The R.I.P. Portfolio's Q3 2018 Update

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Includes: AAPL, ACN, AMGN, BABA, BAC, BHF, BHGE, BRK.B, C, CAH, CCMP, CLDR, CRL, CSCO, DIS, DWDP, FB, FKINX, GE, GM, HON, INTC, JNJ, KEY, KR, MET, MRK, PFE, PFG, PG, PRU, SBUX, SFTBY, SPY, SYF, T, TGT, TWTR, UA, UTX, VZ, WNC
by: WG Investment Research
Summary

This real-money portfolio was first introduced to the Seeking Alpha community in December 2015.

The portfolio has underperformed its benchmark so far in 2018, with several factors being significant contributors, but I believe that the portfolio is positioned to benefit from several major trends.

The financial holdings were again a drag to the portfolio's Q3 2018 performance but, looking out, the banks are well-positioned for the next few years.

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 articles is to allow for my SA followers to track the performance of the stocks that I write about on this platform.

However, I am 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 company's 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 [and annual] 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." -Anonymous.

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. These are 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 January 2018.

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 15% 10-20%
Healthcare 10% 5-15%
Financials 10% 5-20%
Insurance 5% 3-7%
Technology 15% 10-20%
Communication Services 15% 10-20%
Basic Materials 5% 3-7%
Conservative Allocation Fund 5% 3-7%
Consumer 15% 10-20%
Other* 5% 0-10%

*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 broader market.

Q3 2018 Update

Below you will find the portfolio and its performance, and the activity for the third quarter of 2018.

