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David Trainer
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Follow me on Twitter: @NewConstructs David is CEO of New Constructs (www.newconstructs.com), an independent research that specializes in unearthing key insights from the Financial Footnotes of Annual Reports. Having analyzed over 50,000 annual reports and their Financial Footnotes, New... More
My company:
New Constructs
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The Diligence Institute
My book:
The Valuation Handbook
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  • How Are These 19th Century Companies Doing Today?

    Trading stocks sometimes feels like a very modern phenomenon, so it's easy to forget that some of the companies we're investing in go back a century or more. While 21st century tech startups dominate the headlines, old established companies can often be high quality investments. Eli Lilly & Company (LLY), which was founded in 1876, is up 76% since I recommended it in 2011.

    Figure 1 shows 10 other companies that have been around since the 19th century and compares them based on return on invested capital (ROIC) and revenue growth in the past year.

    Figure 1: 19th Century Companies Today

    Sources: New Constructs, LLC and company filings

    The second oldest company on the list, Colgate-Palmolive (CL), is also the top value creator for investors. Its 22.9% ROIC is more than double any other company on the list and puts it in the top-quintile of all the companies we cover. CL is also the only stock in Figure 1 to earn our Attractive rating.

    Not all the companies here have adapted to the modern world as well as CL. The bottom five companies on the list have ROICs in the bottom 40% of all companies we cover and earn our Dangerous-or-worse rating.

    One of them even lands in the Danger Zone this week. To purchase the report, click here. To get access to all our reports and services, click here.

    Sam McBride contributed to this report.

    Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.

    Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: CL, GIS, MRK, DD, JPM, NCR, PFE, IR, IP, AA
    Jul 07 9:40 AM | Link | Comment!
  • How To Avoid The Worst Sector Mutual Funds

    Picking from the multitude of sector mutual funds is a daunting task. In any given sector there may be as many as 213 different mutual funds, and there are at least 607 mutual funds across all sectors.

    Why are there so many mutual funds? The answer is: because mutual fund providers are making lots of money selling them. The number of mutual funds has little to do with serving investors' best interests. Below are three red flags investors can use to avoid the worst mutual funds:

    1. Inadequate liquidity
    2. High fees
    3. Poor quality holdings

    I address these red flags in order of difficulty. Advice on How to Find the Best Sector Mutual fundsis here. Details on the Best & Worst Mutual funds in each sector are here.

    How To Avoid Mutual Funds with Inadequate Liquidity

    This is the easiest issue to avoid, and my advice is simple. Avoid all mutual funds with less than $100 million in assets. Low asset levels tend to mean lower volume in the mutual fund and large bid-ask spreads.

    How To Avoid High Fees

    Mutual funds should be cheap, but not all of them are. The first step here is to know what is cheap and expensive.

    To ensure you are paying at or below average fees, invest only in mutual funds with total annual costs(TAC) below 2.40%, which is the average TAC of the 607 US equity mutual funds I cover. Weighting the TACs by assets under management, the average TAC is lower at 1.48%. A lower weighted average is a good sign that investors are putting money in the cheaper mutual funds.

    Figure 1 shows the most and least expensive sector mutual funds in the US equity universe based on total annual costs. Saratoga Advantage Trust provides 3 of the most expensive mutual funds while Vanguard mutual funds are among the cheapest.

    Figure 1: 5 Least and Most-Expensive Sector Mutual funds

    Sources: New Constructs, LLC and company filings

    Saratoga Advantage Trust: Financial Services Portfolio (SFPAX) and Rydex Series Funds: Electronics Fund (RYELX) are two of the most expensive U.S. equity mutual funds I cover, while Vanguard Specialized Fund: Vanguard REIT Index Fund (VGSNX) and Vanguard World Funds: Vanguard Health Care Index Fund (VHCIX) are the least expensive. The more expensive SFPAX and RYELX receive my 1-star or Very Dangerous rating, while the cheapest mutual funds, VGSNX and VHICX receive my 2-Star and 3-Star rating, respectively. None of the most expensive mutual funds earn a better rating than the cheapest mutual funds. In other cases, quality holdings can make up for high costs.

    However, investors need not pay high fees for good holdings. Vanguard World Funds: Vanguard Consumer Staples Index Fund (VCSAX) is my highest rated sector mutual fund and earns my Attractive rating. It also has low total annual costs of only 0.18%.

    On the other hand, the Vanguard World Funds: Vanguard Industrials Index Fund (VINAX) makes up the fourth cheapest fund in figure 1. Despite the low costs, it earns a 2-star or Dangerous rating. No matter how cheap of fund, it needs to hold good stocks to deliver good returns.

    This result highlights why investors should not choose mutual funds based only on price. The quality of holdings matters more than price.

