The R.I.P. Portfolio: Q3 2017 Update

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Includes: AAPL, ACN, AIG, AMGN, BABA, BAC, BHF, BHGE, C, CAH, CLDR, CSCO, DIS, DWDP, FKINX, FSI, GE, GM, HON, INTC, JNJ, KEY, KMG, KR, MET, MRK, PFE, RHE, SNC, SPY, SYF, T, TGT, TWTR, UA, VZ, WNC, XIN
by: WG Investment Research

Summary

This real-money portfolio was first introduced in December 2015 to the Seeking Alpha community, and the portfolio has outperformed the S&P 500 since that point in time.

The portfolio has underperformed the S&P 500 over the first nine months of 2017 but the portfolio's projected annual dividend income is up 60% YoY.

The financial holdings were again the top performers for the portfolio. However, the largest holding - General Electric - negatively impacted the portfolio's total return so far in 2017.

The Retire In Peace portfolio, or R.I.P. portfolio, was first introduced to the Seeking Alpha ("SA") community in December 2015 and I have published quarterly articles that captured the activity and performance of the portfolio since that point in time. The companies that I write about on SA are largely the holdings of the R.I.P. portfolio, so the main purpose for the quarterly portfolio articles is to allow for my SA followers to track the performance of the stocks that I write about on this platform.

I am, however, also interested in hearing from the entire SA community about these stock holdings because I learn valuable lessons from the insights that are provided on this platform. Therefore, I hope that these quarterly updates lead to constructive discussions about the companies that I consider core holdings.

The core holdings - see linked article above for a listing of the core holdings, in addition to each companies' identified short- and long-term catalysts - are not necessarily the companies that I plan to hold for the next 30 years, but instead, they are the companies that I would like to hold for that period of time (i.e. buy-to-hold strategy). I will closely monitor these holdings and will trim, add to, or eliminate positions if a company's "story" materially changes.

The R.I.P. Portfolio's Goals And Strategy

I am building this portfolio with retirement in mind, so I have 30 plus years to invest and make adjustments; therefore, the quarterly volatility is not a major concern. These funds will stay in the market for the foreseeable future, so the portfolio will have the luxury of compounding for many years.

Compound interest is the eighth wonder of the world. He who understands it, earns it... he who doesn't... pays it." -Albert Einstein.

It is also important to note that this is a real-money portfolio. The R.I.P. portfolio is made of five different accounts: a Roth IRA, a Traditional IRA, and three taxable brokerage accounts. This is not my family's main retirement assets, but it is a portfolio that I hope will greatly contribute to a stress free and relaxing retirement.

The Goals and Strategy section was last updated in March 2017.

Main Investments (i.e. core holdings) - The companies that are considered core holdings should have established management teams that have proven track records of creating value. Furthermore, the companies should have competitive moats and be above-average operators within the respective industries. The core holdings are mainly large cap companies that are widely held by the financial community and this is by design.

Goals & Strategy - The portfolio seeks primarily long-term capital appreciation by investing mainly in equity securities of high-quality companies that have already shown the ability to produce sustainable earnings growth.

The portfolio aims to beat the benchmark, the SPDR S&P 500 ETF (SPY), by at least 1% on an annual basis.

Missing out on short-term gains and/or having paper losses are not my main concerns, because I plan to stay committed to my long-term strategy of utilizing a bottoms-up investing philosophy to select companies that I plan to hold for many years.

The portfolio has the following allocation targets and acceptable ranges:

Industry Target Allocations Acceptable Range
Industrials/Conglomerates 20% 15-25%
Healthcare 10% 5-15%
Financials 15% 10-25%*
Insurance 5% 3-7%
Technology 10% 5-15%
Telecom Services 10% 5-15%
Media 5% 3-7%
Basic Materials 5% 3-7%
Conservative Allocation Fund 5% 3-7%
Consumer 10% 5-15%
Other** 5% 0-10%

*I may allocate more to this category from time-to-time but I plan to keep the overall allocation below 30%.

**The Other category comprises of speculative investments in companies that have the potential to create outsized gains over the next three-to-five years (what I like to refer to as "investing in seedlings"). The investments within this category could eventually become longer ranged holdings if after further analysis it is determined that the companies indeed have the attributes that I look for.

