My Quarterly Non-Taxable Portfolio Update

by: Steven Chen

I probably should have done this earlier, but I am now trying to write about my portfolio performance on a regular basis.

By doing so, I aim to analyze performance attribution so as to learn my lessons and refine my strategy over time.

For this article, I list the leaders and laggers from my non-taxable account for the past three months.


My loyal readers should be familiar with the following factors (weights in descending order) that I use to determine the fundamental quality of each stock:

  1. Management's capital allocation skills (check out the Importance of ROIC).
  2. Growth (this matters only in cases of decent returns on capital).
  3. Shareholder friendliness and corporate governance.
  4. Cash flow.
  5. Profitability.
  6. Financial strength.
  7. Industry.

So how would my quality investing strategy play out and what exactly did this contribute to my investment performance over time? Here comes my first article to analyze performance attribution in order for me to learn my lessons and refine my approach over time. I am hoping to keep doing this on a regular basis.

To start with, I would like to just cover my US retirement portfolio due to the following:

  1. Non-taxable (e.g., no dividend withholding tax): easy to compare to benchmarks; trading costs, however, are included in the calculation of performance (I use Fidelity for this account btw) so the more trading activities the more my performance is hurt.
  2. No cash inflow or outflow: again, easy to calculate relative performances.
  3. US-centric (i.e., with the majority of the holdings in US stocks): so that I can compare to the S&P 500, which Warren Buffett claims it is hard to beat.

Aside from the pros above, I do feel about some cons of using this portfolio for performance evaluation (vs. US equity benchmarks) as follows:

  1. The portfolio is biased towards dividend-paying stocks (for tax reasons), leaving choices of fast-growing and less mature companies out of the picture.
  2. Although the portfolio is US-centric, it does include some foreign stocks in order to save on dividend withholding taxes (e.g., Canadian and German stocks).

Here is the performance of this portfolio for the past three months - from 6/1/2018 till 8/31/2018, my non-taxable portfolio generated a return of 11.91% while the S&P 500 was up 7.25% (with dividends reinvested).

Source: Personal Capital.

At the moment, this portfolio is concentrated with 21 equity holdings (19 US, 1 Canada, 1 Germany). Below I list the leaders and laggers for a short 3-month period while trying not to focus on the short-term events, such as quarterly earnings, analyst upgrade/downgrade, guidance issuance, but on fundamental qualities.


Tractor Supply (TSCO)

Performance (June-August 2018, excluding dividends): 18.8%.

Source: WSJ.

Tractor Supply Company is an American retail chain that offers products for home improvement, agriculture, lawn, and garden maintenance, and livestock, equine and pet care.

The niche market strategy to be the leading rural lifestyle retailer has been benefiting the company with a wide moat to protect from fierce competitions from giant peers such as Amazon (AMZN) and Walmart (WMT). Tractor Supply has maintained a high ROE of 35% TTM, with a manageable debt load (0.39x debt/equity and 1.92x current ratio). For the recent quarter, both revenue and operating income have grown at high single-digits.

TJX Companies (TJX)

Performance (June-August 2018, excluding dividends): 21.8%.

Source: WSJ.

The TJX Companies is the leading off-price retailer of apparel and home fashions in the U.S. and worldwide.

Like Tractor Supply, TJX is another leading niche retailer that is Amazon-proof. The business has generated an astonishing 61% return on equity and 42% return on invested capital over the trailing 12 months with double quarter-over-quarter double-digit growth in revenue, operating income, and EPS.

Microsoft (MSFT)

Performance (June-August 2018, excluding dividends): 13.7%.

Source: WSJ.

This is one of a few stocks in my basket hitting all-time highs during the period. Best known for its Windows and Office lines of products, Microsoft is one of the largest software makers.

The company possesses a wide moat in my view due to its market leadership and highly sticky user base of operating systems and business/productivity software. The return on capital figures drop for the past 12 months, but this was mainly because of the spiking tax rate. In the meantime, the gross margin, operating margin, and EBT (earnings before tax) margin all actually improved. Microsoft also maintains a great track record of converting more than 100% of its earnings to free cash flow (see below), therefore becoming one of the favorite picks by Terry Smith and his fund.

Source: Morningstar.

