Since my last portfolio update I've seen more good results.
For the 5 months ending in September, my spreadsheet shows that I earned a total return of 36% from my stock picks. That easily meets my goal of getting at least 15% per year, especially since I'm taking limited and diversified risks instead of chasing quick gains. Over the same time, the rest of my portfolio earned around 11%.
However, with any stats about investment performance there is a catch. For me it's not the typical ones like survivorship bias (I include my weaker investments and losses) or hidden fees (I don't charge fees to myself, and the results include the costs of actual trades instead of being based on simulations).
There is still one way that this is hiding the truth, because I have been adding to my stock picks when I see a good opportunity. Some of it comes from selling off index funds and some comes from a margin account where I can buy more whenever I want.
There are so many different ways to measure investment performance that there will never be a perfect answer. But the important question is not what measure gives you the "right" answer. The question you should be asking is what if there is a better alternative.
In this case, what would my performance have been if I had been holding extra cash from the start? (it would be lower) What would the opportunity cost have been if I hadn't been able to invest in other things while waiting to find the right stocks? (the cost would be higher)
Looking at returns this way is a common mistake. It's accurate in that those are the actual returns I got. But it doesn't represent what you might get going forward because it assumes you can just come up with additional cash whenever you need to - which is not the case for most investors.
Any time someone talks about the benefits of dollar-cost averaging, you are seeing this in action. It's true that you would earn the returns they say (if the market performs the same). But most of the time you would earn more if you can invest the same amount of cash upfront.
I improved my performance by investing more when I saw the opportunity (most notably with Aimia, which was a large investment and saw rapid gains). In the future I can't just keep dumping in more cash so my performance will be driven more by the cash I have available and that might reduce the returns.
In this case, I don't mind because the way I'm doing it fits my needs and the margin of outperformance is big enough that I'm not too concerned with distortions.
When I see someone claiming great performance, I rarely put much weight on it. Even assuming that they actually did achieve that performance, there are a lot of ways to conveniently ignore the alternatives that could have earned more or carried less risk. Beating a simple index fund is still very hard. The last month demonstrated this.
The Downturn Hits
In October my overall portfolio dropped by 4-5%, and my stock picks actually underperformed that by another 10.7%! The total loss in my stock picks alone was 13.5% in one month. (The numbers don't add up because part of the overall portfolio loss came from my stock picks.)
The losses came from everywhere. My 3 largest positions drifted down (in fact CBL (CBL) took a real dive). That made up about 2/3 of the drop. And there were scattered losses in the rest that covered a wide variety of stocks. Not much was spared. Aimia (OTCPK:GAPFF) added some stability since its price is driven more by the Air Canada (OTCQX:ACDVF) deal than the wider market conditions right now.
As a result, in the 3 months since my last update, my stock picks have lost about 8.2% of their value. Last month broke a string of outperformance that has lasted most of this year.
In a way I'm surprised this didn't happen sooner. I can't outperform every month and if I just have a drop in one month this year, that will be exceptionally strong. I try to focus on buying the most hated stocks at low prices but they can still go down further.
Top Positions (Largest to Smallest)
Aimia: +98.0% total return
During the last few months I've sold off some Aimia shares, taking out around 20% of my position. The return I'm reporting here includes the amounts that I sold.
I believe there is still room for the shares to rise but this allowed me to move money into other stocks that may have more potential gains from current prices. I still have some options expiring in December that will accelerate the profits if the deal closes by then.
CBL announced a potential dividend cut and then made it official recently. Before this I had bought a small add-on that was at higher prices above $5. Since the dividend cut I've bought more in the low $3 range. With all the news coming out, I've spent some additional time reviewing CBL's business. I haven't been able to answer all of my questions but I'm increasingly confident in the prospects.
CBL does have bigger risks than what I saw in Aimia, where the liability was mostly attached to an unlikely scenario and the balance sheet was great aside from that (as proven by the fact that Air Canada is assuming the liability and paying cash on top of that). CBL has real debts and real interest payments and if they aren't carefully managed, they could rapidly unwind the business and give away the assets to someone else. No one should invest in CBL without taking a hard look at that.
On the positive side, they still seem to have enough willing partners to arrange financing that does not involve stealing the assets. There may be some tighter limits, but I believe they will still leave CBL room to operate as long as there is enough stability in the business. And I see a lot of room for positive improvement in the retail business in general and in CBL in particular.
Many of the key metrics are not that different from the last 10 - 20 years which were not a total disaster. What we're seeing right now is a concentrated wave of bad news that definitely could trim down some of the weaker retail spaces.
But it also means that their customers will flow to the remaining ones, few new spaces will be built to compete with them, and there will be new opportunities to bring in stores and update malls in a way that performs a lot better. The difference between public perception and reality in the retail business is one of the largest that I've ever seen (I'm not the most experienced investor of course so it could always get larger).
I believe the most likely result is somewhere between a survivable event and a "once in a lifetime opportunity" as the CEO put it on CBL's last conference call. Even without much improvement, CBL could earn its way to a higher stock price. At best it could be one of the most profitable opportunities today.
On the downside, there could be a permanent reduction in the stock price or even a full bankruptcy. If I see enough negatives develop, I will sell off my position even at a lower price. I believe the risk is small enough that it's worth taking. And even in the worst case, my gains from Aimia will offset the loss so my overall portfolio is healthy.
The reward for this risk is that retail could see a new life that no one is expecting right now, similar to how residential housing developed after 2009 (to the point where there is still pressure from limited supply and growing demand 10 years later). I may write a series of articles about all the positives happening in retail right now. This is exactly the kind of risk I want to take.
And CBL is positioned better to take advantage of this than the old stores themselves. I'm also holding WPG (WPG) and Seritage (SRG) which share in some of the same effects. CBL looks like the best potential reward because of the low multiple and high cashflow relative to the market cap.
