The Good Business Portfolio: 2018 2nd Quarter Earnings And Performance Review

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Includes: ABC, ADP, AMT, ARNC, BA, DHR, DIS, DLR, EOS, FCX, GE, HD, HPQ, IR, JNJ, MCD, MDLZ, MMM, MO, OHI, PEP, PM, SLP, TXN
by: William Stamm
Summary

The portfolio of good company businesses is performing 0.54% lower than the DOW average year to date of negative 3.84%, for a portfolio total gain of 3.30%.

The 24 businesses comprise 99% of the portfolio with the other 1% in cash, and the average total return over the DOW average for the 55-month test period is 23.62%.

The objective is to create a portfolio that is balanced, not income, not dividend growth, not bottom fishing, not value, but balanced among all styles of investing.

Of the 24 companies in the portfolio, earnings of 23 beat their 2nd quarter earnings estimates, and 1 missed the earnings estimate.

This article gives a review of the 2018 second-quarter earnings and 2018 YTD performance of the Good Business Portfolio (My IRA portfolio). Earnings data will be looked at for some of the top positions in the portfolio and recent changes to the portfolio.

Guidelines (Company selection)

The intent of the Good Business Portfolio guidelines is to create a portfolio that is a large cap balanced portfolio between the different styles of investing. Income investors take too much risk to get their high yields. Bottom-fishing investors get catfish. Value investors have to have the foresight to see the future. Over many years, I have codified 11 guidelines for company selection. These are guidelines and not rules. For a complete set of guidelines, please see my article, "The Good Business Portfolio: Update To Guidelines, August 2018". They are meant to be used as filters to get to a few companies on which further analysis can be done before adding them to the portfolio. So it's alright to break a guideline if the other guidelines indicate a Good Company Business. I'm sure this eliminates some really good companies, but it gets me a short list to work on. There are too many companies to even look at 10% of them.

You see from the portfolio below that I want a portfolio that is defensive, provides income and does not take significant risks. I limit the portfolio to 25 companies, as more than this is almost impossible to keep track of. I have 24 companies in the portfolio, so the portfolio does have an open slot.

Portfolio Performance

The performance of the portfolio created by the guidelines has in most years beat the DOW average for over 26 years, giving me steady retirement income and growth. The table below shows the portfolio performance for 2012 through 2017 and 2018 YTD.

Year

DOW Gain/Loss

Good Business

Beat Difference

Portfolio

2,012

8.70%

16.92%

8.22%

2,013

27.00%

39.70%

12.70%

2,014

6.04%

8.67%

2.63%

2,015

-2.29%

5.68%

7.97%

2,016

13.38%

8.68%

-4.70%

2,017

25.10%

21.28%

-3.82%

2018 YTD

3.84%

3.30%

-0.54%

In a great year like 2013, the portfolio did fantastically. In a normal year like 2014, it beat the DOW by a fair amount. So far this year, the portfolio is behind by 0.54% total return below the DOW average gain of 3.84%, for a total portfolio gain of 3.30% which is alright with five months to go, but this volatility will stop someday, and the company fundamentals will continue to shine within the next five months left in the year.

All 24 Companies In The Portfolio

The 24 companies and their percentage in the portfolio and total return over a 55-month test (starting Jan. 1, 2014, to 2018 YTD) period is shown in the table below. I chose this time frame since it included the great year of 2017 and other years that had fair and bad performance. The DOW baseline for this period is 56.15%, and 21 of the positions easily beat that baseline. The other three are companies that did not beat the DOW baseline but still are great businesses. I limit the portfolio to 25 companies and generally let the winners grow until they reach 8%-9% of the portfolio, and then I trim the position. EOS, BA, JNJ, and HD are now in trim position, and I am pushing BA up to 14% of the portfolio. I start the companies at a base percentage of the portfolio of 1% and add to the position if they perform well during the next six months. At 4% of the portfolio, I stop buying and let the company percentage of the portfolio grow until it hits 8%, then it's time to trim.