Apple (AAPL)

Performance (June-August 2018, excluding dividends): 21.8%.

Source: WSJ.

Being Warren Buffett's largest stock holding in his Berkshire Hathaway (BRK.A) (BRK.B), Apple continues to prove its competitive edge in consumer electronics, software, and related online services. The company improved its returns on equity and on capital over the TTM while growing at double digits YoY in revenue, operating income and EPS.

Similar to Microsoft, Apple has been able to convert more than 100% of its earnings to free cash flow for the owners (see below).

Source: Morningstar.

Domino's Pizza (DPZ)

Performance (June-August 2018, excluding dividends): 18.7%.

Source: WSJ.

Domino's Pizza is the seventh-largest fast food restaurant chain by number of locations in the world. Thanks to its asset-light business model, the company generated a 36.4% TTM return on assets with recent quarterly double-digit growth YoY in revenue, operating income, and EPS.

Being only 1/10 of McDonald's (MCD) in terms of market value and taking advantage of the trend that millennials favor pizzas over burgers, Domino's should still have great growth ahead.

Nike (NKE)

Performance (June-August 2018, excluding dividends): 14.5%.

Source: WSJ.

Nike is the world's largest supplier of athletic shoes and apparel and a major manufacturer of sports equipment.

For the latest quarter, the company achieved double-digit YoY growths in top line and bottom line and a high single-digit growth in operating income. The business delivered decent and stable margins (see below) and has a strong balance sheet (i.e., 2.51x current ratio, 0.35x debt/equity).

Source: Morningstar.

Ross Stores (ROST)

Performance (June-August 2018, excluding dividends): 21.4%.

Source: WSJ.

Officially operating under the brand name "Ross Dress for Less," Ross Stores is the largest American chain of off-price department stores. Being a direct competitor with TJX in the States (TJX also operates overseas), ROST did have performances correlated with TJX. Both stocks were up over 21% (excluding dividends) for the period. As of the recent quarter, both companies offer similar gross margins, while Ross Stores did slightly better in operating margin, net margin and returns on assets. Although holding both stocks, I like ROST a bit better as the business is focused on the States only (not a huge fan of diversification to be honest).

Ross Stores generated a 35% YoY growth in EPS (similar to TJX's) along with high single-digit growth in revenue and operating income for this quarter.

Rollins (ROL)

Performance (June-August 2018, excluding dividends): 20.7%.

Source: WSJ.

Rollins is the global leader in providing pest control services and protection against termite damage, rodents, and insects. The stock is also the top American name in my stock quality ranking.

It is also an extremely rare case that has been growing revenue and earnings every year for nearly two decades. There was no exception for the past quarter, where Rollins grew its top line and bottom line by 11% and 20% respectively.

FactSet Research Systems (FDS)

Performance (June-August 2018, excluding dividends): 14.1%.

Source: WSJ.

FactSet provides financial information and analytic software for analysts, portfolio managers, and investment bankers at global financial institutions. As we speak, the business generates a 48% return on equity, 23% on invested capital, and 18.7% on assets.

Although still standing high, the gross/operating/net margins (but not FCF margin) and asset turnover went down during the past year, which is something I will keep an eye on. Additionally, the debt/equity ratio rose to 1.07 as of the latest quarter from 0.07 three years ago. On the bright side, the quarterly growth was healthy (i.e., 9% in revenue and 15% in EPS).

Clorox (CLX)

Performance (June-August 2018, excluding dividends): 20%.

Source: WSJ.

As a leading multinational manufacturer and marketer of consumer and professional products, Clorox markets some of the most trusted and recognized consumer brand names, including its namesake bleach and cleaning products. According to the company, more than 80 percent of the company’s sales are generated from brands that hold the No. 1 or No. 2 market share positions in their categories.

The management currently delivers a superior 130% return on equity, 30% return on invested capital and 17% on assets. The recent quarterly growth was nothing exciting but nothing to complain about from a consumer staples investors' point of view (i.e., low-single digits in revenue and operating income, a high single-digit in EPS).

Gilead Sciences (GILD)

Performance (June-August 2018, excluding dividends): 12.4%.

Source: WSJ.

