The R.I.P. Portfolio's Q4 2018 Update

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Includes: AAPL, ACN, AMGN, APPN, APRN, AVD, BABA, BAC, BHF, BHGE, BRK.B, C, CAH, CLDR, CRL, CSCO, DGRO, DGRW, DIS, DWDP, FB, FKINX, FSI, GE, GM, GPRE, GTX, HON, INTC, JNJ, KEY, KR, KTOS, MET, MRK, MTZ, NIO, PFE, PFG, PG, PRU, REZI, RHE, SBUX, SFTBY, SPY, SYF, T, TDOC, TGT, TSLA, TWTR, UA, UTX, VZ, WNC, XIN, Z
by: WG Investment Research
Summary

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

The portfolio significantly underperformed its benchmark 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 a major drag to the portfolio's full-year 2018 performance but, looking out, the large financial institutions 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.

See the article linked above for additional detail on what I would like to accomplish with these quarterly updates. Additionally, the portfolio goals and my long-term strategy are identified in the section below.

2018 turned out to be the worst year over the last 10 years for the market, and pundits are now concerned about a possible economic slowdown in the months/quarters ahead. As such, the sectors that are typically most impact by slowdowns - i.e., financials and industrials (or any cyclical company for that matter) - have significantly underperformed the broader market. The R.I.P. portfolio was negatively impacted by these concerns as I was heavily invested in both sectors throughout 2018.

Since mid-2018, I have be in risk-off mode and repositioning the portfolio for the next few years. In this quarterly update article, I will highlight the recent changes to the R.I.P. portfolio and how the portfolio performed over the last 3 and 12 months.

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 consists 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%
Funds 10% 5-15%
Consumer 10% 5-15%
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.

Q4 2018 Update

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

Company Ticker # of shares Price At 12/31/2018 Beg. Value 10/1/2018 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) 392.355 $7.57 $4,547 $(485) $(1,092) $(735) $2,970 $(4,236) 2% 0.2% 0.5% $16
Baker Hughes (BHGE) 25.00 21.50 846 - (308) - 538 (390) 0% 1.9% 3.3% 18
Honeywell (HON) 47.76 132.12 6,903 773 (1,365) - 6,310 805 5% 2.8% 2.5% 157
Berkshire Hathaway (BRK.B) 18.00 204.18 3,854 - (179) - 3,675 96 3% 0.0% 0.0% -
United Technologies (UTX) 25.47 106.48 3,540 - (827) - 2,712 (426) 2% 2.4% 2.8% 75
AT&T (T) 316.10 28.54 10,123 306 (1,408) - 9,022 (227) 7% 7.0% 7.1% 645
Verizon (VZ) 51.79 56.22 2,741 - 170 - 2,911 645 2% 5.5% 4.3% 125
Franklin Income (FKINX) 2620.50 2.14 6,000 - (392) - 5,608 774 4% 6.5% 5.6% 314
WisdomTree US Divi Growth ETF (DGRW) 67.11 38.33 - 2,705 (132) - 2,572 (132) 2% 1.8% 1.8% 47
Ishares Core Divi Growth ETF (DGRO) 28.17 33.18 - 974 (40) - 935 (40) 1% 2.3% 2.3% 21
Walt Disney (DIS) 33.64 109.65 3,232 653 (196) - 3,689 1,105 3% 2.3% 1.6% 59
Bank of America (BAC) 420.58 24.64 12,311 - (1,948) - 10,363 3,851 8% 3.9% 2.4% 252
Citigroup (C) 50.31 52.06 3,584 - (965) - 2,619 195 2% 3.7% 3.5% 91
KeyCorp (KEY) 80.63 14.78 1,587 - (395) - 1,192 316 1% 6.3% 4.6% 55
DowDupont (DWDP) 127.01 53.48 6,698 1,211 (1,116) - 6,793 (390) 5% 2.7% 2.8% 193
Synchrony Financial (SYF) 111.67 23.46 3,135 263 (778) - 2,620 32 2% 3.6% 3.6% 94
Target (TGT) 9.47 66.09 829 - (203) - 626 101 1% 4.6% 3.9% 24
Kroger (KR) 119.78 27.50 3,329 141 (176) - 3,294 (62) 3% 1.8% 1.8% 60
Starbucks (SBUX) 14.52 64.40 821 - 114 - 935 225 1% 2.5% 0.8% 7
Johnson & Johnson (JNJ) 40.61 129.05 5,577 - (336) - 5,241 977 4% 3.4% 2.8% 146
Amgen Inc. (AMGN) 8.40 194.67 1,729 - (94) - 1,635 209 1% 3.4% 3.0% 49
Pfizer (PFE) 151.77 43.65 6,642 - (18) - 6,625 2,225 5% 5.0% 3.3% 219
Merck (MRK) 19.97 76.41 1,408 - 119 - 1,526 468 1% 4.2% 2.9% 44
Charles River Labs (CRL) 11.00 113.18 1,480 - (235) - 1,245 111 1% 0.0% 0.0% -
Cardinal Health (CAH) 6.28 44.60 336 - (56) - 280 (159) 0% 2.7% 4.3% 12
AIG warrants AIGWS 27.00 5.44 1,140 (420) (573) (295) 147 (345) 0% 0.0% 0.0% -
Metlife (MET) 55.38 41.06 2,537 - (263) - 2,274 483 2% 5.2% 4.1% 93
Prudential Financial (PRU) 11.74 81.55 1,177 - (219) - 958 (138) 1% 3.9% 4.4% 42
Brighthouse Financial (BHF) 4.00 30.48 177 - (55) - 122 (68) 0% 0.0% 0.0% -
Principal Financial Group (PFG) 1.00 44.17 59 - (15) - 44 (10) 0% 4.0% 4.9% 2
Apple (AAPL) 21.76 157.74 4,894 - (1,461) - 3,433 963 3% 2.6% 1.9% 64
Twitter (TWTR) 111.00 28.74 3,159 (63) 94 72 3,190 1,258 3% 0.0% 0.0% -
Facebook (FB) 7.00 131.09 1,151 - (234) - 918 (250) 1% 0.0% 0.0% -
CISCO (CSCO) 153.24 43.33 7,406 - (766) - 6,640 2,754 5% 5.2% 3.0% 202
Intel (INTC) 78.41 46.93 3,545 133 1 - 3,680 809 3% 3.3% 2.6% 94
Softbank (SFTBY) 12.00 32.60 597 - (206) - 391 (113) 0% 0.0% 0.0% -
Cloudera (CLDR) 2.00 11.06 35 - (13) - 22 (13) 0% 0.0% 0.0% -
Accenture plc (ACN) 5.19 141.01 875 - (144) - 731 155 1% 2.6% 2.1% 15
General Motors (GM) 114.80 33.45 3,835 - 5 - 3,840 155 3% 4.7% 4.5% 174
Procter & Gamble (PG) 8.55 91.92 706 - 80 - 786 144 1% 3.8% 3.1% 25
Alibaba (BABA) 1.00 137.07 165 - (28) - 137 13 0% 0.0% 0.0% -
Wabash National Corp (WNC) 63.00 13.08 930 107 (213) (183) 824 (58) 1% 2.3% 2.4% 20
Under Armour (UA) 104.00 16.17 2,024 - (342) - 1,682 73 1% 0.0% 0.0% -
Other* -- -- -- 8,168 1,793 (1,049) (142) 8,912 (312) 7% 1.5% 1.4% 129
CASH -- -- -- 65 (53) -- -- 12 -- 0% -- -- --
$133,898 $8,038 $(17,259) $(1,283) $124,676 $11,571 100% 3.2% 2.9% $3,583
Industry/Portfolio Companies Value Portfolio Weighting Goal Weighting Over (Under)
Industrials/Conglomerates - GE, HON, BHI, WNC, BRK.B, SFTBY, UTX $17,420.92 14% 15% -1%
Healthcare - JNJ, PFE, AMGN, CAH, MRK, CRL 16,551.75 13% 10% 3%
Financials - BAC, C, KEY 14,173.69 11% 10% 1%
Insurance - AIG*, MET, BHF, PRU, PFG 3,544.47 3% 5% -2%
Technology - AAPL, CSCO, INTC, ACN, CLDR 14,505.73 12% 15% -3%
Communication Services - T, VZ, DIS, TWTR, FB 19,729.21 16% 15% 1%
Basic Materials - DWDP 6,792.55 5% 5% 0%
Funds - FKINX, DGRW, DGRO 9,114.86 7% 10% -3%
Consumer - KR, GM, TGT, UA, BABA, PG, SBUX, SYF** 13,919.14 11% 10% 1%
Other - (XIN), (RHE), (FSI), (MTZ), (AVD), (GPRE), (TDOC), (KTOS), (TSLA), GE call option, (APPN), (Z), (NIO), (GTX), (REZI), (APRN) 8,911.66 7% 5% 2%
Cash 12.20 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 the past few quarters 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 trailing 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 approximately 60% of the total assets (down from 66.18% at Q3 2018).

