This piece is part of a new, ongoing series here on the ETFs & Portfolio Strategy page at Seeking Alpha. The concept is for a money manager or RIA to field a hypothetical portfolio construction question from an SA user about how to best construct a portfolio that will help them meet their financial goals and then proceed to build an effective portfolio that will take their risk/reward profile into account. All participants in this series are real-world professional investors who are available to help individuals, companies, and financial professionals construct intelligent portfolios. To submit a question for a future edition of Build My Portfolio, email Rebecca at firstname.lastname@example.org.
This edition of Build My Portfolio features Robert Balopole. Bob is Founder and President of Balopole Investment Management Corporation, a fee-only Registered Investment Adviser in San Mateo, California, favoring a fundamental value investment style. Bob is a Chartered Financial Analyst and is also a Certified Public Accountant. He practiced accounting in San Mateo for 15 years before selling the practice in year 2000 to concentrate full time on investments.
I am a 29 year old professional poker player who makes roughly $90k a year in endorsements after taxes. (As you're probably aware, poker players experience fairly large 'swings' with their bankrolls so for investing purposes, I'd like to just use my endorsement money and leave my poker bankroll untouched for investing purposes). I have never invested before; my general attitude towards money has always been 'easy come, easy go' and I never considered saving. Now as I approach 30, I want to start putting something away for a rainy day. I already have about $220k sitting in an account which I'm ready to invest - I am planning on adding an additional between 40-50k every 6 months.As someone who is used to taking chances with money on a regular basis, I don't think I'd lose much sleep over significant volatility in my portfolio. As I'm not sure when I'll need this money or how much I'll need exactly, I am willing to take chances with my investments. Just like in poker, I understand that in investing you can only achieve great returns if you take on significant risks - something I am fully willing to do. Please help me build my portfolio.
Las Vegas, Nevada
As a poker player, you know that your style of play must fit your own skill set. If your mind is like a computer, you play a math-based strategy. If you can read people, you focus on the bluffing and the personal dynamics aspect of the game. Investing is the same way. There is no one best style of investing; rather the investment style must fit the skill set of the investor.
The first thing you have to ask yourself is: are you an investor or a speculator? An investor is interested in the ongoing income stream generated by the investment, whereas the speculator hopes to profit from changes in the price of the investment. Most investors who think they have the skill to be speculators are better off pursuing the slow and steady path of the investor. Indeed, over the last century stocks have returned far more in dividends than they have in stock price gains.
Unfortunately, the distinction between investors and speculators has been clouded by the trend of corporations paying little or no dividends. For tax reasons, many corporations favor returning earnings to shareholders in the form of stock buybacks rather than dividends. Stock buybacks usually increase the stock price, so now you have both the investor and the speculator profiting from a rise in the share price. Yet there remains an important distinction: the investor profits from the predictable effect of income accumulation, while the speculator must correctly predict some future event.
Balopole Investment Management Corporation favors the investor approach. We come from an accounting background, so we read financial statements and favor companies with healthy income and cash flow. We study a company’s debt structure closely because too much debt can sink a company, much like playing poker with borrowed money.
You say you want to “achieve great returns” and “take on significant risks”. But should your appetite for risk extend into your life savings, or should you have an investment portfolio that provides a counterbalance to your own risky profession? You say you “want to start putting something away for a rainy day”. Heed your own words. High stakes poker is public entertainment and the public is fickle. Take some money off the table; don’t continue to double down!
We propose the largest portion of your portfolio be allocated to stocks with low price/earnings ratios. In addition, each company needs to have a defense against a slowdown in the U.S. economy, such as: it serves a global market, it is a staple, it thrives during hard times, it can scale down if need be.
Second, we propose stocks which have a low price compared to net asset value. Your investment will be secured by the liquidation value of the underlying assets.
Third are speculative stocks, stocks whose value depends on the occurrence of some future event. We ask two questions: what is the probability this event will occur, and what is the potential payoff? This is the exact same process a poker player uses in deciding whether to call a bet.
Last, we select some fixed income. Given your age and earning power, the fixed income allocation is modest. Our goal here is minimizing exposure to inflation via floating rate funds or funds denominated in foreign currencies. On the fixed income side we use Closed End Funds (CEFs) rather than buying individual bonds. That is because CEFs can buy and sell at wholesale prices, and also because bond investing requires specialized expertise, which the active managers of CEFs have.
Here is our proposed portfolio for you:
Low PE Stocks
Archer Daniels Midland (NYSE:ADM) 5%
P/E 8.3, Fwd P/E 8.3
ADM is a global processor and distributor of corn and oilseeds. People always need food. Middlemen almost always make a profit. Huge infrastructure investment is a big barrier to entry in this industry.
Teva Pharmaceuticals (NYSE:TEVA) 5%
P/E 10.9, Fwd P/E 7.6
Drug demand is insulated from the economy as drugs are mostly paid for by insurance or government. Drug demand is inelastic. TEVA is the largest generic drug manufacturer in the world and generics continue to take market share from brand name drugs.