    How To Avoid Mutual Funds with the Worst Holdings

    This step is by far the hardest, but it is also the most important because a mutual fund's performance is determined more by its holdings than its costs. Figure 2 shows the mutual funds within each sector with the worst holdings or portfolio management ratings. The sectors are listed in descending order by overall rating as detailed in my 2Q Sector Rankings report.

    Figure 2: Sector Mutual Funds with the Worst Holdings

    Sources: New Constructs, LLC and company filings

    My overall ratings on mutual funds are based primarily on my stock ratings of their holdings. My firm covers over 3000 stocks and is known for the due diligence done on each stock we cover.

    Fidelity appears more often than any other providers in Figure 2, which means that they offer the most mutual funds with the worst holdings. Fidelity Select Portfolios: Construction and Housing Portfolio (FSHOX) has the worst holdings of all Consumer Staples mutual funds. FSLEX, FBTCX, and FSUTX also all have the worst holdings in their respective sectors.

    Note that no mutual funds with a Dangerous portfolio management rating earn an overall rating better than two stars. These scores are consistent with my belief that the quality of a mutual fund is more about its holdings than its costs. If the mutual fund's holdings are dangerous, then the overall rating cannot be better than dangerous because one cannot expect the performance of the mutual fund to be any better than the performance of its holdings.

    Figure 2 reveals that one of the cheapest mutual funds, Vanguard World Funds: Vanguard Consumer Discretionary Index Fund (VCDAX) gets my Dangerous rating because its holdings get my Dangerous rating. Similarly, Fidelity Select Portfolios: Construction and Housing Portfolio (FSHOX) also one of the cheapest mutual funds in Figure 2, gets a Dangerous portfolio management rating and, therefore, cannot earn anything better than a 2-star or Dangerous overall rating. Again, the mutual fund's overall rating cannot be any better than the rating of its holdings.

    Find the mutual funds with the worst overall ratings on my Mutual Fund screener. More analysis of the Best Sector Mutual funds is here.

    The Danger Within

    Buying a mutual fund without analyzing its holdings is like buying a stock without analyzing its business and finances. As Barron's says, investors should know the Danger Within. Put another way, research on mutual fund holdings is necessary due diligence because a mutual fund's performance is only as good as its holdings' performance.

    PERFORMANCE OF MUTUAL FUND's HOLDINGs = PERFORMANCE OF MUTUAL FUND

    Best & Worst Stocks In these Mutual Funds

    Applied Materials, Inc. (AMAT) is one of my least favorite stocks held by RYELX and mutual funds and earns my Very Dangerous rating. Over the past nine years, AMAT's after-tax profit (NOPAT) has declined by 8% compounded annually. The company's return on invested capital (ROIC) is also much lower than it used to be, currently at 6%, down from 23% just two years ago. The market seems to think a turnaround is coming for AMAT though, as the stock is up nearly 50% in the past year. To justify its current price of ~$19/share, AMAT would need to grow NOPAT by 12% compounded annually for the next 20 years. Even if AMAT executes on its turnaround, it's hard to see much upside at this valuation.

    Equity Residential (EQR) is one of my favorite stocks held by VGSNX and receives my Attractive rating. Over the past nine years, EQR has grown NOPAT by 13% compounded annually. The company currently earns aROIC of 11%, more than double the average of the 150 REIT companies I cover. The best part about EQR however is its valuation. At its current price of ~$59/share, EQR has a price to economic book value (PEBV) ratio of 0.9. This ratio implies the market expects EQR's NOPAT to permanently decline by 10%. EQR's track record of profit growth suggests it should be able to surpass these low expectations.

    Kyle Guske II contributed to this article

    Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, or theme.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Jun 04 9:11 AM | Link | Comment!
  • How To Find The Best Style Mutual Funds

    Finding the best mutual funds is an increasingly difficult task in a world with so many to choose from.

    You Cannot Trust Mutual Fund Labels

    There are at least 940 different Large Cap Blend mutual funds and at least 5896 mutual funds across all styles. Do investors need that many choices? How different can the mutual funds be?

    Those 940 Large Cap Blend mutual funds are very different. With anywhere from 14 to 1022 holdings, many of these Large Cap Blend mutual funds have very different portfolios, creating different investment implications.

    The same is true for the mutual funds in any other style, as each offers a very different mix of good and bad stocks. Some styles have lots of good stocks and offer quality funds. The opposite is true for some styles, while others lie in between these extremes with a fair mix of good and bad stocks. For example, the Large Cap Blend style, per my 2Q Style Rankings Report ranks first out of 10 styles when it comes to providing investors with quality mutual funds. Small Cap Value ranks last. Details on the Best & Worst Mutual Funds in each style are here.

    The bottom line is: mutual fund labels do not tell you the kind of stocks you are getting in any given mutual fund.