Contributions - I plan to contribute between $1,000 and $2,500 of new capital per month to the portfolio and I typically put the new capital to work each and every month, regardless of the performance of the overall market.

Q3 2017 Update

Below you will find the portfolio and its performance, and the activity for the third quarter of 2017.

Price @ Beg Value @ Activity Quarterly Quarterly Current Unrealized Portfolio Yield Current Annual
Company Ticker # of shares 9/30/2017 7/1/2017 Purchases (Sales) Unrealized G/L Realized G/L Value Gain (Loss) Weighting On Cost Yield Income
General Electric (GE) 469.204 $24.18 $10,606 $1,815 ($1,076) - $11,345 $610 11% 4.2% 4.0% $450
Baker Hughes (BHGE) 25.00 36.62 749 148 18 - 916 (12) 1% 1.8% 1.9% 17
Honeywell (HON) 36.76 141.74 4,876 - 335 - 5,211 1,133 5% 2.7% 2.1% 110
AT&T (T) 113.28 39.17 4,221 - 216 - 4,437 1,367 4% 7.2% 5.0% 222
Verizon (VZ) 95.73 49.49 3,256 1,013 468 - 4,738 242 5% 5.0% 4.8% 226
Franklin Income (FKINX) 2456.89 2.39 5,676 - 196 - 5,872 1,038 6% 6.1% 5.0% 295
Walt Disney (DIS) 27.23 98.57 2,873 - (189) - 2,684 753 3% 2.2% 1.6% 42
Bank of America (BAC) 410.76 25.34 9,918 - 490 - 10,409 3,896 10% 3.0% 1.9% 197
Bank of America A Warrants BACWSA 153.00 13.24 1,842 - 184 - 2,026 1,039 2% 0.0% 0.0% -
Bank of America B Warrants BACWSB 300.00 0.78 237 - (3) - 234 (21) 0% 0.0% 0.0% -
Citigroup (C) 49.00 72.74 3,261 - 303 - 3,564 1,140 4% 2.6% 1.8% 63
KeyCorp (KEY) 77.88 18.82 1,452 - 14 - 1,466 590 1% 3.7% 2.2% 33
DowDupont (DWDP) 73.08 69.23 3,701 904 455 - 5,060 1,160 5% 3.4% 2.7% 134
Synchrony Financial (SYF) 98.90 31.05 2,935 - 136 - 3,071 746 3% 2.6% 1.9% 59
Target (TGT) 9.15 59.01 370 111 59 - 540 16 1% 4.3% 4.2% 23
Kroger (KR) 112.96 20.06 2,627 - (361) - 2,266 (949) 2% 1.8% 2.5% 56
Johnson & Johnson (JNJ) 24.27 130.01 3,191 - (35) - 3,156 1,013 3% 3.8% 2.6% 82
Amgen Inc. (AMGN) 3.04 186.45 522 - 46 - 567 59 1% 2.8% 2.5% 14
Pfizer (PFE) 121.28 35.70 4,035 - 294 - 4,330 809 4% 4.4% 3.6% 155
Cardinal Health (CAH) 6.04 66.92 468 - (64) - 404 (35) 0% 2.5% 2.8% 11
American International Group (AIG) 0.00 61.39 4,385 (4,235) (150) 424 - - 0% 0.0% 2.1% -
AIG warrants AIGWS 152.00 20.00 - 2,859 181 - 3,040 186 3% 0.0% 0.0%
Metlife (MET) 51.44 51.95 2,803 (251) 120 - 2,672 927 3% 4.7% 3.1% 82
Brighthouse Financial (BHF) 4.00 60.80 - 251 (8) - 243 53 0% 0.0% 0.0% -
Xinyuan Real Estate (XIN) 379.91 5.68 1,876 61 220 - 2,158 570 2% 9.6% 7.0% 152
Apple (AAPL) 15.34 154.12 2,201 - 164 - 2,365 872 2% 2.6% 1.6% 39
Twitter (TWTR) 111.00 16.87 1,537 447 (111) - 1,873 (60) 2% 0.0% 0.0% -
CISCO (CSCO) 144.52 33.63 4,360 125 375 - 4,860 1,107 5% 4.5% 3.4% 168
Intel (INTC) 75.19 38.08 2,518 - 345 - 2,863 210 3% 3.1% 2.9% 82
Cloudera (CLDR) 2.00 16.62 31 - 2 - 33 (2) 0% 0.0% 0.0% -
Accenture plc (ACN) 5.05 135.07 624 - 58 - 682 106 1% 2.1% 1.8% 12
General Motors (GM) 76.27 40.38 1,227 1,374 479 63 3,080 558 3% 4.6% 3.8% 116
Alibaba (BABA) 1.00 172.71 141 - 32 - 173 49 0% 0.0% 0.0% -
Adcare Health Systems (ADK) 64.00 0.91 60 - (1) - 58 (41) 0% 0.0% 0.0% -
KMG Chemicals (KMG) 8.00 54.88 389 - 50 - 439 130 0% 0.3% 0.2% 1
State National Companies (SNC) 0.00 20.99 365 (417) 51 138 - - 0% 0.0% 1.1% -
Wabash National Corp (WNC) 43.00 22.82 461 418 103 - 981 188 1% 0.7% 0.5% 5
Under Armour (UA) 79.00 15.02 376 945 (135) - 1,187 (101) 1% 0.0% 0.0% -
Flexible Solutions International (FSI) 170.00 1.72 - 320 (28) - 292 (28) 0% 0.0% 0.0% -
CASH -- -- -- 11 17 -- -- 28 -- 0% -- -- --
$90,183 $5,905 $3,234 $625 $99,322 $19,317 100% 3.6% 2.9% $2,847
Industry/Portfolio Companies Value Portfolio Weighting Goal Weighting Over (Under)
Industrials/Conglomerates - GE, HON, BHI $17,471.50 18% 20% -2%
Healthcare - JNJ, PFE, AMGN, CAH 8,456.79 9% 10% -1%
Financials - BAC*, C, KEY 17,698.77 18% 15% 3%
Insurance - AIG*, MET, BHF 5,955.74 6% 5% 1%
Technology - AAPL, CSCO, INTC, ACN, CLDR 10,803.14 11% 10% 1%
Telecom Services - T, VZ 9,174.71 9% 10% -1%
Media - DIS, TWTR 4,556.75 5% 5% 0%
Basic Materials - DOW 5,059.54 5% 5% 0%
Conservative Allocation - FKINX 5,871.96 6% 5% 1%
Consumer - KR, GM, TGT, UA, BABA, SYF** 10,315.97 10% 10% 0%
Other - XIN, ADK, KMG, SNC, WNC, FSI 3,928.83 4% 5% -1%
Cash 27.94 0% 0% 0%
100%

