Saturday, February 21, 2015

A Single Sector Portfolio

If I had to pick one sector to put my entire portfolio in, its Consumer Defensive and its not even close. As this blog's motto says, the main things I look for in investing are safety, dividends, and growth. There are lots of areas of the stock market where these can be hard to achieve. For example, safety is pretty difficult in most financials since you do not know what they own. Dividends are tough to come by in many parts of sectors like tech, and growth is unpredictable in industrials and as we have seen recently - energy.

But what if there was one sector that could offer a measure of safety, stable dividend income, and slow but steady growth? I think there is one sector - consumer defensive stocks.

Morgan Housel makes the case that keeping things simple lets you focus on the most important thing - compounding. He cites research from Patrick O'Shaughnessy on the historical returns of consumer defensive versus other sectors.

I find this data very compelling. Total gobsmack stuff. Why? Think about it this way. With Healthcare you worry about patent cliffs, government intervention, and research pipelines. With Energy you worry about...well do I need to finish this sentence? Industrials are cyclical and many struggle to maintain a moat. Utilities and Telecom have limited growth. Technology firms' competitive advantage do not last from one decade to the next. Financials? Who even knows what you are buying and what they have on their books? Also, the management team can walk out the door tomorrow.

Morningstar's Heather Brilliant makes a point that is fundamental to long term investing - "The persistence of excess returns is much, much more important than the magnitude of excess returns"

Which brings us back to Consumer staples. If I had to pick one sector to put my entire portfolio in, its Consumer Defensive and its not even close. For high quality companies that generate high ROE and ROIC, have clean balance sheets, above average yields, steady dividend growth, and global exposure, I do not think you have to look any further than Consumer defensive.  On top of that, these are relatively easy companies to monitor and analyze. Most have no leverage or hard to understand issues, and the long run returns are not merely satisfactory, they are best in class.

Ordinarily, a single sector anything is a reason to be worried about risks and correlations. All of the other sectors have distinct risk factors, but about the biggest risk in consumer defensive is the risk of overpaying. Sure, its hard to get excited about buying Colgate-Palmolive for 30 times earnings. And there are some company specific risks for some products like tobacco and junk food, but as a group the biggest risk I see is overpaying. I just don't see the same correlations that you find in financials or energy.

As a proof of concept, here is a short list of 8 companies that sells for 22 times earnings. Not cheap, but with the S&P 500 at 20, this is a 10% premium to the market overall. The S&P's dividend yield is 1.9%, but these eight companies yield nearly double that at 3.5%. So that 10% earnings premium buys you a ton more income. The companies have excellent dividend growth track records and global exposure to boot.

P/E Dividend 5 yr Div Growth
Phillip Morris 17 4.7% 18.3%
Imperial Tobacco 21 4.4 13
Ambev 24 3.5 -1.3
Unilever 21 3.4 8.6
Nestle 24 3.2 16.9
Procter & Gamble 22 3.0 8.3
Diageo 24 3.0 7.5
Coca Cola 23 2.9 8.1
22 3.5 9.9
(Source: Morningstar)

Wallace Stevens' poem "Thirteen Ways of Looking at  Blackbird" contains this passage:

O thin men of Haddam, why do you imagine golden birds?  
Do you not see how the blackbird
Walks around the feet 
Of the women around you?

In this context, investors might ask themselves why try to imagine the next Tesla or biotech, do you not see the razor blades, shampoo, and candy bars around you?

I am not sure it needs to be any more complicated than that. As a postscript, here is a look at how the above eight companies performed from February 2005 to now (* note Phillip Morris is from March 2008 to now).

10 yr Total Return
Phillip Morris (*) 12.4%
Imperial Tobacco 11.2
Ambev 16.1
Unilever 11.4
Nestle 14.4
Procter & Gamble 7.6
Diageo 10.9
Coca Cola 10
(Source: Long Run Data)

Friday, February 13, 2015

Some questions on an above average interesting 13-F season

A great business less from Peter Drucker- it's amazing what you can achieve as a team if you don't care who gets the credit. A related theme for individual investors is - its amazing the ideas you can uncover if you don't mind cloning. This time of year is always interesting. Charlie Munger and Mohnish Pabrai talk about the virtues of cloning ideas:

Pabrai says most of his investment ideas come from other great investors -- though I think he's being modest. "God bless the SEC for their 13-F requirements," he said. "In fact, Nov. 14 was the last time when the 13-Fs came out, and you know, I'm like a pig in [expletive]. It's just great because there's so much to look at. That keeps me busy for a few weeks, and then the next 13-Fs come out."

