Last September, during the depths of the panic-inducing correction that cannibalized all the gains the stock market made in the first half of the year, I published an article about a newly minted portfolio I assembled after snapping up a number of bargain equities. I've always believed that anyone who dispenses investment advice, which by definition encompasses all Seeking Alpha authors including myself, should be willing to put their money where their mouth is. The first question to ask your investment advisor should always be: "What do you own in your own portfolio?" Always be wary of anyone pitching a stock that they're not holding in significant quantities themselves.
The $20,000 portfolio isn't a virtual portfolio - every position was purchased with cold, hard cash. It's a 100% equity, highly concentrated portfolio filled with the five highest conviction stock picks I had at the time. I believed in September that the market was oversold, that there were a lot of great companies trading at bargain bin prices, and that the correct move was to buy. There was nothing complicated going on here, no options or margin trading, no short selling: just buying great businesses at prices far below their intrinsic values.
It's now exactly two quarters later, and every single position in the portfolio is deep in the green. According to Peter Lynch, great investment returns can be had by being right only 6 times out of 10, so I usually don't start out expecting to bat a thousand, but hey, if it happens, I'll take it. Warren Buffett says that the first rule of investing is to not lose money, but even better than that is to make money. For this portfolio review, let's run down the list and see how each position performed. For the starting price of each stock, I used the closing price on Friday, 9/23/11 since the original article was published early morning on Monday, 9/26/11. For the current price, we're using the closing price on Friday, 3/23/12. All data was sourced from Yahoo! Finance.
Why am I using the date of publication to determine the starting price instead of my original buy-in price? One reason: accountability. Anyone can say they bought so and so stock at X and now it's trading at 10X, but unless you can get your hands on their brokerage records, you have no idea if they're being straight with you. But the record dates of published articles are set in stone and are there for all to see. As such, they serve as the best evidence of a given author's position on a stock at any point in time. For this portfolio, I entered some positions at lower prices than the starting value and others at higher, but overall it corresponds pretty well, so that's what we'll go with for now. That said, let's dive in.
Starting Price: $35.06 Current Price: $45.59 Gain/Loss: +30.0%
I originally purchased BP very close to its market bottom after it cratered during the Deepwater Horizon oil spill. When the broader market tanked in the third quarter of 2011, BP got dragged down with it and almost touched those lows again. After BP was forced to cut its dividend due to the costs of cleaning up the spill, the stock was dumped without mercy by income investors, but the company has since reinstated its dividend and offered a very appealing yield for investors who were willing to take on a little more risk (its yield closed in on almost 5% at one point). BP recently reported great earnings with both top and bottom line growth, and its even raised its dividend.
However, I've completely closed out this position, locking in a hefty gain, which means BP is no longer part of this portfolio. While I believe BP still has some room to run, I'm not a big fan of the company's management, especially after they blew that deal with Rosneft last year. What made it worse was that this was the second time CEO Bob Dudley got gamed by the Renova oligarchs, which just made it even more embarrassing. There are two kinds of companies I usually invest in: excellent businesses trading at a small discount, or mediocre businesses trading at a huge discount. The latter kind is immediately sold to lock in profits as soon as it resets closer to its intrinsic value. BP belonged to this group, and it has had a massive run-up since my original purchase, so the position has been liquidated in order to free up capital for better opportunities.
Starting Price: $404.30 Current Price: $595.81 Gain/Loss: +47.4%
In the original article, I said that I was thinking about cashing out part of my position in Apple, since I bought it at around $320 and it had jumped to $400 by then. In the end, I chose to hang on to the stock, and it ended up being the right call, since Apple continued its habit of smashing expectations, and recently broke $500 to become the most valuable company in the world. A lot has happened to the Cupertino technology titan over the past six months. Founder Steve Jobs passed away, which didn't have nearly as large an impact on the stock as people were predicting (indeed, Apple outperformed the Nasdaq on the day Jobs stepped down). The iPhone 4S was released to enormous consumer demand. And now, the company is finally unlocking its war chest, and will initiate its first dividend payment since 1995 this coming July.
That's the right move to unlock shareholder value, and it's why I'm still hanging tight to Apple despite its recent rally. Apple is an operations juggernaut (strip out its non-sales related assets on the balance sheet, and its return on equity approaches infinity), but its cash and investment portfolio is only earning about 0.7% a year. If you're an investor who can pull in more than 0.7% in annualized gains, a dividend is to your net benefit.
