It
is okay to be aggressive if the foundation has already been put in place.
A
different portfolio for slightly different objectives.
Stock-by-stock
discussion of CLX, KMB, TRP, GIS, UPS, LMT, QCOM, NVS, MET, BHF
Introduction:
Why this is a separate portfolio
The focus of this portfolio has always been more
aggressive than the core portfolio. The investment held for the longest period
of time, and the only one that has reached the maximum dollar value guideline
used to manage these portfolios, is an aggressive growth mutual fund. It was
originally, and for a long time, the only holding in this portfolio. That fund was
virtually a technology fund during the build up to the Internet bubble, and,
not surprisingly, its performance took off during the 90s.
It hit the dollar maximum limitation resulting in
sales of mutual fund shares a number of times, especially late in the Internet
bubble. The proceeds were used to purchase some stocks discussed below and a
“parking lot" position in Berkshire Hathaway. Funds were also taken out of the stock
portfolio to purchase long-dated, inflation-indexed Treasuries. This portfolio
was not restricted to 100% common stocks like the Widows’ and Orphans’
Portfolio. The Treasuries resulted in significant capital gains when the
Federal Reserve decided to drive interest rates down in response to the housing
bust.
Until they were sold, the Treasuries provided interest
payments that were used to purchase some stocks in this portfolio. More
recently, some of the Berkshire Hathaway stock has been liquidated in order to
purchase dividend-paying stocks. It took
some time for the mutual fund to recover from the Internet bust, especially
since, late in the bubble, shares were sold to reduce the holding to 25% below
the dollar maximum threshold. Recently, shares of the mutual fund have again been
sold to conform to the dollar limit on individual holdings.
Thus, this portfolio was built more recently than
the core portfolio, and it is intentionally more aggressive. It was also built
in spurts rather than slowly and continuously over a long period of time. As a
consequence of those spurts, there have been times when multiple stocks were
added to the portfolio over short periods of time. A previous posting mentioned
the problems of trying to make a second and third pick in a given year. This
posting mentions a number of times when the consequence of making multiple
selections at once was bad timing. It was possible to correct those by making
subsequent purchases that lower the average cost. Fortunately, so far none of
the picks have turned out to be bloopers.
Hopefully, going forward, the current structure will
be a less volatile than the aggressive growth mutual fund. So far, it has been.
Surprisingly, it has also kept pace with the aggressive growth mutual fund, but
the time period has been very short.
Dividends are reinvested in all holdings in this
portfolio. The only restriction on what stocks can be added to this portfolio
is that it cannot overlap with the core portfolio discussed in previous
postings. It also has to make sense internally as a portfolio, while at the
same time taking into account the holdings in the core portfolio. So, with that
in mind, here's a nifty little 10 stock portfolio.
Clorox
(CLX) - The investment thesis: A consumer non-durable good producer with fewer brands than some of the
alternatives, a history of times when it would take on more leverage than some
of the alternatives, a long history of dividend growth and effective brand
management. Their periodically higher dividend payout ratios (dividends as a
percent of free cash flow and/or dividends as a percent of profits) can be
looked at either as a source of increased risk or as a display of greater
shareholder friendliness. Clorox also has a history of very efficient
production of its principal products including exemplary quality control. Their
production efficiency is often overlooked
More liberal use of leverage and limited product
offering create risk that may be inappropriate for a core holding in a
portfolio with the objectives of the Widows’ and Orphans’ Portfolio, but they
may be tolerable in a supplemental portfolio. Clorox essentially produces two
products. Further, Clorox is less conservative in its use of leverage than some
alternative consumer nondurable producers.
However, when held as a supplement to other consumer
non-durable companies such as Procter & Gamble and Unilever, Clorox can
benefit a portfolio. As stated, it has a long history of effective brand
management, and the vary narrowness of its product offerings makes it less
likely that there will be a loss of focus.
Clorox had been on my watch list of consumer non-durable
producers for a while when circumstances arose that allowed for an
opportunistic entry point. When the news
is all about a phenomenon that should increase the demand for a particular
product and the stock of the producers is not rising, it's an opportunity to
buy.
