they can move independently
from the market in general is beneficial. REITs
diversify the cyclical response of the holdings.
It's quite possible that the exposure to REITs
would remain supplemental rather than becoming a core holding. Welltower and
another REIT, discussed elsewhere, were initially purchased with that intent.
So, portfolio fit was a justification for the initial purchase. The need for additional non-pharmaceutical
exposure to the healthcare industry justified expanding that to a core holding.
The portfolio objectives preclude trying to
capitalize on many types of short-run trends. However, demographic trends are sufficiently stable and long-term to justify
purchases. Welltower is a way to capitalize on the aging of the population. So,
portfolio fit is the principal reason for holding Welltower.
Timing
the purchase of REITs is best done based upon price considerations. One
approach is to set a target yield that has to be available before a REIT
will be purchased. However, with Welltower a different type of opportunity
materialized. During federal discussions
of healthcare funding, investors will from time to time react by increasing or
decreasing their exposure to entire segments of the healthcare service industry
without regard to the details of the profiles of the individual companies in
the industry. With respect to Welltower, it will occasionally drop along
with all other REITs that serve the needs of an aging population without regard
to its profile with respect to public-sector payments versus private-sector
payments.
Disclosure: I own HCH and do not intend to purchase
more shares as long as I retain my current limit on the dollar value of
dividend flows from any single stock. I would recommend it to anyone who needs
exposure to the real estate industry, and
who wants to hold a stock for 20 or 30 years and build a position by
reinvesting dividends. If they also need exposure to the health service
industry in a form other than pharmaceutical, it could well be a core holding.
*Ford
(F)
- The investment thesis: A manufacturer
in a highly-competitive industry that is extremely capital-intensive. It has
demonstrated an ability to survive in that environment.
For years I viewed the auto industry in the same way
that Warren Buffett viewed airlines: it was an industry that ate capital. If
you want an example of an auto producer consuming capital, Tesla serves as a
much better example than Ford. Nevertheless, it is an industry that requires
huge capital investments. Consequently, Ford's ability to manage its balance
sheet in a way that avoided bankruptcy during the financial crisis probably
implies that financially it will be well-positioned for the transition that is
occurring in the auto industry.
Ford is a recent addition to the core holdings. It
will add the cyclical component, but the hope is that Ford has learned to
manage its inventory and time its production in a way that will produce more
consistent earnings. Traditionally the
time to buy Ford was during periods when the car sales cycle had passed its
peak and total volume had fallen and was still falling. During those periods,
earnings would fall and the price-earnings ratio would rise. That is
essentially the situation right now. However, there is more going on that may
make this a unique opportunity to acquire Ford.
Developments in the auto industry have created a
heightened level of uncertainty around the entire industries. The rates of
technical advances as well as adoption rates for things like electric cars,
self-driving cars, and shared ownership through services such as Uber are
compounding the usual problem of trying to forecast the future. Ford has been
perceived as not understanding the changes that are occurring and/or fumbling their
response. The perception of failure has
gotten way ahead of the shortcomings in the response, and it has created a
unique buying opportunity. The disparity between an analysis of their
actual response and the market's perception and reaction to their response
justified a recent buy. It justified a buy that was larger than the usual
initial position, but it was not so large as to preclude adding to the position
as the stock underperformed so far this year.
The management transition that usually occurs with
such a situation has already taken place. The issue now is how quickly the new
management can demonstrate that they are on top of the situation. Thus far they
succeeded in remaining profitable, but not in allaying the long-run fears. That
will have to be done, and, when it is, the stock will recover.
Disclosure: I own F, and with my current dollar
limit on the dividends from any particular holding, I would need a very
compelling argument to acquire more shares. However, that could occur
especially if the stock continues to decline at the same time there is evidence
that management has begun to address the company's issues. I would only
recommend adding it to a 20 or 30 year portfolio if the portfolio included a
large number of companies with very different cyclical responses.
**Aqua
America, Inc. (WTR) - The investment thesis: A long
history of stable-growing dividends, a water utility which has less risk from
regulators than electric utilities, less competition from utilities trying to
get into the gas industry than gas utilities, yet many of the same
characteristics of electric and gas utilities.