Asta Funding (NASDAQ:ASFI) 5%
P/E 34.8, Fwd P/E 11.4
ASFI is a debt collector, and P/E is distorted by non-cash write-downs of debt portfolios. Price to cash flow ratio is below 2. Collection of debts is mostly a function of time, as judgments get paid when real estate changes hands.
China Ceramics (NASDAQ:CCCL) 5%
P/E 1.7, Fwd P/E 1.7
Sells tiles exclusively to Chinese market which may be temporarily overbuilt, but continuing migration to cities will fuel long term demand. CCCL has negligible debt, rare for a manufacturer, so they have staying power.
Entegris (NASDAQ:ENTG) 5%
P/E 9.0, Fwd P/E 8.7
ENTG is a supplier to global semiconductor industry. Profit comes mostly from consumables. Low priced yet critical supplies makes customers reluctant to switch. Competitors lack ENTG’s global footprint.
Stealthgas (NASDAQ:GASS) 5%
P/E 7.1, Fwd P/E 5.1
GASS is a propane shipper in Southeast Asia with little exposure to U.S. economy.
Techprecision (OTCQB:TPCS) 5%
P/E 10.4, Fwd P/E 6.3
TPCS.OB is a large scale high precision metal fabricator. Current sales tied to equipment sales to Chinese solar industry, which is well financed and focused on long term growth. Growth drivers include LED industry, proton beam therapy and nuclear plant replacement cycle.
EZCorp (NASDAQ:EZPW) 5%
P/E 12.8., Fwd P/E 11.4
This pawnshop chain has thrived in good times and bad.
Category Subtotal: 40%
Low Price/NAV Stocks
Silvercrest Mines (STVZF.PK) 5%
Probable gold and silver resource worth more than eight times its market cap.
Yamana Gold (NYSE:AUY) 5%
Proven and probable gold and silver resources worth two and one half times market cap.
Whiting Petroleum (NYSE:WLL) 5%
Estimated proved oil and gas reserves are worth five times market cap. Although this does not reflect production cost, it also does not include reserve growth through exploration.
Caplease (NYSE:LSE) 5%
Tangible book value is 1.4 times market cap. Assets are mostly very saleable office buildings.
Piedmont Office Realty (NYSE:PDM) 5%
Book value is 86% of market cap. Assets are office buildings.
W.P. Carey (NYSE:WPC) 5%
Book value is only 50% of market cap. However, W.P. Carey holds an asset which does not show up on the balance sheet: the right to receive management fees from affiliated REITs.
Transmontaigne Partners (NYSE:TLP) 5%
Book value is only 75% of market cap, but book value is well below market value of assets. Assets consist of pipelines and terminals. Many were acquired in the 1990’s and are substantially depreciated.
Category Subtotal: 35%
Infinera (NASDAQ:INFN) 3%
INFN makes a photonic integrated circuit which is a technological breakthrough in the optical communications equipment market, a $12 billion market. Market cap is only $689 million.
Arena Pharmaceuticals (NASDAQ:ARNA) 2%
Arena manufactures an obesity drug. Unmet need is huge. Market could be many billions of dollars. Market cap is $212 million. FDA sabotaged Advisory Panel meeting by raising issue of tumors in laboratory rats which none of the panelists had the expertise to assess. FDA is allowing Arena to resubmit data proving rat tumors do not pose risk to humans.
Mela Sciences (NASDAQ:MELA) 2%
MELA makes a device for diagnosing melanoma which is as accurate as any expert dermatologist. FDA Advisory Panel voted for approval, but FDA is delaying. Melanoma kills 48,000 per year and is easily cured if detected early. Market cap is $47 million.
Axion Power (NASDAQ:AXPW) 3%
Axion produces a lead acid car battery using activated carbon which has markedly superior performance needed for new generation of microhybrid autos. Total addressable market is $30 billion. Market cap is $50 million.
Category Subtotal: 10%
Western Asset / Claymore Inflation-Linked Opportunities & Income Fund (NYSE:WIW) 5%
This CEF is the best way to buy TIPS. WIW sells at an 11.4% discount to NAV.
Morgan Stanley Emerging Markets Domestic Debt Fund (NYSE:EDD) 5%
EDD currently sells at a 13.79% discount to NAV.
BlackRock Floating Rate Income Strategies Fund (NYSE:FRA) 5%
FRA currently sells at a 8.21% discount to NAV
Category Subtotal: 15%
I would recommend we review your portfolio on a quarterly basis. Most of your investments file reports on a quarterly basis, so this will synchronize your portfolio review with the availability of new information. The cost of the review will be modest in relation to the benefit. With a fairly concentrated portfolio it is very important to keep on top of current developments specific to each company.
Disclosure: Robert Balopole owns all of these securities. This is not an offer to sell securities. Recommendations may not be appropriate for every investor.