Not In Our Portfolio!

|
Includes: AAPL, CVX, IBM
by: Income Surfer

We are still on this amazing road trip, spending this week up in Wisconsin. Through a combination of intentional spending, living below our means, and consistent investing we have been able to spend these past months on the road as a family. It has been a wonderful experience, except perhaps that we have followed the emergence of pollen north, and this experience would have been impossible for me to replicate if I hadn't left my day job. Quitting that government job at 34, without another lined up, may have seemed like an odd move to some. Heck, I still don't have one three months later. It was the right move for us.

All the time on the road has had several excellent side effects. In addition to the abundant family time and joy I feel for travel, the past three months have provided me a great deal of time to think. I am a person who loves to think. I enjoy making observations, developing theories, and testing ideas. Sure, I had some time to do so while sitting in my office, but my distractions at the office were both belligerent and numerous. I tend to be a fairly distractable person anyway, so trying to multitask while running a 34 person engineering department was not effective.

So what have I been thinking about while hiking with our Black Lab or watching the Little Man play at the park? Lots of things honestly. Upcoming travel ideas. Ways to make our lives even more sustainable and satisfying. And investment ideas of course! You're probably most interested in the stock investing ideas, and that's exactly what I'm writing about today.

Long time readers of this site know that I have been skeptical of the US stock market's rally for a couple years. Last week I wrote a post on the subject (If you missed it, you can read it by accessing this link). I also recognize that some investors have been calling for the end of a bull market in stocks, well since stock markets first began trading. Hell, people have been predicting the end of the world for thousands of years as well, so at least there is a historical precedence for all this non productive time spent predicting. That's all noise, and I try very hard to tune it out. Such things are not readily knowable, and even if I am skeptical, I am not a good enough trader to sell all of our investments today and repurchase them cheaper tomorrow. Nope! We have however used recent rallies to sell out of individual stock positions which would not make satisfactory long term holdings. The idea is to reinvest that capital over time, in line with our desired portfolio allocation.

I spend some time looking at broad trends and thinking about the investing themes that will power our portfolio for the next few decades. Those ideas are often tangential, and lead to pockets of investments for me to analyze. I spend most of this time, however, thinking about individual companies. In keeping with my inner Carl Gustav Jacob Jocobi, sometimes I like to think about the problem backwards. Warren Buffett has famously said that he went through the publicly traded companies, one by one. That is a daunting task, and I concede that Mr Buffett has far more focus and concentration than I do! So instead of asking which companies I would invest in, sometimes I think about the companies in which I wouldn't invest. I have found this process of elimination to be helpful in spotting trends and issues, of which I was unaware. Digging into the prolific growth of Kinder Morgan's (NYSE:KMI) debt in 2014 and 2015, kept me out of that debacle. With that in mind, below is a list of seemingly blue chip companies in which I am skeptical at best, and bearish at worst.

International Business Machine (NYSE:IBM) - Big Blue has been struggling for years now. Even though management has been buying back tons of stock, the revenue per share and earnings per share stats have been falling for years. The nominal figures look even worse. Take a look at the Gurufocus summary graphic below. In addition to the issues I mentioned, debt has continued to climb (I believe to fund the buyback), and free cash flow has gone nowhere.

Click to enlarge

Look, I get that the company is transitioning from a hardware conglomerate to a software services company. That will be very good for long term shareholders, but when management spent billions of dollars buying back shares at higher prices while generating no earnings growth and a continued downward trend. I am skeptical. I get that the current price to earnings metric is basically 11, which is much lower than the broad US market. I would also like to remind my fellow investors that if the denominator declines year after year, it will never be cheap enough to be a good investment. I know that some superstar investors, like Warren Buffett, are huge fans of IBM and its management. Remember also that IBM now has a "Buffett Premium." If he was to start selling his stake, I am sure the stock price would decline 20% or 30%. His track record is far longer and better than my own, but let me leave you with the graphic below. It is a snapshot from the company's earnings report this week. Eventually growth may materialize, but all I see is that the most recent quarter was another quarter of deterioration.

Click to enlarge

Chevron (NYSE:CVX) - As the second-largest US-based integrated oil/gas company, Chevron Corporation is largely a household name. In our current low interest rate environment, it has also become wildly popular with dividend investors. The Gurufocus chart below shows the company's dividend growth over the past 10 years, and I agree that it is a beautiful chart.


Notably less appealing, is the company's cash burn issue. I understand that the collapse in the price of oil, over the last 2 years, has greatly reduced the company's profits. What is more interesting though, is that the company has actually been burning through its cash for the last few years. That's right, before the price of oil collapsed. I think the Gurufocus chart below shows the situation pretty well.

To generate the additional cash needed to keep the company afloat, management has been selling quality assets, issuing additional debt, and even issuing additional shares of common stock. You read that right. The same management group that was spending billions of dollars buying back shares at much higher prices, is now diluting existing shareholders at these lower levels. Talk about value destruction! I am fairly sure the company will survive the current collapse in oil prices and avoid bankruptcy, but I also think the company will be far less attractive at that point. It will have lost good quality assets and taken on more debt, all in order to avoid cutting the dividend. I am glad to have sold all my Chevron shares a couple weeks ago, and I have another article coming out next week because I feel so strongly about the dangers in this stock.

Apple (NASDAQ:AAPL) - Apple, yep THAT Apple. The one that has had an astronomical run over the past 15 years. The company whose products fill our homes. I am sure to get some hate mail on this, but hear me out. I know the company is selling at a price to earnings metric of 11.4, and appears a better value than the broad market (or the company's own 5-year average) based on the Morningstar table below. Unfortunately, the company's business model is also predicated on continually developing/selling amazing new consumer goods. There is little reoccurring revenue, and even less predicable service income. Apple needs to keep coming out with amazing new products to keep consumers buying and profit margins high. They have enjoyed outstanding profit margins for a long time, but as the pipeline appears to be drying up and competitors are trying to mimic Apple's products, I see little to get excited about. For the last 10 years the Apple story has been an innovation and growth story, and Steve Jobs led it in a great direction. That rate of growth has been slowing and where future growth will come from has become less certain, so investors are not willing to pay as much of a premium for future growth. That is part of the reason the company's shares have fallen off lately. Look at the Morningstar table below. This company is legitimately cheaper than it has been recently, but I think shares are selling at lower levels for a very good reason.

As the market for Apple's existing products has become closer to saturated, and competitors knock off more of Apple's products, I believe Apple's results will begin to look less appealing. That being said, I do not think Apple is going to go bankrupt or any such thing. The company has way too much cash and too many existing products, for it to shrivel up and die. I just don't think there will be growth, and most people invested in Apple as a growth story.

Click to enlarge

Well there you have it. I see my fellow investors putting their hard-earned capital into these companies, and I am not interested in any of them. This of course is just my opinion. Chevron and IBM I won't touch with the proverbial "10 foot pole," but Apple is most likely dead money over the next decade. Time will tell, of course. In general I see the broad markets as over priced, so we've been holding cash and looking for opportunities.

What are your thoughts on IBM, Chevron, and Apple?

Disclosure: I have no position in the stocks mentioned. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional. The information above is provided by Yahoo Finance, GuruFocus.com, and Morningstar.com.