At some point, the CDC identified some potentially
catastrophic pathogen that could only be effectively counteracted by washing
down all surfaces with bleach. In order to demonstrate its own importance, the
CDC was making sure that the story was getting extensive unwarranted press
coverage. However, Clorox stock had not risen at all in response. In fact, it
had been downgraded by one of the Wall Street firms. It became an advantageous
entry point since the concern the CDC raised resulted in a predictable
temporary spike in sales of bleach. That sales spike surfaced a few months
later in a strong quarterly report from Clorox. The stock experienced a step up
in its price appreciation for a period of time.
Disclosure: I own CLX and am accumulating additional
shares through dividend reinvestment. I don't plan to, but cannot rule out,
opportunistic purchases on price pullbacks. A statement buy is possible if the
opportunity arose, but it would probably not result in a large exposure.
Kimberly
Clark (KMB) - The investment thesis: A consumer
non-durable producer with a long history of very efficient production of its
principal products, a reasonably strong balance sheet, and reasonably, but not
exemplary, brand management. Nevertheless, it has very well-entrenched brands.
It is easy to overlook how well-entrenched
Kimberly-Clark's products have become. Years ago to dislodge Kleenex from an
extremely dominant market position, it took government action. In order to
facilitate the entry of a competitor (who probably made bigger campaign contributions),
the government restricted Kleenex’s ability to refer to its product as Kleenex.
It insisted that the company refer to it as Kleenex tissues. Kleenex is now
seen as a competitor in the tissue market rather than other tissues being
viewed as competing in the Kleenex market. Similarly, Charmin toilet paper
established its brand by reference to its superiority to the “leading brand.”
They did not even have to name Scott's in order to position their product
against it.
The reasons for holding Kimberly-Clark as a
supplemental investment are the same as those for Clorox and will not be
repeated. However, like Clorox, Kimberly-Clark should be kept on the watch list
of anyone whose portfolio has reached the point where supplemental purchases
may be appropriate. That was the case with Kimberly-Clark.
The opportunity to add it as a supplemental arose for
totally different reasons from Clorox. They are discussed in some depth in a
previous posting: MARCH 30, 2010, “Wall Street doesn’t run the world.” Basically, Kimberly-Clark has been
downgraded by Goldman Sachs, and for the reasons explained in that posting, the
downgrade was totally irrelevant. It presented an opportunity for long-run
investors to purchase on a temporary and (for the long-run investor) irrelevant
dip. Given the exaggerated importance the media attached to Goldman Sachs’
opinions at that time, it was an opportune time to acquire Kimberly-Clark if
for no other reason than to demonstrate how easy it is for a long-run investor
to play Goldman Sachs like a fiddle. Since then, dividend reinvestment seems
justifiable for the holding as a supplement. A long-run investor can play Wall Street's short-run focus to time
purchases.
Disclosure: I own KMB and am accumulating additional
shares through dividend reinvestment. I don't plan to, but cannot rule out,
opportunistic purchases on price pullbacks. A statement buy is possible if the
opportunity arose, but it would probably not result in a permanent holding as a
large exposure.
TransCanada pipeline (TRP)
- The investment thesis: A pipeline
company, a long history of dividend increases, a C-corporation, a Canadian
company with Canadian and US market exposure.
This is a fairly new
addition to the portfolio. It went from just a company I was aware of, to its being
on a watch list when it entered the headlines in connection with the controversy
surrounding the Keystone pipeline. The
stock held up fairly well despite being yanked around by the regulators and
mischaracterized by environmentalists, but there was no major catalyst to
buy. From a long-term investor's perspective, it was encouraging that they stuck to the economic and business
case for their pipeline rather than taking the shortcut solution of paying
Bill Clinton a bundle of money to speak at one of their functions and getting
the pipeline approved. It also was
encouraging that while trying to get approval of the Keystone pipeline, they
were also planning other contingencies.
By late in 2014, the
viability of the company as a holding had been demonstrated. On a pullback
associated with news on one of their pipelines, the stock declined slightly,
and an opportunistic purchase was made. When attention shifted away from the
Keystone pipeline to pipelines they were planning, the price recovered.