*AIG and BAC TARP warrants are included in value and weighting

**Direct consumer play --read articles on profile for more info

Sales -

(1) State National - This specialty insurance company agreed to be bought by a larger company (see below for more detail) so I sold the SNC shares for a nice gain.

(2) American International Group - I sold my AIG common stock and rolled part of the funds into the company's Tarp Warrants. The warrants are a long-term levered bet on this global insurance and its stock --see this article for an understanding of the Tarp warrants.

(3) General Motors - I purchased another block of GM shares during the quarter and later sold a portion of the recently purchased shares for a small gain after the dividend ex-date. I still hold a sizable GM position but I believe that the car company is a lot less attractive at $40 compared to the $35 range.

Purchases -

(1) Added to (or initiated) the following positions: Verizon, Baker Hughes, Twitter, Flexible Solutions, General Electric, Wabash National, Target, Xinyuan, Cisco, Under Armour, AIG Tarp Warrants, DowDupont and General Motors ^

^ - Subscribers of the Going Long With W.G. marketplace service receive advance notifications/explanations for all purchases and sales, in addition to receiving buy/sell/hold recommendations for all equity holdings of the portfolio. Please consider checking out the marketplace service for your investment research and analysis needs. Additionally, see articles on my profile for the respective companies for additional thoughts on each of holding.

Portfolio Performance for Q3 2017 and since the portfolio was first introduced to SA community (December 4, 2015)

Return (Q3'17) Return (YTD) Return (Intro) Cost Basis Review
3.5% 5.9% 22.8% 35.9%
This period YTD Since Intro Since Intro
Beg. Balance $90,183 $77,428 $52,610 Cost Basis $46,042
Contributions 5,905 16,833 31,155 Contributions 31,155
Unrealized G/L 3,234 5,060 15,557 Realized G/L 2,809
Ending Balance $99,322 $99,322 $99,322 Unrealized G/L 19,317
Portfolio Bal. $99,322
Dividend Inc. $725 $1,861 $3,596
Realized G/L 625 1,545 2,809 Dividend Income $3,596

Full Disclosure: The American Association of Individual Investors, or AAii, prescribed calculation (The Beginning Vs. the End) was used for calculating the portfolio's return for each period-end.