    Paralysis By Analysis

    I firmly believe mutual funds for a given style should not all be that different. I think the large number of Large Cap Blend (or any other) style of mutual funds hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many mutual funds. Analyzing mutual funds, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each mutual fund. As stated above, that can be as many as 1022 stocks, and sometimes even more, for one mutual fund.

    Any investor worth his salt recognizes that analyzing the holdings of a mutual fund is critical to finding the best mutual fund.

    Figure 1: Best Style Mutual Funds

    Sources: New Constructs, LLC and company filings

    The Danger Within

    Why do investors need to know the holdings of mutual funds before they buy? They need to know to be sure they do not buy a fund that might blow up. Buying a fund without analyzing its holdings is like buying a stock without analyzing its business and finances. As Barron's says, investors should know the Danger Within. No matter how cheap, if it holds bad stocks, the mutual fund's performance will be bad.

    PERFORMANCE OF FUND'S HOLDINGS = PERFORMANCE OF FUND

    Finding the Style Mutual Funds with the Best Holdings

    Figure 1 shows my top rated mutual fund for each style. Importantly, my ratings on mutual funds are based primarily on my stock ratings of their holdings. My firm covers over 3000 stocks and is known for the due diligence we do for each stock we cover. Accordingly, our coverage of mutual funds leverages the diligence we do on each stock by rating mutual funds based on the aggregated ratings of the stocks each mutual fund holds.

    Vanguard Specialized Funds: Vanguard Dividend Growth Fund (VDIGX) is the top-rated Large Cap Value mutual fund and the overall top-rated fund of the 5896 style mutual funds that I cover. Only four investment styles contain any Attractive (i.e. 4-star) or better rated mutual funds. The best every other style can offer is a Neutral or 3-star mutual fund.

    Sometimes, you get what you pay for.

    It is troubling to see one of the best style mutual funds, Manning & Napier Fund, Inc: Dividend Focus Series (MNDFX) has just $185 million in assets despite its Attractive (4-star) rating. On the other hand, Neutral rated Massachusetts Investors Growth Stock Fund (MIGNX) has $6,262 million in assets. MIGNX has lowertotal annual costs than MNDFX (0.51% and 0.66% respectively), but low costs cannot drive positive performance. Quality holdings are the ultimate driver of performance.

    I cannot help but wonder if investors would leave MIGNX if they knew that it has such a poor portfolio of stocks. It is cheaper than MNDFX, but, as previously stated, low fees cannot growth wealth; only good stocks can.

    Sometimes, you DON'T get what you pay for.

    The smallest mutual fund in Figure 1 is Royce Fund: Royce Micro-Cap Discovery Fund (RYDFX) with just $6 million in assets. Sadly, other Small Cap Value mutual funds with more assets and inferior portfolios charge more than RYDFX In other words; Small Cap Value mutual fund investors are paying extra fees for no reason.

    Financial Investors Trust: Stonebridge Small-Cap Growth Fund (SBSGX) is one of the worst mutual funds in the Small Cap Growth style. It gets my Very Dangerous rating based off the fact that barely 9% of its assets are allocated to Attractive-or-better rated stocks, while 67% is allocated to Dangerous-or-worse stocks. SBSGX also has total annual costs of 6.49%, higher than RYDFX's 2.45%. One would think that SBSGX would have fewer assets than RYDFX, but instead it has over $20 million. Investors are paying extra fees for poor holdings.

    The worst mutual fund in Figure 1 is Royce Fund: Royce Micro-Cap Discovery Fund (RYDFX), which gets a Neutral (3-star) rating. One would think mutual fund providers could do better for this style.

    I recommend investors only buy mutual funds with more than $100 million in assets. You can find more liquid alternatives for the other funds on my mutual fund screener.

    Covering All The Bases, Including Costs

    My mutual fund rating also takes into account the total annual costs, which represents the all-in cost of being in the mutual fund. This analysis is complex for mutual funds, as one has to consider not only expense ratios, but also front-end load and transaction fees. A high front-end load not only costs investors at the beginning, it also reduces the growth investors can experience later on. While costs play a smaller role than holdings, my ratings penalize those funds with abnormally high costs.

    Top Stocks Make Up Top Mutual Funds

    CIGNA Corporation (CI) is one of favorite holdings in FSMVX and earns my Very Attractive rating. Over the past decade, CI has grown after-tax profits (NOPAT) by 13% compounded annually. CI currently earns an impressive return on invested capital (ROIC) of 12% and has generated positive economic earnings in nine of the past 10 years. With the stock being down around 5% this year, CI is very undervalued. At its current price of ~$83/share, CI has a price to economic book value (PEBV) ratio of 1.1. This ratio implies the market expects CI's NOPAT to only grow by 10% from the current level for the remaining life of the corporation. This low expectation is awfully pessimistic for a company that has grown profits by double digits annually for a decade.

    Kyle Guske II contributed to this post.

    Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, or theme.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Tags: CI
    Jun 02 10:13 AM | Link | Comment!
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