However, the real
opportunity to purchase the stock at discount occurred later in 2015. With the
final announcement that the Keystone pipeline would not be approved by the
Obama administration along with the fall in oil prices, the stock price fell.
That would've been the best time to make a statement buy. When the media and the market are focusing on one particular project
and overlooking alternative contingent plans, it can present a buying
opportunity. In cases where the stock is already held, it's an opportunity to
average down the acquisition cost.
Equally important, the fall in the price of
TransCanada pipeline late in 2015 demonstrates the importance of accumulating
into a position rather than buying it all at once. For me it was an opportunity I couldn't fully
capitalize on. My initial position on the opportunistic buy absorbed much of
what I wanted to invest in this holding. In this case, it would have been
better to wait for the big opportunity to buy rather than taking advantage of
the smaller opportunity earlier. However, it was an opportunity to average the
price down with subsequent purchases.
Disclosure: I hold TRP
and would recommend it to anyone planning a long-term portfolio. I would be
comfortable initiating a small position at the current price, but will only be
using dividend investment unless a better opportunity for a statement buy
arises. The position in Kinder Morgan
might be liquidated in order to take advantage of a buying opportunity in
TransCanada pipeline. The structures of their pipelines are quite different,
but their roles in these portfolios are the same.
Lockheed Martin (LMT)
- The investment thesis: A defense
contractor with technical expertise in a couple of areas that are in high
demand, and a major beneficiary of the planned military buildup.
This, too, is a recent addition to the portfolio.
The stock was put on a watch list as result of the change in policy implied by
the most recent presidential election. The
federal government policy shifts can definitely create buying opportunities,
but the company has to be in a position to respond to the opportunities.
The
situation with Lockheed Martin was, in many respects, analogous to the
situation with Boeing described in a previous posting (2a). Defense systems
have long developmental lead times. While Boeing has to finance those
internally, defense contractors will get assistance from the federal government
during the developmental phase. But, much of the payoff to the development
process occurs when the defense system goes into production. When there is a shift from the
developmental process to ramping up production, it is quite often a buying
opportunity.
How
much of a buying opportunity is created by the shift to production depends upon
the anticipated volume of subsequent purchases, or, in more general terms, a
forecast of demand. In that respect, Lockheed Martin was
doubly advantaged: It was transitioning to production when the political
environment was transitioning to a posture of higher demand.
Interestingly
enough, the president's posturing regarding the price of Lockheed Martin's new
fighter only distracted attention from the tremendous sweet spot Lockheed
Martin was in. When the market mistakes
negotiating postures for actual rigid positions, it will often create a buying
opportunity. The media and the markets were also focusing on the controversy
surrounding one product and ignoring other product areas where demand would be
growing.
Disclosure: I own LTM and do not intend to purchase
or sell additional shares. However, I would recommend a purchase under current
conditions. I would recommend that purchase either as an entry point to a
long-term hold or as an entry point to a shorter-term trade.
Qualcomm (QCOM) - The
investment thesis: A microchip producer,
principal revenue source is licensing its intellectual property, exposure to
communications most notably the cell phone market, but it is often involved in
disputes related to its intellectual property licensing.
The best time to buy Qualcomm is when they're
involved in a dispute over their intellectual property. But, it has to be
bought with the realization that the investor is taking a position on the
outcome of the legal dispute. I
can attest to the importance of the timing since my timing was terrible. A lot
more shares could have been purchased if the timing had been correct.
This was the third
stock bought over a very short period of time: Lockheed Martin worked out very
well. TransCanada pipeline was less well-timed, but the position could be
improved by subsequent purchases bringing down the average price. In the case
of Qualcomm, the purchase was made between when they settled their dispute with
the Chinese government and when they began one with Apple. Thus, this
experience seems to support the argument for avoiding entering multiple
positions all at once. Impatience can
undermine a good investment thesis.
From the perspective of
this individual stock, it suggests it's pretty important to know when
individual contracts are up for renegotiation. Further, it can only be a
long-term hold if you have confidence in their legal staff's ability to defend
their intellectual property.