DOW Baseline

56.15%

Company

Total Return

Difference

Percentage of Portfolio

Cumulative Total

55 Months

From Baseline

Percentage of Portfolio

Boeing (BA)

169.83%

113.68%

13.01%

13.01%

Home Depot (HD)

154.66%

98.51%

9.82%

22.83%

Enton Vance Enhanced Equity Income Funf II (EOS)

74.69%

18.55%

8.66%

31.49%

Johnson & Johnson (JNJ)

59.74%

3.59%

8.03%

39.52%

Omega Health Inv. (OHI)

71.72%

15.57%

7.20%

46.72%

Walt Disney (DIS)

63.88%

7.74%

6.44%

53.17%

Altria Group Inc. (MO)

87.24%

31.09%

6.07%

59.24%

Texas Instrument (TXN)

153.27%

97.12%

5.56%

64.79%

Automatic Data Processing (ADP)

115.26%

59.12%

5.97%

70.76%

Mc Donalds Corp. (MCD)

95.75%

39.60%

5.38%

76.14%

Philip Morris INTL INC. (PM)

17.52%

-38.63%

4.71%

80.85%

Ingersal-Rand plc (IR)

73.42%

17.27%

4.62%

85.48%

Digital Realty Trust (DLR)

181.67%

125.52%

3.28%

88.76%

General Electric (GE)

-29.60%

-85.74%

1.93%

90.68%

Spare

0.00%

90.68%

Hewlett Packard (HPQ)

237.59%

181.45%

1.62%

92.31%

Freeport McMoRan (FCX)

-52.42%

-108.56%

1.42%

93.72%

Mondelez (MDLZ)

71.72%

15.58%

1.27%

94.99%

3M (MMM)

60.33%

4.19%

1.35%

96.35%

Simulation Plus (SLP)

**

**

0.10%

96.45%

Spare

0.00%

96.45%

Danaher Corp. (DHR)

74.43%

18.28%

0.89%

97.33%

Pepsico Co. (PEP)

56.28%

0.13%

0.52%

97.85%

American Tower (AMT)

109.45%

53.30%

0.67%

98.52%

Arconic Inc. (ARNC)

**

**

0.58%

99.10%

** NA No long-term data

Average Above

29.01%

DOW

One mistake I admit to making is, I hold a position too long when it starts to go bad. My first job out of college was with GE, and I loved working for them testing the LEM (Lunar Excursion Module), and GE has some great products, but the misleading accounting of the past is now taking its toll. GE will be good over time, but the management needs more time, about a year more to see the gains from the reorganization of GE's companies.

The graphic below shows the Dow average for the past five years, a good chart with nice gains as the United States economy is growing again with better-increasing growth.

Chart ^DJIA2M data by YCharts

The above is the full list of my 24 Good Businesses positions. I have written individual articles on all of these businesses, please see my full list of articles if you are interested.

Earnings Comments

For the Second-quarter earnings season, the 24 portfolio companies did very well with one laggard, 22 beat earnings estimates, Disney missed estimates and EOS a CEF had good NAV gains beating the market.