Company Ticker # of shares Price At 9/30/2018 Beg. Value - 7/1/2018 Activity - Purchases (Sales) Quarterly Unrealized G/L Quarterly Realized G/L Current Value Unrealized Gain (Loss) Portfolio Weighting YOC Current Yield Annual Income
General Electric (GE) 402.733 $11.29 $5,275 $150 $(878) - $4,547 $(3,879) 3% 2.3% 4.3% $193
Baker Hughes (BHGE) 25.00 33.83 826 - 20 - 846 (81) 1% 1.9% 2.1% 18
Honeywell (HON) 41.48 166.40 5,375 654 874 - 6,903 2,171 5% 2.9% 2.0% 136
Berkshire Hathaway (BRK.B) 18.00 214.11 2,800 636 419 - 3,854 275 3% 0.0% 0.0% -
United Technologies (UTX) 25.32 139.81 3,149 - 391 - 3,540 401 3% 2.3% 2.0% 71
AT&T (T) 301.47 33.58 6,809 2,956 358 (59) 10,123 1,181 8% 6.7% 6.0% 603
Verizon (VZ) 51.34 53.39 2,559 - 182 - 2,741 475 2% 5.5% 4.5% 124
Franklin Income (FKINX) 2586.27 2.32 5,897 - 103 - 6,000 1,166 4% 6.4% 5.2% 310
Walt Disney (DIS) 27.64 116.94 2,876 - 356 - 3,232 1,301 2% 2.4% 1.4% 46
Bank of America (BAC) 417.88 29.46 11,715 - 596 - 12,311 5,798 9% 3.8% 2.0% 251
Citigroup (C) 49.96 71.74 3,322 - 262 - 3,584 1,160 3% 3.7% 2.5% 90
KeyCorp (KEY) 79.78 19.89 1,546 - 41 - 1,587 711 1% 6.2% 3.4% 54
DowDupont (DWDP) 104.15 64.31 6,828 - (130) - 6,698 726 5% 2.7% 2.4% 158
Synchrony Financial (SYF) 100.88 31.08 3,344 - (209) - 3,135 810 2% 3.6% 2.7% 85
Target (TGT) 9.40 88.21 711 - 118 - 829 305 1% 4.6% 2.9% 24
Kroger (KR) 114.37 29.11 3,243 - 87 - 3,329 114 2% 1.8% 1.7% 57
Starbucks (SBUX) 14.44 56.84 635 51 135 1 821 111 1% 2.4% 0.9% 7
Johnson & Johnson (JNJ) 40.37 138.17 4,866 - 711 - 5,577 1,313 4% 3.4% 2.6% 145
Amgen Inc. (AMGN) 8.34 207.29 1,530 - 200 - 1,729 303 1% 3.1% 2.5% 44
Pfizer (PFE) 150.72 44.07 5,427 - 1,215 - 6,642 2,243 5% 4.7% 3.1% 205
Merck (MRK) 19.84 70.94 1,195 - 213 - 1,408 350 1% 3.6% 2.7% 38
Charles River Labs (CRL) 11.00 134.54 1,235 - 245 - 1,480 346 1% 0.0% 0.0% -
Cardinal Health (CAH) 6.22 54.00 301 - 35 - 336 (103) 0% 2.7% 3.5% 12
AIG warrants AIGWS 78.00 14.62 1,001 80 60 22 1,140 (67) 1% 0.0% 0.0% -
Metlife (MET) 54.30 46.72 2,299 32 206 14 2,537 746 2% 5.1% 3.6% 91
Prudential Financial (PRU) 11.62 101.32 609 478 90 - 1,177 81 1% 3.8% 3.6% 42
Brighthouse Financial (BHF) 4.00 44.24 160 - 17 - 177 (13) 0% 0.0% 0.0% -
Principal Financial Group (PFG) 1.01 58.59 - (36) 95 103 59 5 0% 3.9% 3.6% 2
Apple (AAPL) 21.68 225.74 3,999 - 895 - 4,894 2,424 4% 2.6% 1.3% 63
Twitter (TWTR) 111.00 28.46 4,847 - (1,688) - 3,159 1,227 2% 0.0% 0.0% -
Facebook (FB) 7.00 164.46 583 669 (101) - 1,151 (17) 1% 0.0% 0.0% -
CISCO (CSCO) 152.24 48.65 9,407 (2,883) 882 25 7,406 3,529 6% 5.2% 2.7% 201
Intel (INTC) 74.97 47.29 3,800 (83) (172) 166 3,545 808 3% 3.3% 2.5% 90
Softbank (SFTBY) 12.00 49.75 428 - 169 - 597 93 0% 0.0% 0.0% -
Cloudera (CLDR) 2.00 17.65 27 - 8 - 35 (0) 0% 0.0% 0.0% -
Accenture plc (ACN) 5.14 170.20 841 - 34 - 875 298 1% 2.6% 1.7% 15
General Motors (GM) 113.89 33.67 3,199 1,070 (434) 19 3,835 150 3% 4.7% 4.5% 173
Procter & Gamble (PG) 8.48 83.23 660 - 46 - 706 64 1% 3.8% 3.4% 24
Alibaba (BABA) 1.00 164.76 186 - (21) - 165 41 0% 0.0% 0.0% -
Wabash National Corp (WNC) 51.00 18.23 952 - (22) - 930 (27) 1% 1.6% 1.6% 15
Under Armour (UA) 104.00 19.46 2,192 - (168) - 2,024 415 2% 0.0% 0.0% -
Other* -- -- -- 7,502 843 (178) 345 8,168 594 6% 2.0% 2.1% 173
CASH -- -- -- 59 6 -- -- 65 -- 0% -- -- --
$124,217 $4,624 $5,056 $635 $133,898 $27,547 100% 3.4% 2.7% $3,563
Industry/Portfolio Companies Value Portfolio Weighting Goal Weighting Over (Under)
Industrials/Conglomerates - GE, HON, BHI, WNC, BRK.B, SFTBY, UTX $21,215.66 16% 15% 1%
Healthcare - JNJ, PFE, AMGN, CAH, MRK, CRL 17,172.66 13% 10% 3%
Financials - BAC, C, KEY 17,481.63 13% 10% 3%
Insurance - AIG*, MET, BHF, PRU, PFG 5,090.52 4% 5% -1%
Technology - AAPL, CSCO, INTC, ACN, CLDR 16,755.49 13% 15% -2%
Communication Services - T, VZ, DIS, TWTR, FB 20,407.04 15% 15% 0%
Basic Materials - DWDP 6,697.95 5% 5% 0%
Conservative Allocation - FKINX 6,000.14 4% 5% -1%
Consumer - KR, GM, TGT, UA, BABA, PG, SBUX, SYF** 14,843.67 11% 15% -4%
Other - XIN, RHE, FSI, MTZ, AVD, GPRE, TDOC, KTOS, TSLA, GE call option, APPN, Z, NIO 8,167.52 6% 5% 1%
Cash 65.31 0% 0% 0%

*AIG TARP warrants are included in value and weighting

**Direct consumer play (read articles on profile for more info)

Sales & Purchases - There was an uptick in trading activity this past quarter because I started trading in-and-out of dividend-paying stocks in order to capture additional income.

See information below for details on how I am positioning the portfolio for the future.