Aqua is the long-term holding that slowly grew to
the point of being a core holding. From a portfolio
fit perspective, a utility should be represented in the portfolio. Because
of their dividends, utilities often move over interest-rate cycle in a way
different from that of the other stocks in the portfolio. That same
characteristic, behavior over the interest-rate cycle, determines when it is
opportune to buy this company. When
interest rates rise, the stock of this utility falls or just doesn't rise.
That's the time to purchase additional shares.
As implied by the discussion above, I have not had
to make opportunistic purchases. Rather I just had dividend reinvestment
working for me for a long time. However, during
the recent aftermath of the financial crisis, a very unusual opportunity arose.
The stock of the company fell as if the distress of the recession was going to
cause people to stop drinking water. How absurd! An opportunistic purchase of
the company stock at that point was appropriate.
Aqua also has the appeal of being overshadowed in
the eyes of many stock analysts by American Water Works. As a consequence, it tends
to be a bit more stable and behave in a way that is more closely related to the
underlying performance of the company. American Water Works, at times, seems to
be driven by investment styles rather than fundamentals. Nevertheless, American
Water Works is a good alternative for a long-run investor.
Disclosure: I own WTR and from time to time add to
the position through dividend reinvestment. I don't currently have any
intention of buying or selling stock, I cannot guarantee that I would not buy
it opportunistically if the stock price declines for reasons unrelated to the
fundamentals of the business.
**National
Retail Properties, Inc. (NNN) - The investment thesis: A REIT that provides exposure to retail real
estate properties, leases are triple net which substantially reduces risk, in
the past the company has maintained occupancy rates during economic downturns,
and NNN has a history of dividend growth.
National Retail Properties is often compared on a
stock-by-stock basis to Realty Income Corporation (O). Either would fit the
portfolio fit rationale for holding a REIT in this area. The selection of
National Retail Properties was based on a totally subjective assessment of the
corporate level financial position of the two companies and the details of the
properties they hold. Realty Income Corporation could easily be substituted
with almost all of the justifications for purchases outlined below.
National Retail Properties was initially purchased
as a supplement in the REIT space. Retail REITs seem more appealing than
residential or industrial REITs or some of the specialty REITs at the time the
position was initiated. As a long-run holding they have certain other
advantages. Their cycle is more predictable since they profit based upon the
overall performance of the consumer economy. Consumer behavior tends to be more
stable than business investment behavior, and retail is not subject to the
cyclical anomalies associated with housing, although it does have its own
building cycle.
National Retail Properties would have remained a
supplemental holding but for an opportunity that has arisen currently. The current perception seems to be that
e-commerce will totally absorb the retail sector. All retail exposure is being
discounted as if every retail property faced the same risk as many of the
department stores currently, and bookstores previously, face from e-commerce.
What is totally being ignored is the role of startup individual entrepreneurial
enterprises in absorbing retail space. Also, being ignored is the use of retail
space to provide services that are almost totally immune to e-commerce.
Disclosure: I own NNN and would recommend it to
anyone who needs retail REIT exposure in a portfolio that they intend to hold
for 20 to 30 years. I intend to make additional purchases on any price
pullbacks.
Perspective
or side note 1 – Each of the stocks that have been added
to the core holdings represents a more risky investment than individual stocks
in the 10 stock portfolio. However, looking at them as a group would indicate
that they tend to represent risks that offset each other or a risk associated
with one of the 10 original core holdings. A classic example would be pairing
an industrial firm like Honeywell with the consumer non-durables like Unilever
and supplementing it with the utility like Aqua.
Further, each one individually adds very little risk
to the portfolio, and any increase in risk associated with holding them could
be offset by the portfolio weight assigned to them. Modern Portfolio Theory
stresses that it is not the risk associated with the individual investment that
matters: It's the combined risk of the total portfolio that matters, and adding
individual investments that may be higher risk if they were the only holding
can allow an investor to move to a higher return without changing the risk-return
profile of the total portfolio.
Long-run
supplements to the core holdings
In addition to expanding the core portfolio, stocks
have been added that are intentionally held as a supplement to the core. They
were added to the portfolio with the intention of being permanent supplements. They
are discussed below.
United
Technologies (UTX) - The investment thesis: Like General Electric and Honeywell, United
Technologies is an industrial conglomerate that
provides coverage of a number of industry areas, has a strong balance sheet, and
has a history of paying rising dividends.
