2012 Portfolio Review: 2 Out Of 3 Ain't Bad

Includes: ALCO, BBY, HCBK
by: Wealthcompound

This post has been sitting 90% unfinished on my computer for several months so I figured a good new year's resolution would be to complete it.

So I was definitely wrong regarding Best Buy (NYSE:BBY). The company is a mess and while I still don't think the business model is completely dead, it is certainly in need of radical change. Although my financial losses were minimal (more on that later), my ego took a bit of a bruising. However, what bothers me more than being wrong was my sheer stupidity. Not only is BBY involved in a business that I don't really understand (technology and electronics), it is a consumer discretionary retailer, a business that I don't really like. These two reasons alone should have been big, bright red stop signs and my research and analysis directed towards other possible investment opportunities. Yet inexplicably, I continued.

Why? Well, I convinced myself that I could understand the qualitative aspects of BBY because, based on sheer quantitative metrics, the company was extremely undervalued. In retrospect though, the undervalued financials were probably an illusion considering no buyout firms were biting. Normally, even troubled businesses that are selling for 4-6 times cash flow would attract some type of interest. Even Richard Schultze, the founder of BBY, has delayed proposing a buyout offer numerous times. The offer is now expected sometime within Q1 of this year.

So what is wrong with BBY? Well, as investors discovered in 2012, management was not entirely focused on the business. Generally, personal indiscretions of top managers are mostly irrelevant to business operations (favorable promotions are an example of actions that can be problematic), even when those indiscretions are of the inter-office variety. The removal of Brian Dunn as CEO and the reasoning presented by the company (in such a public fashion as well) indicate something more than just a personal indiscretion between boss and subordinate, possibly affecting the business operations and/or decision making. Read more about BBY here.

Going further in depth on what is wrong with BBY is difficult because since I sold the shares, I haven't followed the company that closely. A quick glance at the earnings report released last week does show a decrease in free cash flow, a potentially troubling sign. The reader may be asking why did I sell? Well, I wish I could proclaim some great investing wisdom here but the truth is that it was sheer luck. Two events happened that led to liquidating my position for a loss of less than 10% (shares were purchased over several months in 2012 with a final cost basis of $21.34. All shares were sold on June 27th, 2012 for $19.56 resulting in an approximate 8.5% loss). The first event happened to be a BBQ. A good friend who was at the BBQ happens to be an IT professional and, for as long as I have known him, extremely knowledgeable on all things tech. When the subject turned to investing I began to discuss BBY and why, on a financial basis, the company was cheap.

While readily admitting he knew nothing about the financial side (something I should have admitted to myself on the tech side), he told me how much he disliked BBY and why they were in serious trouble. Mind you, every point made was based on the qualitative aspects of the business but the reasons sounded an awful lot like the bearish cases against BBY over the past two years. Maybe it was the booze but I really started to reconsider my investment in BBY. The kicker, however, came three days later when a small bank I had been watching for several years and missed as the price ran up announced its intention to de-list from the NASDAQ, which drove the shares down to "buy" territory.

Thankfully, I finally made a correct judgment regarding BBY, which was to sell. Let it be clear though that had these two occurrences not happened, I am 99% sure I would still own the stock and be sitting on a 35% loss (at the Friday January 18th closing price of $14.88). It almost sickens me to think what was sold that enabled me to have the cash for the BBY investment (more on that in my next post) but I escaped relatively unscathed. It could have been much worse. Lesson learned.

While BBY would have been best avoided, my other two portfolio components (not counting the banks shares that I began to purchase after divesting BBY and continue to do so) performed well for the year. While I don't necessarily recommend such a highly concentrated portfolio for most investors (index funds would be the best bet for those unable or unwilling to perform the necessary due diligence and analysis), it is the only approach that makes sense to me. Reason being is that it forces me to think about allocations within the portfolio.

As a result, while I may have been stupid investing in BBY, I wasn't stupid enough to make it my biggest holding. In fact, it only made up 10% of the portfolio. The other two companies, Alico (NASDAQ:ALCO) and Hudson City Bancorp (NASDAQ:HCBK), made up 57% and 33%, respectively. HCBK agreed to be acquired by M&T Bank (NYSE:MTB) for $3.7 billion back in August in a cash and stock deal. During my analysis of the deal and debating whether I wanted to receive cash or stock, HCBK stock continued to climb well past the $3.7 billion acquisition price. As a result, I sold all my shares on October 24th at $8.64/share. With the shares having a cost basis of $5.28, my gain was approximately 64%.

On an even brighter note, ALCO shares in my portfolio returned 124% from December 2011 to January 10th of the New Year (cost basis on the shares of $18.02 and all shares were sold for $40.28). You can read my ALCO post here. In my original analysis, I believed that ALCO land was worth somewhere between $41-55/share (the 25% correction factor was to demonstrate how grossly undervalued I believed the shares to be). This analysis was done before the company sold several thousand acres in 2012. As the shares nudged my low estimate, I decided to sell. However, if you are an ALCO shareholder, I think that it is still a good investment, just not dirt cheap like it was back in late 2011. General land values have made some good gains in recent months (albeit from a low level in some parts of the country) and inflation fears could move investors into companies with large amounts of quality tangible assets. However, for my purposes, the time to sell is before every last dollar of value is realized and if that leaves some money on the table, so be it.

Overall for 2012 (and a bit of late 2011), my portfolio gained 91% compared to the S&P 500 gain of 16%, mid-cap index gain of 17.9% and small-cap index gain of 16.3%. An eye popping number to be sure, achieved without any leverage. It is important to note that this gain is highly unlikely to be repeated anytime soon, if ever. Already I am having trouble finding equities selling for prices that I find attractive which is why I am currently 75% in cash (the exception being the community bank I mentioned earlier and another community bank which I don't own personally but have bought for a family member). Does this mean that I believe the market is due for a fall or a correction? Not necessarily, but I am proceeding with caution.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.