From an income perspective, the projected annual dividend income is trending in the right direction.

For Q3 2017, the portfolio's dividend income was $725, which is significantly higher QoQ ($598 in Q2 2017) and YoY ($433 in Q3 2016). Furthermore, the portfolio's projected dividend income for full-year 2017 is 60%, or $983, higher than the previous year. It should be noted that I do not have a written dividend income goal for the portfolio, but I have purposefully focused on investing in high-quality dividend paying stocks since late 2015.

The recent performance of the portfolio (Q3 2017 and YTD 2017) is nothing to brag about but the portfolio is still outperforming the S&P 500 since December 4, 2015.

The portfolio's outperformance is largely a result of the significant investments made in the financial sector - Bank of America, Citigroup, and KeyCorp - over the last few years.

As shown, the financial sector makes up a little over one-third of the portfolio's unrealized gains as of Q3 2017, with Bank of America being the largest contributor. Looking forward, I believe that this portfolio is well-positioned for the future and that it will greatly outperform the broader market as we head into 2018 and beyond.

The top 3 performers and under performers for the portfolio for the most recent quarter are: Performers - [1] Bank Of America, [2] General Motors, and [3] Verizon; Under performers - [1] General Electric, [2] Kroger, and [3] Walt Disney.

I will touch on the top performer and under performer for the quarter. The two companies that I will be talking about here (BAC and GE) are actually also the top two holdings of the R.I.P. portfolio. It was encouraging that BAC (including the A & B warrants) had an ~$670 unrealized gain for Q3 2017 but, on the other hand, the ~$1,070 unrealized loss for GE shares was a major drag on the portfolio's overall performance.

Bank Of America is (and has been) a top holding in the R.I.P. portfolio. I started investing in this bank years ago but only recently has the market opened up to the idea that BAC shares have a real chance to greatly outperform the broader market for years to come.

As I described in this article, the investment thesis for Bank Of America has not changed since 2013 and, in my opinion, investors should actually be more excited now (even with shares trading hands around $25) about this bank's future business prospects. Also, long-term investors should ignore some of the pundits because this bank is way more than just a play on a rising interest rate environment, as described in "BAC: Just Plodding Along, But That's Okay".

It also helps that BAC is still trading at an attractive valuation when compared to its peer group.

Chart BAC Price to Tangible Book Value data by YCharts

So, as you can probably tell, I am still very bullish on Bank Of America. Moreover, in a broader context, the financial holdings of this portfolio have a promising setup as we head into 2018 and beyond (see more on this topic below).

General Electric, on the other hand, has failed to impressed so far in 2017. The market soured on this company's major restructuring plan and it shows by the fact that GE shares are down over 20% over the first nine months of 2017. I do believe that GE is a broken stock but, in my opinion, it is not a broken company. This industrial conglomerate still has a great business - Aviation, Power, Healthcare, and Renewable Energy - and promising long-term prospects, but the market is simply not sold on the company's near-term prospects.

I recently described to the SA community why I am not overly concerned about the "risks" that the bears have been harping about since late 2016:

  • The downturn in the oil & gas industry will indeed pressure Baker Hughes, A GE company's results in the quarters ahead but Mr. Flannery and team has the flexibility to either ride out the storm or spinoff (or sell) its majority stake in BHGE.
  • GE's cash flow metrics have been under pressure but the company has already shown some improvements (free cash flow in Q2 2017 was a lot better than Q1 2017) and cash flow generation is expected to improve in the second half of 2017. The additional $2.6B from the Industrial Solutions sale will help too.
  • The GAAP vs non-GAAP debate has been going on for a while now, but, as I described here, the difference is a non issue to me until at least the end of 2018.
  • Margin pressure is something that the company will focus on by cutting out unnecessary costs (it helps that management's bonuses are now tied to the company's industrial operating profit, thanks to the Trian Fund), but additional non-core asset sales is another factor that will likely come into play through 2018.