United Technologies has been held for a long time as
a supplement to General Electric. It was originally purchased to hedge the risk
of mismanagement at General Electric and to provide additional industry
coverage. It was particularly effective at hedging competitive losses or
mismanagement in either company’s aircraft engine division. Holding multiple competitors in the same
industry can hedge out the risk associated with the performance of anyone
competitor if the investor wants industry coverage but doesn't feel comfortable
trying to identify the strongest competitor.
The primary subsequent purchases were dividend
reinvestment. It is worth noting that dividend
reinvestment can be a particularly advantageous acquisition strategy if stock
in a company displays volatility unrelated to the business while retaining a
stable and growing dividend. It is likely that a careful analysis of United
Technologies business and stock performance can provide the basis for
advantageous opportunistic purchases. I've made those types of purchases twice.
First, when it pulled back from the high 80s to close to 70, and a second time
when it pulled back from well above 100 into the 90s.
Disclosure: I own UTX and am accumulating additional
shares through dividend reinvestment. I don't plan, but cannot rule out,
opportunistic purchases on price pullbacks or even a statement buy if the
opportunity arose.
Bell
Canada (BCE) – The investment thesis: BCE Inc. represents an initial effort to
overcome the US-centric nature of the telecommunications industry coverage
implied by holding Verizon. In the international telecommunications space, it
has the best potential of becoming a long-term holding.
Portfolio
fit was the primary reason for acquiring the stock.
Although all of the stocks in the initial Widows’ and Orphans’ Portfolio are
US-based, other than Verizon, they all provided exposure to the economies of
many countries other than the US. Thus, while Bell Canada increases the
exposure to telecommunications, it diversifies the country exposure of the
telecommunications holdings.
Price
relative to the price of US-based alternatives can be used to time the
purchase. It was purchased to extend the telecommunications
coverage at a time when the US carriers’ stocks appeared to be too expensive.
Disclosure: I own BCE and do not expect to purchase
or sell shares over the near-term. I would only recommend it to someone who
wants international exposure in the telecommunications industry in a way that
is consistent with the objectives of this portfolio.
AbbVie
Inc. (ABBV) - The investment thesis: A pharmaceutical company with a history of
dividend growth, a pure-play pharmaceutical supplement to the J&J holdings,
a long history of dividend growth, and shareholder friendly behavior while part
of Abbott's Laboratories.
Pharmaceuticals provide good candidates for a
dividend-growth portfolio. It seemed appropriate to add a pharmaceutical as a
supplement to Johnson & Johnson, but I had a hard time finding one. I
purchased Pfizer, but ended up trading in and out of it two times. They were
successful trades, but I would drop it whenever management would be placing too
much emphasis on financial engineering and not enough on their core business of
drug development. Abbott Laboratories seemed like a more stable growth company
suitable for the portfolio. However, there did not seem to be opportunities to
purchase it that were as relatively appealing as Pfizer.
When Abbott Laboratories started to be criticized
and stock started to be penalized for its multiple business lines, the
opportunity arose. Their history of
shareholder-friendly behavior indicated that the depressed price during the
period of controversy would result in either the company staying together and
recovering or the company being broken up in a shareholder-friendly way.
As
details for the breakup became known, an opportunity arose to purchase Abbott
Laboratories with the intent of holding either part. Then after the split up
there was a good chance that, with a little patience, an investor could recover
more than half of the acquisition cost by selling the other part.
There is a lot of uncertainty associated with corporate breakups such as what
Abbott Laboratories went through. It's rare that one can rely on management's
shareholder-friendly behavior enough to justify the strategy deployed here.
With a willingness to take a position and hold it for reasonable amount of time,
it seemed like a rare opportunity to trade into a desirable long-run position.
