I’m generally content with my portfolio performance. In addition to one book review (on Peter Schiff’s book “The Little Book of Bull Moves”) I wrote about 6 investment ideas. I view three of these ideas as being a resounding success (buying CTL, buying ARMH and buying a straddle on FRO). However, I believe it is too early to be judged on two (one of which, avoiding CMG, is trending against me and the other, on Canadian income trusts, is trending in my favour), and one (on commodities pair trade) has been generally been mixed.
Because of the inconsistency in results I will record this article as a minor failure.
My concerns surrounding CMG's ability to grow at a consistent pace remain. First, the same store sales are skewed as it takes 24 months or more for earnings to ‘normalize’ at each new location. Same store sales for the first 9 months of 2010 were up nearly 8.3% (I remind you of my comments in my last article that “KKD was able to maintain 10% same-store sales growth in the year before its stock price deflate”). Part of CMG’s growth is due to an increase in menu prices and not because of driving new customers to the stores. If new stores perform as well as old stores and the company is able to add stores at its historic rate then the company should grow at just over 20% (remember the affect is multiplicative not additive). However, in addition to my above noted concerns on same-store-sales, I likewise doubt if the company can add new stores at 12% a year (the current rate at which it adds new locations). As the company grows, the larger base makes it harder for CMG to grow at the same rate. True, CMG is expanding to international markets, however, CMG actually added more stores in 2009 than it did in 2010. Even if CMG could grow at 20% a year, a 45x multiple (or a PEG of 2.25) still seems rich. I still believe the CMG is too risky to own.
The table to the side, shows how my rankings fared from September to December. Overall, not only did the top ranked outperform the bottom ranked, but none of the top ranked had a negative return.
Disclosure: I am long ARMH, CTL, FRO, MSFT.
6 Month Review of Investment Ideas and Strategies
1) On June 21nd I wrote Commodity Conundrum. In this article I noted that commodity prices (gold, silver, copper etc.) had increased in value, but the mining companies (e.g. NYSE: ABX, NYSE: KGC, NYSE: AA etc.) had not appreciated to the same extent. I advocated a pairs trade: buying the mining companies and shorting the commodity ETFs (e.g. NYSE: GLD, NYSE: SLV, NYSE: JJC, NYSE: JJU etc.). In my article I did a case study of Kinross (KGC) and suggested “that for every one GLD shorted, approximately 6.6 shares of Kinross will be purchased.” On June 22nd Kinross was trading at $18.08; it is now trading at 18.53, during that time there was a 5 cent dividend, which combined resulted in a 2.7% return for the period. Conversely GLD appreciated from $121.39 to 134.66 during this period, which resulted in an 11% return. The case study proved wrong over the time period. I was too quick with my entry point. Less than a month after I wrote this article KCG was down 14% where the GLD was down 4%. If you entered the trade on July 1 (which is a few weeks BEFORE KGC's low point) then you would have purchased 7.2 shares of KGC for every one of GLD and by October 1st (3 months later) you would have been up 5.8%. Timing is everything.
These charts show a few other combinations of this thesis. The thesis was hit or miss when implemented on gold stocks, but with aluminum and silver the pairs trade worked out much better. The pairs trade for silver would have netted you a 25% return and the pairs trade for aluminum would have netted you an 8.4% return (about the same as the loss in the KGC/GLD trade).
2) On June 14th I wrote about Chipolte Mexican Grill (NYSE:CMG), I saw it as potentially the next Crox (NASDAQ:CROX) or Krispy Kreme (NYSE: KKD) and told you to stay away. Those who commented on the article gave me a lot of flack, and that bolstered my opinion that CMG was a ticking time bomb; it was becoming too popular and people were loading up on it because it was the hot stock/hot restaurant and not based on the financial fundamentals. But I cautioned, in large part because of this momentum, not to short the stock. I suggested, just as was demonstrated by CROX and KKD, that this stock would likely appreciate in leaps and bounds until one day everything would change. As with the others listed, I had expected that CMG may drop so quickly that stop losses would be ineffective. After falling about 15% from the date of writing the article, CMG rocketed back and is now up 50%.
When I wrote the initial article, CMG was trading at 30x P/E. It is now up to 45x and its PEG is now over 1. It appears that investors expect the company to grow at a faster rate than it has in the past.
3) On June 23rd I suggesting buying a straddle on Frontline (NYSE: FRO). It was a company that I generally liked but whose stock price saw large swings. FRO’s options seemed to underprice the stock's volatility and I estimated that there was about 60% chance that the strategy would be profitable. Given the low cost to enter the strategy and the potential payoff, it seemed like a reasonable trade to make.