Gilead Sciences is a research-based biopharmaceutical company that discovers, develops and commercializes medicines in areas of unmet medical need. The company focuses primarily on antiviral drugs used in the treatment of HIV, hepatitis B, hepatitis C, and influenza.

The stock is a turnaround play in my view, which I do not recommend investors do a lot of. However, Gilead Sciences does possess great cash generation/reserves with prudence in M&A spending. For the past 12 months, the business produced 36 cents FCF on every dollar of sales, with 40% of assets in cash (or cash equivalents) on the balance sheet as of the latest quarter. The company is increasing its presence in China, which is a potential growth story.

The risk is, however, that the margins (gross, operating, FCF, EBT) and asset turnover are still trending down.

Johnson & Johnson (JNJ)

Performance (June-August 2018, excluding dividends): 12.6%.

Source: WSJ.

Johnson & Johnson is the global leading medical devices, pharmaceutical and consumer packaged goods manufacturing company. For the period, the stock (excluding dividends) beat the benchmark by a wide margin but only narrowly outperformed my portfolio.

The best thing I like about JNJ is its track record of dividend growths and recession-proof-ness. For the latest quarter, the company generated double-digit YoY growth in top line, but only a modest one in operating income, with the margins being pressured down as the long term and short-term trends. The FCF margin, however, has been firmly kept above 20% for recent years.


Philip Morris (PM)

Performance (June-August 2018, excluding dividends): -2.1%.

Source: WSJ.

This is one of the only two stocks that generate negative returns (excluding dividends) during the period.

Philip Morris International is a US cigarette and tobacco manufacturing company, with products (including the most recognized and best-selling product, Marlboro) sold only outside the US (in over 180 countries actually).

I like PM's international market share and think it would benefit from the growth story in the emerging markets. The management has been able to maintain consistently high margins (e.g., EBT margin over 35%) and returns on capital (e.g., ROA over 15%) and convert over 100% of earnings to free cash flow on a historical average basis. For the recent quarter, the business grew by double digits YoY in terms of revenue, operating income and EPS.

Altria (MO)

Performance (June-August 2018, excluding dividends): 5%.

Source: WSJ.

Altria can be regarded as the "US-only" Philip Morris and is one of the world's largest producers and marketers of tobacco, cigarettes and related products.

The stock (excluding dividends) underperformed the benchmark during the period partly due to some regulation concerns, but as Fundsmith's Terry Smith once pointed out, more regulation would actually benefit those big tobacco players already existing in the market.

Altria is the only case in my portfolio to have experienced negative growth in both sales (-5.37%) and operating income (-2%) over the past quarter. However, the business is still maintaining remarkably high margins (e.g., 39% EBT) and returns on capital (e.g., 37% ROIC).

SEI Investments (SEIC)

Performance (June-August 2018, excluding dividends): -1.1%.

Source: WSJ.

SEIC is one of the top American names on my quality ranking list, but was a bit of a disappointment for the period (I would be definitely patient though), being one of the only two stocks that significantly underperformed the S&P 500 (excluding dividends). SEI Investments Company is a global provider of investment processing, investment management, and investment operations solutions.

The growth for the latest quarter is healthy with a high single-digit increase in revenue and double-digit increases in both operating income and EPS. The business is also able to convert more than 28% of its sales into free cash flow for its shareholders. For the past 12 months, the management improved the company's returns on capital, asset turnover, and margins.

Amgen (AMGN)

Performance (June-August 2018, excluding dividends): 11.2%.

Source: WSJ.

As a leading biotech company, Amgen discovers, develops, manufactures and delivers various human therapeutics. This is another healthcare stock with a wide moat, proven growth capability, high profitability, and demonstrated the willingness of delivering returns to its shareholders (AMGN increased its dividend per share 8x for the past six years).

The stock (excluding dividends) beat the benchmark by a wide margin while lagging behind many of my other holdings during the period. Amgen experienced a modest growth for the latest quarter in both sales (4.29%) and operating income (4.97%).

Canadian Railway (CNI)

Performance (June-August 2018, excluding dividends): 6.5%.

Source: WSJ.

Canadian National Railway is Canada's largest railway, in terms of both revenue and the physical size of its rail network, and is Canada's only transcontinental railway company, spanning Canada from the Atlantic coast in Nova Scotia to the Pacific coast in British Columbia.

