The Concentrated Portfolio, June Update

Summary

• The Concentrated Portfolio is up nearly 23% in 6 months.
• The S&P 500 Index is up 7.5%.
• Bet your beliefs!

Alpha can ultimately only be found by picking more “winning” stocks than "losing" stocks in your portfolio. By winning stocks, I mean those stocks which go up by 20%+ in a year. We all have them in our portfolios. The problem is that most of our portfolios contain 20+ stocks and we tend to end up with a mix of losers and winners that are evenly spread. The result of this stock picking methodology is that you end with no alpha and you may as well invest in ETFs.

What’s the point in saying you are a shareholder of Amazon (AMZN) if it only represents a tiny 1% portion of your portfolio? Feel free to pat yourself on the back for your investment acumen but in real terms the net impact on your net worth is negligible.

Investment success is not just based on picking winners; it is also fundamentally rooted in how much you risk on picking winners. Oftentimes, I think many dismiss this iron law of investing. Conviction is fundamentally important to investment success.

"Long AMZN" is a near meaningless statement. "Long AMZN 10%" says so much more.

To my mind, it is far easier to have a “winning” portfolio if it consists of just a handful of stocks because you are forced to think deeply about your stock selection.

"Portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort level he/she must feel with its economic characteristics."

– Warren Buffett, CEO, Berkshire Hathaway

To that end, the Concentrated Portfolio consists of just 5 stocks. Market beating alpha is sought via high conviction selections on a small pool of winners. The Concentrated Portfolio is really an attempt to try and make sure that I have far more winning stocks than losing stocks in my portfolio.

The 5 positions of the Concentrated Portfolio are Microsoft (MSFT), Amazon (AMZN), Celgene (CELG), PayPal (PYPL) and Unilever (UN).

The YTD development of portfolio weightings is as follows. No stock purchases or sales have occurred since the start of the year, other than an investment in Red Hat (RHT) that I made on June 29th. I felt it was more practical to include Red Hat as a component of the portfolio from July 1st onward.

The Concentrated Portfolio is not a subsection of another portfolio. The funding for the Concentrated Portfolio comes from after-tax savings and legacy investment realisations. I started the portfolio in 2016 and have committed more funds to it than my retirement portfolio. I’ll admit that when I initially began assembling the portfolio I did invest in lots of companies but in December 2016 I reduced the portfolio to just 5 stocks, having been influenced by the writings of Buffett and Munger and the fascinating story of Claude Shannon and Edward Thorpe in the book Fortune’s Formula. I also decided to move brokers and the cheapest/safest way for me to do this was to reduce my holdings to as few stocks as possible.

I have not looked back since.

Please note that I do have a retirement portfolio with a broker in a tax deferred account. My retirement portfolio does contain about 20 positions in a range of industries but I do plan to slim down the portfolio to 10-15 companies that are disruptors. I think significant technological change is imminent in our society over the next 10 years and my investments need to be backing the right horses. Furthermore, the pace of technological could accelerate a lot quicker than many of us appreciate and I want my money with the brightest, the best and the richest companies.

Performance

The Concentrated Porfolio has destroyed the performance of the S&P 500.

It is up 22.8% YTD (June 30^th) Vs 7.5% for the S&P500.

The NASDAQ is up 13% YTD.

Individual Company performance

Ticker	Jan	Feb	Mar	Apr	May	June	YTD
Microsoft (MSFT)	3.79%	-1.49%	2.94%	3.95%	2.02%	-1.30%	10.15%
Celgene (CELG)	-2.19%	6.34%	0.74%	-0.31%	-7.77%	13.51%	9.36%
Unilever (UN)	0.10%	16.43%	4.97%	5.15%	8.69%	-2.66%	36.10%
PayPal (PYPL)	-1.17%	5.58%	2.43%	10.93%	9.41%	2.80%	33.34%
Amazon (AMZN)	9.26%	2.62%	4.91%	4.34%	7.53%	-2.68%	28.44%
Total	1.80%	5.59%	3.23%	4.86%	4.32%	1.15%	22.78%

Click to enlarge

Amazon and Microsoft suffered in June as tech stocks were hit but PayPal was an exception to the rule posting a near 3% gain in June alone. Celgene had a stellar month as it jumped 13.5% in June (although it lost nearly 8% in May alone). Unilever took a breather. I have to admit I was fortunate to pick Unilever. Its role in the portfolio was to be that of an anchor, to provide stability. Instead it’s turned out to be the best YTD performer, beating off the likes of Amazon and PayPal. Who could have foreseen this?

Thoughts

I believe PayPal and Microsoft trade at fair value. Growth in earnings and cashflow at the next earnings report could present opportunities for investors.

Celgene is not the next best value stock in the biotech arena. Neither does it have the best revenue diversity presently. Celgene has a very strong pipeline however and growth expectations for its current products are healthy. I am comfortable continuing to hold but I much prefer my tech stocks and their sturdy business models. The binary betting business model of the biotech/pharma world leaves me a little cold and looking over my shoulder. Any drug producer must continue producing the hits and at some point this business model comes unstuck. Whilst I don't have much diversity in the portfolio it was great to see Celgene perform the way it did in June as most of the other stocks took a hit.

Amazon is overvalued, but Bezos is the greatest investor alive today in my opinion. He has fused great investment acumen with great technological innovation. The proof is clear: Online retail, Amazon Web Services, digitized logistics, Prime membership, Amazon Echo, Kindle, etc. Amazon is generating lots of operating cashflow that Bezos continues to invest, hence its low free cash flow. Bezos has changed the world and he will continue to do so, and he has more capital than ever at his disposal to continue the journey. I'm a believer and want my savings invested with this visionary.

I still believe Unilever has more upside. The sale of the spreads business will unlock operating margin, reduce capex requirements and free more cashflow for buybacks and dividends. I am getting a little nervous that there is not much news on the sale of the spreads business, however. If the spreads business is not sold then the price of Unilever will fall.

Finally, a quick look at Red Hat that I started a position in on June 29th. The company is trading at fair value with a near 5% free cash flow yield to enterprise value. The company has a wonderful business selling subscriptions of mission critical software to cash-rich enterprises. Such customers will always pay up during a recession. The company has made a number of astute acquisitions of dev-ops SaaS applications that leverage the company's rich history in this area. This segment of revenues is experiencing hyper growth that will continue in my opinion and given this growth vector the company is trading at good value. I expect Red Hat will exceed management guidance for 2017 earnings.

Conclusion

All in all, June was the worst month for the Concentrated Portfolio this year, but it still posted a nice 1% gain. Celgene came to the rescue and showed, dare I say it, that a little bit of diversity is no bad thing.

Analyst’s Disclosure: I am/we are long CELG, AMZN, UN, PYPL, RHT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.