American Eagle Outfitters (AEO)
Starting Price: $11.17 Current Price: $17.14 Gain/Loss: +53.4%
American Eagle, like BP, is another mediocre company I bought because it was selling at a heavy discount to its underlying business value. Unlike BP, I don't believe that AEO is anywhere close to approaching its intrinsic value (which I estimate to be around $22/share), so I'm still fully invested. As far as new developments go, Eagle has finally found a replacement for its retiring CEO in Levi's Robert Hanson, whose moxie remains to be tested. This means the company is much less likely to be acquired by private equity, so shareholders looking to make a quick and easy buck will probably be disappointed. However, a number of tailwinds are prepping up to lift the company this fiscal year, the most important of which is probably much, much cheaper cotton prices. If the economy recovers further and the flow of money trickles down to the poorest of America's consumers, the teenagers, then Eagle has no place to go but up. Furthermore, as of the latest quarter, Eagle is sitting on more than $700,000 in cash, making it one of the most liquid companies in the apparel retail sector.
JPMorgan Chase & Co (JPM)
Starting Price: $29.59 Current Price: $45.18 Gain/Loss: +52.7%
JPMorgan hasn't had a very good couple of quarters, mostly because negative market sentiment led to severe declines in its investment banking revenue. The company continues to be the strongest player in the banking industry, but after much deliberation, I've decided to close out my position and take my profits off the table. Banking continues to be one of the most complex and difficult to understand businesses around, and the consequence of any incorrect analysis is magnified by the enormous amounts of leverage these companies take on. Furthermore, the new Basel regulations will deliver a hard blow to the returns on equity banks can achieve, leading to a lower normalized P/E across the industry. With Europe's sovereign debt crisis still shrouded by a fog of war, I don't believe that big banks are particularly undervalued at the moment, though I still believe in JPM's management and remain bullish on the company as a whole. I just think that there's safer money to be made elsewhere. However, I still remain a big fan of CEO Jamie Dimon - one of his recent remarks about how he wants the stock price of his company to go down so he can repurchase more shares shows that he's one of the rare managers who truly understands shareholder returns.
Starting Price: $66.37 Current Price; $81.43 Gain: +22.7%
Berkshire actually rallied hard on the same day I published the original $20,000 portfolio article, since that was the day Buffett announced that the company had just authorized a landmark share repurchase program. The shares have continued to rise since then, which means he hasn't had much opportunity to actually buy any shares back, but the company is as strong as it has ever been, with rising operating income (by far the most relevant measure of Berkshire's financial health). A couple of important new developments have happened over the past few months, both of which serve as evidence that Buffett's investment jujitsu is as sharp as ever and continues to be refined.
The first is Berkshire's $5 billion investment in Bank of America (BAC), netting a fantastic 6% interest rate and more importantly, a large number of warrants with a dirt cheap exercise price and a ridiculous duration of ten years. Warren is a shark, and age hasn't dulled his bite in the least. The second is Buffett's sizable investment in IBM (IBM), which took pretty much everybody by surprise, given his longstanding aversion to the technology sector. This investment shows that Buffett continues to be a learning machine even in his advanced age, and is constantly adding to his circles of competence. All in all, the fact that the old guy is still razor sharp is very good news for shareholders, especially considering that Berkshire stock pretty much doesn't carry any sort of Buffett premium anymore.
$20,000 Portfolio vs S&P 500
Okay, so a lot of money was made with this portfolio. At this point, the correct response would be: "So what?" Portfolio results are meaningless without a benchmark. After all, just because you made a lot of money in the 1990s doesn't mean you're a good investor - everybody made a lot of money back then. Astute readers will immediately notice that the starting date for this portfolio began when the S&P 500 index was at its 52-week lows, and it's now trading at a 52-week high. Almost any portfolio would've made money in this time frame. So to put our profits into context, let's look at how this portfolio has performed compared to the index. We'll be looking only at capital gains and ignoring dividends, since the yield of the $20,000 portfolio is roughly the same as the yield for the broader index (I had two stocks that paid much higher dividends than the S&P, one that was roughly equal, and two that didn't pay any).
- If you had purchased the SPDR S&P 500 Index Fund (SPY) at its closing price on 9/23/11 of $113.54, and sold it on Friday, 3/23/12 at $139.68, you would've pulled in a +23.0% gain.
- If you had purchased the five stocks in the $20,000 portfolio in equal weights at their closing prices on 9/23/11 and sold them on Friday, your total gain would be +41.2%.
And there we have it: not only did we outperform the index in aggregate by almost 20 percentage points, every single stock in our portfolio crushed the index on its own, except for Berkshire, which tracked it. Not too shabby for half a year of effort, especially considering that the majority of professional fund managers can't even match index returns. Every stock pulled its own weight in this portfolio, no one got subsidized. Of the original five stocks, I've sold two, and the portfolio is currently sitting on 25% cash. I've freed up a lot of dry powder because there are a few brand new stocks I have my eye on that I needed to make room for. One of these is a microcap that I've slowly built a sizeable position in and now represents the largest holding in the portfolio by far...but more on that later.