Current Makeup Of Portfolio

Below is a graphic from Morningstar that captures a high-level snapshot of the R.I.P. portfolio as of the period-end.

Source: Morningstar

Full Disclosure: The AIG Tarp warrants are not included in this Morningstar analysis.

I do not want to spend too much time here but there are a few data points that should be highlighted: the holdings of the R.I.P. portfolio are attractively valued when compared to the S&P 500 on a price-to-prospective earnings basis but, in the same breath, the portfolio holdings also have significantly lower-than-average ROA and ROE ratios. Moreover, the projected EPS growth over the next five years for the portfolio is well behind that of the average for the S&P 500.

Lastly, the R.I.P. portfolio is highly levered to cyclical companies and, as expected, Large Cap value still makes up well-above 60% of the total assets.

Portfolio Performance for Q3 2018 and since the portfolio was first introduced to SA community (December 4, 2015)

Return (Q3'18) Return (YTD) Return (Intro) Return On Invested Capital (Review)
4.0% 4.2% 32.2% 44.0%
This period YTD Since Intro Since Intro
Beg. Balance $124,217 $110,901 $52,610 Initial Value $46,042
Contributions 4,624 17,959 55,423 Contributions 55,423
Unrealized G/L 5,056 5,038 25,864 Realized G/L 4,885
Ending Balance $133,898 $133,898 $133,898 Unrealized G/L 27,547
Portfolio Bal. $133,898
Dividend Inc. $988 $2,695 $7,017
Realized G/L 635 1,776 4,885 Dividend Income $7,017

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.

The realized gains (losses) recognized for the quarter were: $290 gain in a retirement account and a $345 gain in a brokerage account.

From an income standpoint, the portfolio's annual dividend income has grown significantly since 2016 (portfolio was first introduced in December 2015).

Note: Q4 2018 and Full-year 2018 are projections.

The portfolio's dividend income was $988 for Q3 2018, which is slightly higher than the previous quarter ($868 in Q2 2018), but significantly higher YoY ($724 in Q3 2017). Furthermore, the portfolio's projected dividend income for 2018 is approximately 43% higher than the total income received in 2017. It should also be noted that I do not have a specific income goal for the portfolio, but I have purposefully focused on investing in high-quality dividend paying stocks since late-2015.

Starting with the most important metric, the R.I.P. portfolio has underperformed its benchmark by over 6 percentage points since the portfolio was introduced to the Seeking Alpha community on December 4, 2015. The recent performance of the portfolio through Q3 2018 is also nothing to brag about (and that is putting it lightly), as the portfolio has continued to fall behind its benchmark so far in 2018.

The portfolio outperformed its benchmark from late 2016 to late 2017 but the SPY has continued to pull away since the start of 2018. There are 3 main factors for this underperformance (let me stress that these are reasons, not excuses):

(1) Value: The Value-tilt to the portfolio has been a major contributor to the underperformance (remember, as shown above, Large Cap Value makes up approximately 66% of total assets). To this point, the Value factor has significantly underperformed other factors, especially growth, so far in 2018.

Source: FactSet

I believe that value will eventually come back into favor but, regardless, I plan to stay heavily invested in value stocks.

(2) Financials: According to the Morningstar analysis, the Financial Services sector makes up over 20% of the portfolio's assets. As such, the underperformance of the financial sector when compared to the S&P 500 has contributed to the portfolio's lackluster return.

Source: Fidelity

(3) General Electric: Yes, it's that simple. I have held an overweight position in this storied industrial conglomerate for years and I have paid the price in 2017/2018 for this decision.

Chart
GE data by YCharts

The poor performance in 2018 was largely a result of the overweight General Electric position blowing up in my face, and more recently the underperformance of the financials, but the strong past performance was a direct result of the investments that were made in the Financial, Technology and Communication Services sectors (see the "Looking Ahead" section below for additional thoughts on the positioning of the portfolio):

During the most recent quarter, the top performers and under-performers for the portfolio were: Performers - [1] Pfizer, [2] Apple, and [3] Cisco; Under-performers - [1] Twitter, [2] General Electric, and [3] General Motors.

I will now spend a few minutes talking about the top performer, Pfizer, and under-performer, Twitter, over the last quarter, which are actually two companies that I am very bullish about.

Pfizer has been a consistent performer over the last year but, more recently, the stock has had upward pressure due to the company's impressive operating results. For example, the company reported adjusted Q2 2018 EPS of $0.81 (beat estimates by $0.07) on revenue of $13.4B (beat estimates by $160M).