Any way you slice it, these concerns are short-term in nature. There is a lot to like about the portfolio of businesses that are currently under the GE umbrella. Yes, it may take time for Mr. John Flannery, CEO, to right the ship but that is okay if you have the time to wait out the storm. I think that the company's management team (with the help of the Trian Fund) will eventually figure it out. Plus, from a valuation standpoint, GE shares are currently trading at 15x 2017E earnings (per Yahoo! Finance). Lastly, this storied company's dividend yield is ~4% so investors are being paid to be patient.

Noteworthy Quarterly News:

General News

(1) It was reported that the U.S. government rescinded American International Group's Systemically Important Financial Institution, or SIFI, designation. The government's decision will create a lot of value for AIG shareholders, as the company already announced that it would save over $150MM in compliance costs due to the fact that it would not have to comply with the SIFI rules and regulations. A SIFI-less AIG is worth a lot more than the company in its current state, in my opinion.

(2) American International Group is going to reorganize into three separate units - [1] general insurance business unit, [2] a life & retirement unit, and [3] a stand-alone tech unit - to streamline operations and rightsize its expense base. This is the new CEO's, Brian Dupperreault, first major move and, in my opinion, investors should expect more business portfolio changes to occur over the next year or two.

(3) Warren Buffet stay true to his word and converted his Bank Of America preferred stock into common stock, and Berkshire (NYSE:BRK.A) (NYSE:BRK.B) now holds over 700MM shares of the bank.

Buybacks And/Or Dividend News:

(1) Verizon increased its quarterly dividend by 2.2% (from $0.5775 to $0.59), which makes the forward dividend yield 4.7% based on today's price.

(2) Honeywell increased its quarterly dividend by 12% (from $0.665 to $0.745), which makes the forward dividend yield 2.1% based on today's price.

Merger, Acquisitions and Disposals:

(1) State National entered into an agreement to be bought by Markel (MRK) for $21/share, if the deal receives regulatory approval.

(2) The Dow Chemical and Dupont (DD) merger of equals closed and the new entity now sells under the (DWDP) ticker symbol.

(3) Brighthouse Financial (BHF) was spun out of MetLife in August 2017, and Baker Hughes, A GE Company (BHGE) was formed by the completed merger of GE's oil & gas assets and the old Baker Hughes.

(4) General Electric agreed to sell its industrial solutions business to ABB for $2.6B, which marks the first major deal made by the company's new CEO, Mr. John Flannery.

Looking Ahead - It's Not About Tomorrow, It's About 10 Years From Now

In a broader context, I am positioning the R.I.P. portfolio to capitalize on a few major trends: [1] the digitalization megatrend, which includes autonomous cars and the Internet Of Things industry, [2] a rising interest rate environment, and [3] the changing media space, which includes how companies will be structured and how content will be consumed by/distributed to customers.

More recently, I have been warming up to the idea that President Trump will finally get a win by passing some type of tax changes, although I do not expect for corporate rates to be lowered to 20%, as proposed. Additionally, I fully expect for the new administration to roll back some of the burdensome regulatory requirements, i.e. Dodd-Frank and SIFI, or at least limit new rules from being implemented so the big banks and insurance companies will benefit from an improving backdrop.

For more details about this portfolio and how it is structured to benefit from tomorrow's economy, please consider joining the Going Long With W.G. subscription service.

Thoughts

I look forward to reading (and responding to) everyone's thoughts on this portfolio, because I believe that the best investment advice is hearing the opposing viewpoint and responding to constructive criticism. I try to contribute at least $1,000/quarter to this portfolio, but sometimes it is a little more or a little less. I will attempt to provide quarterly updates but I may miss some quarters.

Please let me know if you would like for me to incorporate any additional analysis within these updates. Lastly, I will still write about these companies on a regular basis so stay tuned.

All of my investment decisions are made with these two quotes in mind:

Peter Lynch - "Behind every stock is a company. Find out what it's doing."

Warren Buffett - "Successful investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time: You can't produce a baby in one month by getting nine women pregnant."

If you found this article to be informative and would like to hear more about these companies, please consider hitting the "Follow" button above or subscribing to the Going Long With W.G. marketplace service.

Disclosure: I am/we are long GE, BHGE, HON, T, VZ, FKINX, DIS, BAC, C, KEY, DWDP, AIG, MET, UA, TWTR.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.