Disclosure: I own
QCOM and do not intend to buy or sell
additional shares. I would recommend it to anyone who's willing to bet on it
legal staff’s ability to defend its intellectual property. I caution anyone
purchasing the stock that it's going to be volatile.
Novartis (NVS) - The
investment thesis: European
pharmaceutical company, positions in prescription and nonprescription products,
strong balance sheet, and a history of successful drug development.
Portfolio
fit is always important. The stock was put on a watch list
because of the need for increased pharmaceutical exposure. It was one of a
number of foreign and domestic pharmaceutical companies being analyzed.
Exposure to a foreign market was also considered appropriate for the portfolio if
it could be acquired in an advantageous way.
The
relative performance of the US markets and European markets can be used to time
purchases of Novartis whenever those general market trends include
pharmaceutical companies. It was purchased for this portfolio
in order to provide exposure to foreign markets. To a limited degree, the
timing was determined by the relative stronger performance (higher prices) of
the US market versus European markets.
Also, there was a minor pullback in
Novartis that seemed unjustified. The only explanation I could find for the
pullback was concern about the breath of the products offered by Novartis. Whenever the diversification of a
diversified company becomes a negative in-and-of itself, it presents a buying
opportunity. In the case of Novartis, it was an extremely mild phenomena.
European investors seem to be a little less in love with financial engineering than
American investors. Consequently, European stocks seem to get yanked around a
little less by Wall Street trends in financial engineering.
Disclosure: I own NVS, and,
because dividend reinvestment is not offered by my broker on this ADR, I will
be making additional purchases using dividends.
General Mills (GIS)
- The investment thesis: Well-entrenched,
branded food products; conservatively managed financially, and a long history
of shareholder- friendly behavior, including a long history of rising
dividends.
General Mills is a highly reliable company.
Nevertheless, circumstances can create buying opportunity. It is a company with
a reputation for a particular type of behavior. That behavior can go in and out
of style. There times when new products
are valued much higher than reliable existing products. That's often the best
time to buy General Mills.
Currently, General Mills stock is lagging due to the
phenomena just mentioned and the belief that its products are “tired.” Whenever there is a new product that is
challenging one of General Mills existing products, it will present a buying
opportunity if the market is discounting “reliable” in favor of “new.” One
can generally hold off until the results of General Mills’ response become
apparent, but that involves sacrificing a fair amount of the upside because
General Mills is so widely followed.
Disclosure: I own (GIS) and recommend it to anyone
planning to build the dividend-growth portfolio by reinvesting dividends over a
prolonged period of time. I also would recommend purchasing it at its current
price. There is a possibility I may make additional purchases.
Metropolitan Life (MET) and Bright House Financial
(BHF) - The investment thesis: Provides exposure to the financial services industry, the consolidated
financials of the two companies represented a financial powerhouse despite the
federal government's inclination to want to tinker with it, and, after the
split up, there's no urgency associated with disposing of either successor
company.
I have owned MetLife off and on before. Thus, it's
been on my watch list for many years. Mergers,
split ups and spinoffs do more than provide news items for the financial media.
Often they will depress the price of the stock because of the uncertainty it
introduces. So, I began looking at the status of MetLife in greater detail as
talk of the separation into two companies began. As details of the plan became
available, it looked like an opportunity.
Metropolitan
Life was purchased before it was broken into two companies with the
understanding that both companies would be in a businesses that could
comfortably fit in the portfolio, at least temporarily. It
is a purchase that has the potential to work along the same lines as was
described in a previous posting in connection with Abbott Laboratories. The
difference in this case is that it isn't immediately apparent which piece of
the split up company will be the more desirable to hold. Both will be in good
businesses as the population ages and self-directed retirement planning becomes
more common. Whether both, one, or neither company is retained will depend upon
an assessment of their ability to execute.
The US financial service industry does not have the
level of dividend stability that one would want in a widows’ and orphans’
portfolio. While the dividends from MetLife may become unstable, they seem to
be something that can be forecast. A decision to reduce the dividend is not
something that happens abruptly.