Source: Earnings Presentation

And more importantly, management expects for the company to have a strong finish to 2018.

I plan to stay the course with Pfizer and I may actually add to my overweight position if the stock pulls back to the $30 per share range.

Twitter's stock has been pounded as the financial community is deeply concerned about regulatory risk. While I do believe that the risk level is higher today than it has been in the past, in my opinion, Twitter is still a great long-term investment. As I described in early 2017, I cannot imagine a world without Twitter and this still holds true today. This company is a high risk/high reward holding that will be apart of the portfolio for the foreseeable future.

Noteworthy Quarterly News:

General News

[1] The government filed an appeal to the AT&T-Time Warner merger but, in my opinion, it is a shot in the dark for the Justice Department. At the end of the day, I believe that the merger will go through as originally anticipated.

Buybacks And/Or Dividend News:

[1] Verizon increased its quarterly dividend by 2.1% (from $0.59 to $0.6025), which brings the forward dividend yield 4.5% based on today's price.

[2] Accenture increased its quarterly dividend by 9.8% (from $1.33 to $1.46), which brings the forward dividend yield to 1.5% based on today's price. Additionally, the board approved an additional $5B to be added to the company's buyback program, which brings the total program to approximately $6B.

[3] Honeywell its quarterly dividend by 10.1% (from $0.745 to $0.82), which brings the forward dividend yield 1.8% based on today's price.

Merger, Acquisitions and Disposals:

[1] Cabot Microelectronics (CCMP) announced the acquisition of KMG Chemicals in a deal that is valued at $1.6B. I booked an approximately 80% gain on my investment by selling all of my KMG position when shares were trading around $77.

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

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

[i] Digitalization Megatrend

Projections for how connected the global economy will be in the future are all over the place but most (if not all) of the estimates are calling for significant growth in the years ahead. For example, connected devices are expected to exceed 50B by 2020 (up from 28.4B in 2017).

[ii] Rising Rate Environment

The interest rate environment has been a major headwind for financial institutions since the Financial Crisis, as rates have been at historical low levels for the past decade.

Source: Fed Funds Rate History

The Federal Reserve has hiked rates several times in 2017/2018 and current estimates are calling for rates to continue to rise from current levels - a development that is already in full swing.

It has been a promising two years but rates need to continue to tick higher before the financial industry sees the real benefits.

[iii] The Changing Media Space

There is no denying just how fast the digital video streaming industry is growing and disrupting the media companies.

Source: Business Insider

More importantly, the growth is not expected to slow down anytime soon, as revenue and the number of users in the Video Streaming (SVoD) segment are anticipated to trend higher through 2022.

Source: statista

And finally, it is especially important to note that the way that we get our content is changing by the day.

Source: Marketer

Putting It All Together: Positioning The Portfolio

The following companies in my stock universe are the ones that I see being the biggest beneficiaries of these trends: [i] Digitalization - Cisco, Intel, Apple, Accenture, General Electric, Honeywell, GM, AT&T, and Verizon; [ii] Rising Rates - Bank of America, Citigroup, KeyBank, AIG, Principal Financial, Prudential and MetLife; and, [iii] Media Shift - Disney, Twitter, Time Warner, AT&T, Facebook, and Verizon.

More recently, I have also been factoring in expectations for the business environment to improve over the next few years, as the current administration appears committed to creating a business-friendly environment. The tax reform bill is already having a positive impact and lower corporate rates is more than just a one-time benefit. The trade wars, on the other hand, is creating a great deal of uncertainty.

Lastly, 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 should benefit from an improving backdrop.

Final 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 opposing viewpoints and responding to constructive criticism. I try to contribute at least $1,000 per quarter to this portfolio, but sometimes it will be a little more or a little less. I will attempt to provide updates on at least a quarterly basis but I may miss a quarter or two over a 12-month span (I have not missed a quarter since late-2015 so hopefully this streak will continue in 2018).

For full disclosure, I plan to still write about these companies on a regular basis so stay tuned. And lastly, I always have these two quotes in mind whenever I make an investment decision:

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."

Disclosure: I am/we are long bac, c, HON, GE, BHGE, T, VZ, TSLA, PFE, JNJ, AMGN, AAPL, CSCO, INTC, SFTBY, NIO, XIN, FKINX, BRK.B, UTX, DIS, DWDP, SYF, TGT, KR, SBUX, PFE, MRK, CAH, MET, BHF, PFG, TWTR, FB, CLDR, ACN, GM, PG, UA, BABA. 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 discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.