Abbott Laboratories has been on the watch list for a
long time as a supplement to the J&J holdings. Consequently, it was
possible to have enough confidence to proceed with the trade with the intention
of holding a part of the split up company that is now AbbVie. This type of trade only makes sense if the
investor is in a position to cover tying up about twice as much capital as they
intend to eventually invest. An alternative that is usually preferable is
to wait until after the split up, and then try to accumulate the desired
position as the price of the stock fluctuates while things are being sorted
out. That's especially true for spinoffs as opposed to splitting up of the
company such as occurred with Abbott Laboratories. Future opportunities to
accumulate ABBV will probably be limited and dependent upon rumors related to
their drug development efforts. It is, however, the successor to a company with
a long history of successful drug development, and thus when there are rumors that it has no pipeline, that may be the
opportune time for a long-term investor to buy.
Disclosure: I own ABBV, and don't intend to buy or
sell, but I recommend its purchase to an investor who is willing to accept the
volatility that will occur with the successes and failures of its drug
development efforts. I would not recommend it at its current price.
Enbridge
Inc. (ENB) and/or Kinder Morgan, Inc. (KMI) - The investment
thesis: Quasi-utilities that are in the
business of collecting tolls for the transportation of oil and gas. They are
C-corporations in an industry populated by many limited partnerships. They
allow participation in the industry without the potential tax headaches of
limited partnerships. Enbridge is the more conservatively
run.
Enbridge is more likely to become a core holding if
the need for exposure to pipelines increases. It has a more stable business
structure and dividend history, and has avoided the temptation to over-leveraging
and expanding too quickly that have been characteristic of other firms in the
industry. However, Enbridge is primarily a natural gas
pipeline as opposed to an oil pipeline.
Opportunities in the pipeline industry usually
relate to the geography of the pipelines involved. I know of no other way to identify buying opportunities than by analyzing
existing and planned pipeline paths. An illustration of that principle is
possible, but it does not involve Enbridge. When the
previous administration chose to block the building of the Keystone pipeline,
it was possible to look at the geographic distribution of pipelines and
identify primary beneficiaries. They did not necessarily have to be competitors
in the transmission of crude. Blocking Keystone also had major implications for
where the demand for transportation of refined products would be stretched
allowing the existing pipelines to fully utilize capacity and raise charges. As
a result, I purchased Pan American Pipeline and experienced about a doubling in
price plus dividends. I exited the position to avoid the hassle associated with
the limited partnership. The timing of the exit was opportune, but totally
accidental. I used part of the proceeds to establish the position in Enbridge.
Disclosure: I own ENB and accumulating additional
shares through dividend reinvestment. I have no intention of other major
purchases but might if the opportunity arose. I also own KMI,
but do not intend to accumulate more holdings. I would recommend ENB to anyone
planning to build a portfolio using dividend reinvestment over the next 20 to
30 years. As an alternative to KMI, I would recommend TransCanada (TRP) for
anyone planning to build a portfolio with dividend reinvestment over a
prolonged period of time.
Goldcorp
Inc. (GG) and Pan American Silver Corp. (PAAS) -
The investment thesis: Precious metal
exposure with production originating in politically-stable countries.
Previous postings have discussed investing in
precious metal miners (FEBRUARY 21, 2014, “Without the Glitter”). The best time to buy miners of precious
metals is very similar to the right time to buy mining firms in general; it
is after the busting of a speculative
bubble and the pain of the adjustment process to reduce output. The
difference is that precious metal miners are responding to speculative bubbles,
whereas other miners may be responding to longer-run economic developments.
Precious metal miners can provide a hedge that is
valuable. However, it is very important to understand what they actually hedge.
Many of the postings on the Hedgedeconomist.com that addressed gold focused on
debunking various myths about what gold hedged. Understanding what gold
actually does hedge was felt to be sufficiently important to warrant a posting
on APRIL 5, 2010 entitled “Gold: Be sure you know what you’ve hedged.”
Disclosure: I own positions in both GG
and PAAS but at portfolio weights well below what is often recommended by those
who try to prescribe cross-asset class portfolio allocations.
Emerson
Electric Co. (EMR) - The investment thesis: A conservatively run industrial firm, a
reasonable balance sheet, a long history of dividends and dividend growth,
multiple products sold into multiple industries, but exposed to the
construction industry’s cycles.
Emerson Electric, like any industrial firm, tends to
move in cycles. The principal difference is that it can move largely driven by
construction cycles, especially commercial construction. It is best bought during slumps in its end markets and earnings. The
best way to view Emerson Electric is as analogous to the other industrial firms
in the portfolio, except that it's closer to the consumer than some of the
heavy industry portfolio holdings.