HCG (OTCPK:HMCBF): -6.4%
Home Capital has drifted down continuously since the start of this year, despite the business getting stronger. This may be due to the popular idea of "shorting Canadian sub-prime lenders in a housing bubble".
I have had some increased concerns about the business since the growth in originations has slowed down more than I expected and they seem to be branching off into new lines of business where they may not do as well as they have in the past.
Even so, it could double from today's prices just to match the book value plus a very low ROE. To buy Home Capital at these prices, you have to believe that management will not destroy the business completely and that the housing market will not implode completely.
I did buy a bit more at recent lows because I see too much economic strength supporting the market and too much level-headed management to believe in the worst case. I expected that a few more earnings releases, and clarification on returning capital to shareholders, will support the price at some point. I don't expect it to do much more than double so this may be the last I buy.
When a Berkshire-Hathaway (BRK.A)(NYSE:BRK.B) credit facility was announced for Seritage, the stock price jumped rapidly and took my small position with it. I knew that buying right after good news wasn't necessarily a good idea so I planned to wait a bit and see if the price got lower. I was soon rewarded as the news of the Sears bankruptcy dropped the price and I increased the position.
Amazon (AMZN): +65.8%
Despite recent drops, the stock price is still well above where I bought last. I would consider gradually adding more at this level.
Shopify (SHOP): +35.1%
I've added a bit to this as share prices dropped. I haven't kept up with the latest updates but still see good growth potential. One short-term threat to this might be increasing employment drawing down the number of people who want to start their own business. But this would largely affect the low-quality businesses that are not a large part of Shopify's revenues. I would consider adding more at current prices.
Washington Prime (WPG): -0.4%
This follows a similar principle as CBL. The business is in a better position but it has a lower cashflow than CBL so I've kept this to a smaller position.
Netflix (NFLX): +2.1%
Recent investor disappointments have dropped the price a bit so I bought some more. After some more research, I've increased my estimate of the long-term potential.
Golar LNG (GLNG): -1.2%
I was alerted to this thanks to J Mintzmeyer's reports. I haven't done extensive research but rapidly rising prices in a growing market that won't see additional supply (competition) for a few years matches my investment requirements pretty well! It's still a fairly small position due to my lack of knowledge of the industry. The potential here seems to justify making it a significant position despite the unknowns.
Berkshire Hathaway: +11.4%
While the price has risen since I first bought shares, I want to add more to this since the multiple has stayed at a reasonable level and there have been some relatively large buybacks this year. I don't want to keep buying on margin and I don't have anything I want to sell in my tax-sheltered accounts to buy this so I'm holding off for now.
I have smaller positions in a bunch of other stocks with good prospects, but their size makes them mostly irrelevant to my portfolio. They are a combined 27% of my stock picks which are a little over 25% of my portfolio.
I hold them mostly so I can keep track of the stocks and see if they drop enough to get more interesting. There are also a couple that are purely speculative and I have no real idea about how well they will do but they are interesting anyways.
One that I would like to buy more of is Fiat-Chrysler (NYSE:FCAU). It's been a favorite among value investors for years and the gains so far may have delivered a large part of the potential profits.
On the other hand, it has dropped recently and the net cash could soon approach half of the market cap which would leave the remainder of the share price at a very low P/E multiple. The improvements in the business have gone on for over a decade so it's likely that many of the top executives are well-prepared to think like Sergio Marchionne and continue what he started. There seem to be some good opportunities that just require basic execution and discipline.
When I looked at my portfolio 3 months ago, it was hard to see where I could add to positions. Everything seemed to be going up and my largest positions had good gains. I still did a couple of small buys.
Now the situation is different since good opportunities have come up with many of the stocks. I'm not planning to add a lot more to the portfolio right now and I don't see anything that I really want to sell.
It's possible that prices will fall a lot more. That's not the most likely outcome but it certainly could happen. I don't typically want to bet on that - I would rather focus on the larger probability that they will rise - but I also don't want to get too aggressive when the prices are just "good".
Concentrating The Bets
I may sell off a few existing small positions if they are no longer interesting. However, they don't amount to much.
The biggest potential change is Aimia. If the deal closes soon and shareholders place a high enough value on the shell company that will be left behind, I could sell most of my shares. As the potential future gains fall below 100%, I will be ready to move the cash into something else. Even with very low risk, a profit under 50% isn't enough.
Either way, I will mostly distribute the cash between my current positions based on their future prospects and current prices. At some point, I'll have to make more hard choices and pick which of my favourite stocks I want to buy more of and which ones I want to cut back.
Buying more different stocks will not improve my returns since it means the gains will be spread out between smaller amounts. Instead, I need to identify which ones have the highest potential and the lowest risk and focus on those so I can increase the total return.
My stocks are divided among multiple countries, industries, and styles. That should provide some protection in case I'm completely wrong, since some will likely do well just by luck (in fact a few have doubled far sooner than I expected).
More importantly, they work well together. Some of them have great long-term potential for growth that can exceed my benchmark of 15% per year. Those are the ones I never want to sell.
Others are value stocks that could deliver rapid short-term gains (as Aimia showed) which means that re-investing those profits in the long-term stocks will earn me more than just putting everything into a few consistent ones upfront. It's still hard to say no when I see potential though!
Regardless of how much cash I put into my portfolio, I need to divide it between the stocks in some way. My choices will determine the returns. I can improve that without adding more cash. That will be my main focus for now. The decisions are hard since I have good reasons for holding all of these stocks.
I wouldn't have expected this 2 years ago when I was still avoiding picking stocks because I didn't think I could figure out which ones were good enough to beat an index fund!
Disclosure: I am/we are long ALL OF THE 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.
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