This is one of the very few cyclical stocks in my portfolio, simply because of its consistently high returns on capital on top of its legal monopoly kind of market position. The ROIC and FCF/EBT/operating margins are currently near the high end of the company's historical ranges over the past decade. For the recent quarter, the management delivered a 9% growth in revenue and a 30% increase in EPS (both Y/Y).

The stock (in USD, excluding dividends) narrowly underperformed the S&P 500 during the period.

Last but not least, Canadian stocks are exempted from dividend withholding taxes in US retirement accounts - a saving of more than 20%. This is why CNI appears here in my US-centric portfolio.

Fuchs Petrolub (OTCPK:FUPBY)

Performance (June-August 2018, excluding dividends): 11.5%.

Source: WSJ.

Fuchs Petrolub is the world's largest independent manufacturer of lubricants, and related specialty products. The US ADR (excluding dividends) beat the S&P 500 by a wide margin while lagging behind many of my other holdings during the period.

The management has shown great capital allocation skills with the focus on Fuchs Value Added (i.e., EBIT - cost of capital), which is the central KPI. For the past quarter, the company generated high single-digit growth in revenue, operating income, and EPS. The current returns on assets and invested capital are 15.8% and 21.8% respectively, both of which are quite acceptable but worth further tracking, as they are trending down.

If you are wondering why a German name appears here, then please be aware that German ADRs are also exempted from dividend withholding taxes in US retirement accounts - another saving of more than 20%.

Paychex (PAYX)

Performance (June-August 2018, excluding dividends): 11.7%.

Source: WSJ.

Paychex is the "ADP" (i.e., provider of payroll, human resource, and benefits outsourcing services) for small- to medium-sized businesses in the US. It operates with even higher capital efficiencies compared to ADP in terms of returns on capital.

The management was able to grow the EPS YoY by double digits for the recent quarter with no debt on the balance sheet. The stock (excluding dividends) beat the benchmark by a wide margin while lagging behind many of my other holdings during the period.

New Positions


NIC Inc. is the leading provider of digital government services that help governments use technology to provide a higher level of service to businesses and citizens and increase efficiencies.

The company operates through a transaction-based funding model (so-called B2B2C) to fund most enterprise partnerships. Hence, it generates predictable, repeatable, small-ticket, non-bargainable revenue streams through almost monopolized channels of public services, whenever users want to renew vehicle registration online or purchase a national park ticket over the mobile app.

Of course, I need to admit one risk facing the business is losing government contracts as the client base appears a bit concentrated. For the past decade, the company has consistently generated double-digit returns on assets, equity and invested capital (see below).

Source: Morningstar.

EGOV was a newly-initiated position in my portfolio during this period. It is regarded as a high-quality hidden gems stock, being undercovered here in the Seeking Alpha community.

Colgate-Palmolive (CL)

CL had been on my watch list for a long while before I finally established a position recently. The company is the leading provider of oral, personal and home care products and pet nutrition products (see the familiar brands below).

Source: Colgate-Palmolive 2017 Annual Report.

You may find the story boring here but be aware that 1/3 of the world population are still brushing teeth without toothpaste and that people are more likely to cut spending on their own food or even their children's than they are to save money on pet food.

Colgate-Palmolive delivered double-digit returns on assets every year for the past 10 years (see below). Looking forward, one of the biggest challenges facing the company (like many other consumer staples businesses) is the trend of digitization/e-commerce along with the associated changing consumer behavior.

Source: Morningstar.


11.91% is a good quarterly number under any market condition in my view. Meanwhile, beating the market (7.25%) even adds to the pleasure. When analyzing the recent performances, I try to pay more attention to the fundamental changes than to quarterly earnings. An earnings miss, analyst downgrade, or guidance being revised down would certainly not trigger my selling, while I consider deteriorations in return on capital, balance sheet, cash flow, and profitability as warning signals.

Again, because of the taxation benefits, this portfolio is more concentrated in dividend-paying US stocks. Today the investable world has never been this international, and therefore, I am hoping to carve out some time to cover my other portfolios while continuing the update on this one.

Disclosure: I am/we are long MOST OF THE STOCKS MENTIONED ABOVE. 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.