Sites like Dataroma and GuruFocus do a great job of summarizing the information. Given the energy washout and other knock on events, this season figures to be more interesting than most.

Two investment operations that I follow are Tom Gayner at Markel and Berkshire Hathaway.

Tom Gayner had a couple of large and somewhat surprising moves in the last quarter. First, he sold out of all of his Coca Cola and sold out 74% of Markel's Berkshire Hathaway holdings.  Reading the tea leaves is always hard. Coke was a relatively small position and so perhaps it was just time to move on.  However, its does not appear overvalued to me. The Berkshire selling is harder to figure. Granted Berkshire appreciated quite a bit last year, but I assume that Markel incurred a fair amount of capital gains on the transaction. The sells were the most interesting events, Gayner did not make major investments in energy, though he did nibble a bit in energy. The biggest buy was Deere which takes advantage of the weakness in Ag stocks. Raven has been suffering for similar reason.

The Berkshire 13-F should be out very soon. Its always interesting to see what they do with buying new positions or managing existing ones. Given the context, this year there are a lot of interesting questions:

* Did they buy more IBM. Buffett laid out a great case for IBM when he bought it and said he did not expect a ton of growth in the near term, but I doubt he expected the challenges they faced. For one thing, buybacks were a big part of the thesis and those are halted. IBM is one the largest single buys he has ever made, and the price has gone down. Did he buy more?

* Energy - Exxon has only gotten cheaper, did Buffett buy more of that? Ted Weschler and/or Todd Combs own CBI also in energy, price got cut in half - did they buy more? Same goes for Suncor, National Oilwell Varco, and other evergy holdings.

The 13-F will be followed by a special 50th anniversary letter by both Buffett and Charlie Munger, so February promises to be a great month for reading.

Monday, February 2, 2015

What Your Portfolio Can Learn from Beast Mode

Buffett famously has a "too hard" pile where most stock ideas wind up. One of the hallmarks of his approach is avoiding complex situations, he is not going to try and figure out the next Genentech or Google.

On the other side, the polar opposite of "too hard" is Beast Mode - if you have the ball on the one yard line, hand the ball to Marshawn Lynch (disclosure: I am a Pats fan and glad that this did not happen). The point is that just like buying things that are too complex can you get you into trouble, and why you need a "too hard" pile. You can also miss good ideas by overthinking things, and that's where beast mode applies.

A good example here in my view is Exxon Mobil. Its impossible to consider all of the things that drive energy prices. But its very possible to look at Exxon's long history and see that Exxon yielding 3+% just does not happen that often and when it does its been a good bargain.

XOM Dividend Yield (TTM) Chart

This is not to say that big picture complexity doesn't matter. It does and will in the short term, but Exxon has next to no debt (0.1 Debt/Equity) so they have the strength to see it through to the other side. Plus, Exxon has raised its dividend 9.8% on an annualized basis over the last ten years. The yield has not been this attractive in the last decade even including the crisis. Generally speaking, buying companies at crisis prices has worked out well.

Given that plus the fact that Exxon lowest ROE in the last ten years is 17%, and a 33% payout ratio that leaves plenty of room to grow the dividend, taken together this makes Exxon a solid pick for the 10th pick in the WMD portfolio.

As much as investors cheered on Apple's record quarter, from a defensive standpoint Exxon's is just as remarkable. Consider the smaller companies and drillers are cutting dividends, but Exxon has scale and refineries to generate cash in a downturn. There are other big integrated players, but Royal Dutch Shell has no way to grow its dividend because its payout ratio is north of 70% and are cutting capex. Chevron is in better shape but they had to suspend buy backs. That leaves Exxon who did not do layoffs, still plans to buy back $1B of shares in Q1, and has a very safe dividend. There are lots of ways that investors can make money from the energy downturn, but from defensive standpoint, Exxon stands alone.

Bottom line is that overthinking the macro environment can cause investors to miss simple, effective ideas. That's not to say investing is simple, the safety and quality checks must be in place. It is important to remember where the individual investor's advantage lies, which is patience and longer time horizon; trying to establish an edge of near term oil prices is not a path to paydirt.