- The market will act irrationally at times, selling off excellent companies without a justified cause.
- The patient long-term investor should aggressively act on these opportunities.
- Never fear taking a profit, as few stocks go straight up.
The bullish advance was stymied in the first quarter as the market traded in a sideways pattern. Many blamed the unseasonably cold weather for the lull in trading, I am of the opinion it was a simple sideways action as we awaited further info on the path of interest rates. Interest rates continue to remain at historical low levels which have astounded many, as the Fed continues to reduce its bond purchases. In my opinion, the bull market will cease to exist once interest rates meaningfully rise above 4% on the ten-year US Treasury bond. When this event will happen is anyone's guess; I will continue to remain long and look for capital gains. There were six transactions made in the model portfolio as I continue to trim fully valued companies and use the proceeds to invest in more attractive companies.
IBM Corp. (NYSE:IBM)
Colgate Palmolive (NYSE:CL)
Ensco Plc (NYSE:ESV)
Gilead Sciences (NASDAQ:GILD)
Philip Morris (NYSE:PM)
Wells Fargo (NYSE:WFC)
Schlumberger NV (NYSE:SLB)
CBS Corp. (NYSE:CBS)
Coca-Cola Enterprises (NYSE:CCE)
Bank of New York (NYSE:BK)
Sirius Satellite Radio (NASDAQ:SIRI)
BP Plc (NYSE:BP)
Las Vegas Sands (NYSE:LVS)
Admiral Group Plc (OTCPK:AMIGY)
|Dollar Tree (NASDAQ:DLTR)|
I would like to begin with the purchase of Gilead Sciences. The market as a whole can act in a very irrational manner, offering the patient long-term investor an excellent entry price. Such was the case here with GILD, as the whole biotech sector sold off aggressively in April. There was significant uncertainty going into the earnings report, as the momentum players were tripping over themselves to exit out of positions. I was able to capitalize on this irrational behavior, entering into a position at $73.59. I detailed my rationale in depth here. GILD has returned a very handsome 20% in less than 3 months, which is simply outstanding. To make room for GILD, I had to sell AmerisourceBergen (NYSE:ABC). ABC is an excellent company; however its long-term profit potential pales when compared to GILD. A very easy trade-off, in my opinion.
The second move I would like to highlight was the sale of the venerable Coca-Cola (NYSE:KO). KO has a stable of impressive, recession-proof brands that are enjoyed the world over. Having great brands by themselves doesn't necessarily make for a great investment. I find the management team at KO to be extraordinarily greedy with their excessive executive compensation plan. When I entered into the position in KO, I expected a stable company with a nice mix of capital returns coming from dividends and share repurchases. With a stable business, consistent share reductions will lead to outsized gains over a ten-year time span as the business continues to generate profits. The key here is the profits will be shared with a smaller and smaller shareholder base as shares are retired. An excellent example of this behavior is XOM, as it relentlessly reduces its share count on a quarterly basis. In KO's case, the share reductions will be severely curtailed due to the dilution effect. The executive compensation plan will negate a large percentage of the shares that would be reduced. In essence, management will be rerouting the monies that should be used to lower the share count into their respective bank accounts. Absolutely unacceptable behavior, even Warren Buffett was less than thrilled.
KO is still a wonderful company, yet I suspect total overall returns will be constrained going forward. I continue to have exposure to KO through one of its bottling franchises. CCE is an excellent, well-run company that is returning a great deal of its profits to shareholders via share reductions and dividends. I fully expect CCE to vastly outperform KO going forward. For those who are interested in this unique company, feel free to review the following article I wrote about CCE.
The original proceeds from the sale of KO were placed into Dollar General (NYSE:DG), a unique player in retail. The shares were in an ascending pattern until news broke that its excellent CEO would be retiring next year. The announcement was unexpected and caused an immediate downdraft in the shares. I have no doubt a large portion of the downward move is due to speculators fleeing from DG as the chances of it acquiring its wounded counterpart Family Dollar (NYSE:FDO) decreases. I actually didn't expect it to acquire FDO, yet the announcement of the CEO's retirement injected a bit of unwanted uncertainty into the equation. When combined with the Supreme Court's decision for traditional broadcasters, the choice to move the assets into CBS became quite clear. CBS was one of the candidates to replace KO, yet I hesitated due to the uncertainty of the court case. Once the uncertainty has been removed, the choice became clear. I will write a detailed article explaining my investment thesis on CBS once the final details of its tender offer are announced.