  • Boeing is the largest holding in the portfolio at 13.01%. Boeing is being pressed to 14% of the portfolio before trimming because of it being cash positive on 787 deferred plane costs at $571 million reported in the fourth-quarter earnings in January 2018, an increase from the third quarter. S&P CFRA has a one-year target of $405. BA is a long-term buy and has a backlog of over seven years. So far this year, they are beating Airbus (OTCPK:EADSY) in orders and a bit behind Boeing's projected delivery estimate for the year because of supplier problems on the 737 program. It may take 3-6 months to fix the supply problem, but then earnings and cash flow will strongly increase. The second-quarter earnings (released 7/25/2018) were $3.33, beating the expected by $0.06 and higher than last year of $2.55, with revenue increasing 5.2% year over year, another good report. I am getting greedy with Boeing and have stopped trimming and will let it run for a few more quarters.
  • On 7/17/18, Johnson & Johnson's earnings were above expected at $2.10 compared to last year at $1.83 and expected at $2.06. Revenue beat expected revenue by $440 million, with total revenue up at $20.8 billion or up 10.6% Y/Y. The strong dollar is hurting JNJ, but they are still growing and have plenty of cash to buy companies and continue their growth. JNJ will be pressed to 9% of the portfolio because they're so defensive in this post-BREXIT world. Earnings in the last quarter beat on the top and bottom lines. JNJ is not a trading stock but a hold forever. If you want a hold forever top-notch medical supply company with a growing 2.8% dividend (56 years of increases), JNJ is for you.
  • On 7/26/2018, Altria's earnings were $1.01, beating expected of $1.00 and compared to last year's $0.75. Hold and only sell when MO becomes too large a percentage of the portfolio. Revenue missed by $140M and e-cig will have to be watched to make up the difference in revenue going forward when the FDA approves it. Total revenue was $4.88 billion, down 3.7% year over year. Hold this defensive position for its 4.7% dividend and moderate growth.
  • On 8/14/2018, Home Depot earnings were expected at $2.84 and came in at $3.05 and compared to last year at $2.25, a great quarter Y/Y. Revenue was up compared with expected by $450 million. Total revenue was $30.46 billion, up 8.4% Y/Y. Hold and only trim when HD becomes too large a percentage of the portfolio, which is now. This was a blockbuster report.
  • On 7/19/12018, Philip Morris's earnings were $1.41 compared to expected at $1.23 and last year at $1.15. Revenue beat by $200 million from the expected, with total revenue at $7.73 billion, up by 11.7% year over year. Hold for now and only trim when PM becomes too large a percentage of the portfolio. Exchange rates and the strong dollar are causing PM (a total international company) earnings to have a headwind, but they came through with good earnings. They pay a 5.6% dividend and are in a defensive business with growth to come from smokeless products, which had weak growth this quarter but will go up when the FDA approves their smokeless products in the United States. They guided lower, and Mr. market took them down, Mr. Market is blind.

In the portfolio, only two companies are losing money over the 55-month test period - Freeport-McMoRan and General Electric.

  • FCX cash flow has recovered well and should be able to have positive cash flow each year even with the present lower price of copper. Copper demand is increasing each year with little new supply on the horizon. The Portfolio did buy some FCX when it got down to $4.00/share, their assets were worth much more than $4.00, so this move did reduce the loss, but FCX still needs more time as copper prices will rise over time when the trade wars stop. Right now FCX has gotten an extension to ship cooper for another year and is making progress on a final long-term deal to export copper concentrate with the Indonesian Government. The sale of Rio Tinto's share in the Grassburg operation should help in meeting the requirement of the Indonesian Government. With copper at just about $2.65/Lb., FCX is a good speculation at the present price. I have added a guideline to be careful of commodity companies as a result of the poor total return performance of Alcoa (AA) and Freeport-McMoRan.
  • The other problem company is General Electric; the portfolio is losing money and is behind the DOW over the test period of 55 months. On 7/20/2018, General Electric's earnings were at $0.18, compared to expected at $0.17 and last year at $0.28. Total revenue was $30.1 billion, up 3.5% year over year and beat expected revenue by $790 million. They are reorganizing which should help if you are patient. They are almost all industrial now and have great products; time to grow the standard business. They have a new CEO so let's hope this can change the direction of GE. The new CEO is taking action, but it will take time to cut costs; hold for now and give the new CEO some more time, I think there are no more cockroaches to come out of GE.