I suggested that "buying July calls with a strike of $32.5 for $2 and buying the July puts with a strike of $32.50 for $1.10”. The net investment would have been $3.10. This trade had a very short window, only 17 days, but if made it, you could have earned a tidy 30% profit. The following chart show the potential return across the period
By definition, you would be underwater when you entered this trade (no arbitrage here). However by the second week you were up between 25% and 30%, this would have been the time to take your nice gain and walk away. The trade eventually turned against you, but if you were not greedy, sizable profit was to be had in a very short amount of time.
4) On July 5 I advocated buying Arm Holdings (NASDAQ:ARMH), the chip designer that is in just about everything. The company had huge growth, big margins, lots of cash, and was expanding into new markets. When I suggested buying Arm it was trading at 270pence (in London) and about $12.30 (as the ADR). It now at 430pence or $20.15, or over a 60% return in the 5 month period.
There is not much more to say about this article except that this was a big success. The financial made sense, it was, in spite of its high P/E, a true growth story. And, unlike CMG (mentioned above), because Arm does not physically make the chips it growth was not limited by external forced (CMG is limited by its ability to open new store locations).
To grow, Arm needs to find new customers. As the world has been going mobile this has not been hard for Arm to do. Not only are there more devices, but the devices are now using multiple chips. The one concern is the possibility of new entrants. Intel (NASDAQ: INTC) and Advanced Micro Devices, Inc. (NYSE:AMD) seem to focus on computers and not mobile devices, although this may change. Texas Instruments (NYSE: TXN) and Motorola (NYSE: MOT) make chips but are not true competitors as these types of companies purchase licenses from Arm. At less than 1/10 Arm’s size, MIPS Technologies, Inc (NASDAQ: MIPS) is an up and comer to look out for.
I am currently contemplating an exit point for Arm. I believe at its current valuation it is now time to monitor the stock and if it should it drift down, I will consider selling. That being said Microsoft Corporation (NASDAQ:MSFT) recently announced that it will be using the ARM chipset in its new mobile computers.
5) On August 23 I looked at the Canadian income trusts. For those that don’t know, as of January 1, 2011 new tax rules will be in place and Canadian income trusts will become taxable entities.
My thesis was that certain entities would need to cut their payout ratio upon the tax rule change while other entities would be able to maintain the payout. I surmised that those that maintain their payout would outperform those that were forced to cut their payout. It is likely too early to review this strategy since the law has not yet changed. By way of example, Crescent Point Energy (OTCPK:CSCTF) which already converted to a corporate structure and maintained its dividend has performed very well (up nearly 30% once the dividend is factored in). Conversely, Canadian Oil Sands (OTCQX:COSWF) which, although has not converted yet, has announced that it will cut its dividend, is up only 3.7% (including the dividend) for the same time period.
Only time will tell what will happen after the SIFT rules take effect.
6) On October 13 I wrote about CenturlyLink (NYSE: CTL) and updated my thinking on November 3rd. Since the date of this article, the stock, including dividends, has returned over 18%. I am happy to admit I was long CTL before I wrote the article. Although on a percent and net basis CTL is not my biggest gainer of the half year, I consider this position one of my better picks.
The thesis developed, like it did for so many others because of a dividend screen. These screens often pick up stocks that have fallen from grace, and for many CTL was just that, a stock with declining earnings that deserved to be beaten. But, as described more fully in the article, I saw a secular shift from telephones to internet lines and figured, despite the decline in earnings, that the dividend was safe. So far this has proven correct, and I continue to hold CTL.
As described in the follow up article the earnings in the most recent quarter were not as strong as I had hoped, but the balance sheet remains intact and I see little reason to exit this position until my exit price (somewhere in the low to mid 50’s) is reached. The stock has had a lot of momentum recently (up 7% since December 8th) and I am comfortable riding this momentum for the next while.
All in all this half year has been a fairly good one. Things started slowly but the markets generally trended upwards, with sufficient volatility to find some trading opportunities. The Dow Jones Industrial average is up 13% since June, with most of the gains coming from September onward, and the TSX is up slightly more.
I am still very bullish on my home country of Canada, resource rich nations like Canada and Australia should continue to perform well, although our manufacturing sectors may suffer as our dollars appreciate.
Conversely, although I think the US is past the worst of its troubles, the double deficit remains a concern and given that I believe that the Canadian dollar will continue to outperform the US, my picks of US securities will be limited, as I must obtain a return that is greater than the my expected currency loss (I don’t typically hedge with ETFs); this is a concern many readers don’t share. Like so many others, I am concerned about Europe. I am also starting to wonder what the effect of China’s tightening of its monetary policy will be both there and globally.