Thus, while the current plan is to hold both
companies as long-term holds, it is possible that one or both would be sold
well before 20 years. However, it is also possible that through dividend
reinvestment the positions will build to a point where any setbacks can be
absorbed without harming the overall portfolio's performance.
While mergers present a unique opportunity because
of the uncertainty they introduce, in general, the best opportunity to buy financial service companies is during a
major downturn. Again, it illustrates that the buy part of buy-and-hold can be
very difficult. The purchase might be made after dividends have been cut
and the company has experienced what might be considered a near-death
experience. The near-death experience has never occurred with MetLife, but the
impact of financial downturns and economic downturns definitely have.
Disclosure: I own (MET) and (BHF) and have no plans
to buy or sell either over the near-term. I intend to hold them over the long-term,
but may liquidate one or both if there is a need to reduce the portfolio’s exposure
to the financial services industry, or, if a financial service firm with the
likelihood of a more desirable price and dividend behavior is identified.
United Parcel (UPS) - The investment thesis: A reliable dividend grower in the transportation services industry, a
strong balance sheet, and considerable expertise in logistics.
United Parcel has been
in this portfolio for a long time. It was one of the earliest purchases, perhaps
the first. To illustrate, it was originally purchased because of its long
dividend history. But, the thesis behind retaining it was the trend toward
increased catalog sales. Things change, and now it is retained in order to
benefit from the trend toward e-commerce. However, the truth is their business
is far more dependent upon business-to-business shipping than business to
consumer shipping.
UPS can be bought on pullbacks with a high degree of
confidence that the pullback is temporary. In
the future, an entirely new profile may emerge. The relationship to e-commerce
may actually create a new kind of opportunity. Over the last few years, UPS has developed a distinct seasonal pattern,
falling in January. That could represent a systematic pattern of the only
buying opportunity that seems to exist with UPS.
Disclosure: I own (UPS)
and would recommend it to anyone who wants to build a dividend-growth portfolio
by reinvesting dividends over 20 to 30 years. I would point out the seasonal
pattern that has surfaced in the last few years, but recommend making a small
initial purchase, and then adding to it on any pullback.
The portfolio characteristics
The portfolio weights
in this portfolio are allowed to vary widely. Dollar limits are irrelevant
since neither the dividend flows nor the value of any individual stock holding
is anywhere near a limit. The positions just haven't been held long enough to
get to the limits. Further, since all dividends are currently reinvested,
managing the percent of dividends from individual holdings seems inappropriate.
As a percentage of the portfolio, the individual stock holdings are roughly
equal with the exception of Bright House Financial which is a much smaller
position. However, that's purely accidental since the size of the positions is
allowed to vary within a much wider range than is characteristic of the Widows’
and Orphans’ Portfolio.
The aggressive growth mutual
fund is very close to the limit on dollar amounts in any one investment, which
implies that there will be future funds to be allocated from the mutual fund to
the individual stock holdings. Consequently, a number of the stocks in this
portfolio are back on my watch list:
General Mills appears,
on the surface, to be presenting a buying opportunity. But, that will require
an assessment of the stock’s performance versus the underlying performance of
the company. Qualcomm is a more difficult situation to assess because of the
uncertainty associated with the current dispute with Apple. It is likely that
this dispute will cost Qualcomm. However, it is hard to tell whether the decline in the stock price
reflects what the dispute will cost, or whether there is an excessive discount
because of the uncertainty. The breakup of MetLife has resulted in two new
companies that require a re-examination. Lockheed Martin will undoubtedly
increase in value, but a determination will have to be made as to whether that
is a trade or an opportunity to enhance permanent holding. UPS is displaying a
seasonal pattern in stock price that, if it continues, may be used either to
enhance the position or as a trade.
Finally, because this
portfolio is supplemental and holds large mutual fund position, a decision will
have to be made as to whether to maintain the portfolio at 10 stocks. It could
easily be increased or decreased. Each has its advantages. Further, just from a
portfolio management perspective, taking into account all the stocks being
held, reducing the total number of stocks from 39 may be desirable. That may be
accomplished by eliminating the practice of not having this portfolio overlap
with the core portfolio.