Recent Portfolio Changes

  • On August 22 increased the percentage of DLR to 3.3% of the portfolio, I want to get this REIT to a full position of 4%.
  • On August 15 sold all remaining Amerisource Bergen (ABC) in the portfolio.
  • On August 9 reduced Amerisource Bergen to 0.4% of the portfolio. I will most likely sell the remainder of ABC next week. The company margin is very thin, and I don't like the present pressure of the opioid crisis. The risk has gotten too high versus the reward.
  • On July 12th bought a small starter position (0.1% of the portfolio) in Simulation Plus a small software company that helps test/simulate new drugs before they are released. This is a very speculative investment and should be watched carefully.
  • On June 20th closed out covered calls and sold KHC position, I needed some cash. I got a better price using the calls but missed some of the recent gains.
  • On June 8th sold KHC July 57.5 calls against the position and will make 4% if the KHC price remains the same. The calls are now in the money, and I may move them up and out when the time value is small.
  • On May 14th, I trimmed the position of Eaton Vance Enhanced Equity Income Fund II from 9.2% of the portfolio to 8.9%. I still like EOS and don't want to overweight this fund which is high in technology companies.
  • On March 29 increased position of American Tower to 0.8% of the portfolio, I will continue adding to this position as cash is available.
  • On March 29 sold entire position of L Brands it does not look good for the company going forward.
  • On March 23 increased position of Freeport-McMoRan to 2.4% of the portfolio and will add to this position as cash is available.

The Good Business Portfolio trims a position when it gets above 8% of the portfolio. The four top companies in the portfolio are, Johnson & Johnson is 8.0% of the portfolio, Eaton Vance Enhanced Equity Income Fund II is 8.7% of the portfolio, Home Depot is 9.8% of the portfolio and Boeing is 13.0% of the portfolio, therefore BA, EOS, JNJ and Home Depot are now in trim position.

Boeing is going to be pressed to 14% of the portfolio because of it being cash positive on 787 deferred plane costs at $316 Million in the first quarter of 2017, an increase from the fourth quarter. The second quarter saw deferred costs on the 787 go down $530 Million a big jump from the first quarter. The second quarter of 2017 earnings was fantastic with Boeing beating the estimate by $0.25 at $2.55. The third quarter of 2017 earnings were $2.72 beating the expected by$0.06 with revenue increasing 1.7% year over year another good report. The first quarter earnings for 2018 were unbelievable at $3.64 compared to expected at $2.64. Farnborough Air Show sales in dollar value just beat out Air Bus by about $6 Billion, and both companies had a great number of orders. The second quarter earnings beat expectations by $0.06 at $3.33, but a good report was hurt by a write off expense on the KC-46 which should start delivery in October of 2018.

JNJ will be pressed to 9% of the portfolio because it's so defensive in this post-BREXIT world. Earnings in the last quarter beat on the top and bottom line and Mr. Market did like it. JNJ has announced a dividend increase to $0.90/Qtr which is 56 years in a row of increases. JNJ is not a trading stock but a hold forever; it is now a strong buy as the healthcare sector remains under pressure.

Conclusion

The 11 guidelines referenced in the article give me a balanced portfolio of good companies that are large-cap and can grow their revenues, earnings, and dividends for years. They have the staying power to fix whatever goes wrong. In each case, the company has the size and good management to fix the problem. The portfolio has growth companies, defensive companies, income companies and companies with international exposure, giving it what I call balance. Of the 23 companies in the portfolio, three are underperforming the DOW average in total return. All three companies are being hurt by the strong dollar since they are multinational and have a portion of their income coming from foreign operations. The portfolio is 0.54% behind the DOW average YTD with increases in earnings expected in the third quarter for almost all of the portfolio companies. So with five months to go the portfolio is slightly behind but not enough to worry about. I intend to continue writing separate comparison articles on individual companies. I have written articles on all of the companies in the portfolio and others, and you can read them in my list of previous articles if you are interested. If you would like me to do a review of a company you like, please comment, and I will try to do it.

Of course, this is not a recommendation to buy or sell, and you should always do your own research and talk to your financial advisor before any purchase or sale. This is how I manage my IRA retirement account, and the opinions of the companies are my own.

Disclosure: I am/we are long JNJ, HD, BA, MO, EOS, DIS, PM, GE, MMM, MCD, ADP, OHI, IR, MDLZ, TXN, FCX, HPQ, ABC, DHR, PEP, AMT, ARNC, DLR. 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.