The third transaction I would like to highlight came about through an acquisition. In this particular case, T purchased DIRECTV (NASDAQ:DTV) for cash and stock, which left me a very interesting choice. Do I simply wait for the merger to be approved and consummated, which would then cause T to become my largest holding? I choose to be a bit more proactive and sold the shares immediately following the announcement of the deal. The premium for holding the shares, in my view, doesn't outweigh the risk in DTV shares if the merger is scuttled for any reason. I choose to invest the proceeds into VIAB, an extremely well-run media company. I expect VIAB to follow the same playbook that has been serving it well the past few years, namely repurchasing shares and raising the dividend. VIAB is looking to retire an additional 20% of its market cap over the next few years. I will be along for the ride, as I expect it to complete this task with minimal difficulty. For a more in-depth review of the case for VIAB, click here.
The fourth transaction revolves around taking advantage of a temporary market anomaly. In this particular case, the market's irrational sell-off of casino stocks due to weaker traffic. A thesis being bandied about is the Asian gambler will be distracted by the World Cup, and less money will flow to casino tables. Growth and incomes will continue in this area of the world, setting the stage for a fertile casino environment. As incomes continue to rise, the Chinese will look to test their luck, and what better place than in Macau. I decided to part ways with Bristol-Myers Squibb (NYSE:BMY) to create the capital needed to enter into a position in LVS. The investment thesis is two-pronged, the first being there will be casino-style gambling allowed in Japan. I fully expect LVS to be granted one of the licenses, with a gambling resort similar to its Singapore property being built in Tokyo before the 2020 Summer Olympics. The Japanese market is tailor-made for LVS, with the high incomes and advanced age of the population auguring well for increased casino activity. The second part of the thesis revolves around the continued growth of Macau. LVS is well-suited for the mass gambler who continues to flock to Macau. The Chinese government will spend billions in infrastructure making Macau more accessible to the mainland. LVS is a long-term hold, as I expect the shares to outperform the market for the rest of the decade.
The last transaction I would like to highlight was the disposal of my stake in NOC. NOC is quite simply a fabulously run company that has generated a 50% return for me in one year. The defense industry sold off rather briskly in the winter of 2012, as the threat of massive defense cuts heavily weighed on the industry. The rather stable, predictable industry with long lead times dropped to a sub-10 P/E, which was simply too cheap. While defense cuts did come in, what wasn't anticipated by the analysts is the managements of these companies using their stable, predictable cash flow to retire shares. NOC announced an aggressive plan to retire roughly 25% of all shares outstanding by the end of 2015. The shares rallied in an almost straight-line fashion since the announcement.
While I am grateful for the immediate gain, the stock's meteoric rise has mitigated some of the impact of the share reduction plan. Management will fall well short of their 25% goal, as the shares are simply far more expensive than before. When you are investing in a company that is going through an industry change, (Defense contractors and IBM), you want the shares to languish for an extended period of time to allow the full effects of the share repurchase to work. IBM has done exactly that, languished for a few years as the share count is furiously reduced. When the inevitable upswing in business materializes, the increase in profits will fall to a significantly reduced share count.
I am replacing NOC with a stake in DLTR, and slightly increasing my stake in TGT. DLTR is a phenomenally well-run company that I have detailed in depth. The investment thesis behind DLTR is actually quite simple - the company generates quite a bit of free cash flow. The cash flow is used to open new stores and reduce the number of shares outstanding. In my opinion, the company is recession-proof, as the products sold by it cost $1 or less. DLTR actually does better during a recession, as more consumers become price-conscious due to restrained incomes. The shares have gone nowhere the past year, as the brutal winter wreaked havoc on all the retailers. Year-over-year earnings growth will be subdued, as most retailers have already stated they will be unable to make up for the lost sales due to inclement weather. Therein is the opportunity for the patient long-term investor to acquire an ownership stake in a well-run retailer while it is on sale. I expect management to use the remaining of its share repurchase plan by the end of the year, which will reduce the shares outstanding by more than 5%. Patience is all that is required here, as the management team is superb.
In summary, I managed to generate five transactions, which is a bit more than I prefer. I am fairly certain these moves will pay off handsomely over the next few years, with a few already showing stellar returns. I would like to thank you for reading, and I look forward to your comments.
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