Disclosure: I own EMR and do not intend to increase
or decrease my holdings. I would recommend it to anyone who wants to build a
portfolio over a long period of time by reinvesting the dividends.
BHP
Billiton plc (BBL) - The investment thesis: A global mining conglomerate with a long
dividend history and the history of adjusting to multiple commodity cycles,
trades on non-US markets. An alternative holding would be Rio Tinto (RIO).
Rather than repeat the justification for holding a
BHP Billiton, I will be quoting from a posting on FEBRUARY 5, 2015: “BHPBilliton stock’s role in a dividend growth portfolio.”
“It provides exposure to resource prices, foreign
exchange markets, foreign stock markets, and indirectly to developing economies.
The impact of the dollar on BHP Billiton is complicated and easy to
underestimate: its output is priced in dollars.”
“BBL is actually in two businesses. One is the
operation of extractive activities (mines and wells). The second is the
allocation of capital across the development of those resources’ including the
acquisition and sale of those mines and wells.”
“…despite the volatility of BBL's stock price, it
can work to stabilize a portfolio. The volatility in the stock's price means
that the timing of purchases is very important.”
The posting cited above provides a far more detailed
explanation of why BHP Billiton might be appropriate for dividend growth
portfolio. It also discusses the different forms in which a US investor could
invest in BHP Billiton.
The buying opportunity with this miner is analogous
to that discussed above in connection with precious metal miners. The time to buy is after the commodity
prices have peaked and the miners have cut capacity to reflect the bust.
The practice of buying a small initial position as soon as portfolio fit is
judged to be appropriate resulted in a paper loss initially; accumulating over
time, rather than with one large purchase, allowed averaging down the
acquisition price.
Commodity
cycles in industrial metals are much longer than those in the precious metals, thus
the investor has the opportunity to wait until there are visible signs of the
trough in the commodity price. Very little upside
movement in the stock price is sacrificed by waiting for a confirming movement
in the commodity price.
Comparing BHP Billiton to Rio highlights the risk
associated with buying into a position as a company is preparing for a spinoff.
If the intention is to hold part of the resulting two companies, the timing of
the sale of the part that is not desired can become problematic. Unlike in the
example above with Abbott Lab, the spun off entity did not sit comfortably in a
Widows’ and Orphans’ Portfolio, even temporarily. Thus, eliminating the spun
off position required a precision in timing that wasn't required with respect
to Abbott Lab.
Disclosure: I own BBL and would recommend exposure
to BHP Billiton or Rio Tinto in a dividend portfolio with the long-run horizon
and the need for exposure to non-US markets and the mining sector. I do not
intend to expand or contract my position in BHP Billiton.
The
composition of the resulting portfolio
With the addition of these stocks, the portfolio
size increases by nine more core holdings. That brings the total of core
holdings to 19 positions. The weights of the 19 positions vary with the
objective of having each holding contribute a certain amount to the dividend
flow. The percentage and dollar value of each holding is still monitored, but
dividend flow has become a deciding factor, primarily due to my age and need to
draw cash from the dividend flow.
There are also nine supplemental positions mentioned
thus far, 10 if Chevron is included. Many of those are held to hedge a
particular risk associated with other holdings. The amount of the holdings of
the supplemental positions varies substantially depending upon what they hedge.
So, the total portfolio consists of 29 stocks. The three mutual funds that were
held as supplements to provide exposure to international, small-cap, and real
estate markets have been reduced to one mutual fund for small-cap exposure. The
stocks that have been added to provide international exposure and real estate
exposure were selected as more suitable for a portfolio with the objectives of
the Widows’ and Orphans’ Portfolio.
There is yet another portfolio designed totally to
supplement this portfolio. It will be discussed in the next posting. A primary
objective of that portfolio was to accomplish the same objectives with
absolutely no overlap with this portfolio. It consists of 10 stocks bringing
the total up to 39 which is probably more than is required to accomplish the
objectives. It's legitimate to view the additional 10 in the next posting as a
separate portfolio. They are included because they present additional examples
of how to recognize buying opportunities of stocks in a dividend-growth
portfolio. Most of the stocks in that posting would qualify for almost anyone's
dividend-growth portfolio definition.
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