Portfolio Performance for Q4 2018 and since the portfolio was first introduced to SA community (December 4, 2015)

Return (Q4'18) Return (YTD) Return (Intro) Return On Invested Capital (Review)
-12.5% -9.9% 10.2% 19.5%
This period YTD Since Intro Since Intro
Beg. Balance $133,898 $110,901 $52,610 Initial Value $46,042
Contributions 8,038 25,997 63,461 Contributions 63,461
Unrealized G/L (17,259) (12,222) 8,604 Realized G/L 3,603
Ending Balance $124,676 $124,676 $124,676 Unrealized G/L 11,571
Portfolio Bal. $124,676
Dividend Inc. $920 $3,615 $7,937
Realized G/L (1,283) 494 3,603 Dividend Income $7,937

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: $1,283 loss in the brokerage accounts - i.e., done for tax purposes.

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

Note: Full-year 2019 is a projection based on: (1) expected contributions to portfolio and (2) estimated growth in dividends.

The portfolio's dividend income was $920 for Q4 2018, which is slightly lower than the previous quarter ($988 in Q3 2018), but significantly higher YoY ($726 in Q4 2017). Furthermore, the portfolio's projected dividend income for 2019 is approximately 35% higher than the total income received in 2018. 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.

Now, for the most important metric, the R.I.P. portfolio has underperformed its benchmark by over 9 percentage points since the portfolio was introduced to the SA community on December 4, 2015. The 2018 performance of the portfolio was what I would consider a major disappointment, as the portfolio went from outperforming its benchmark in 2017 to now materially underperforming it as of December 31, 2018.

As shown, 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 that contributed to 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 well-over 60% 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: Yardeni Research, Inc.

(3) General Electric: Yes, it's that simple. I 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 - the industrial conglomerate made up over 10% of the portfolio in 2017 - 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] Twitter, [2] Tesla, and [3] Verizon; Under-performers - [1] Bank of America, [2] Apple, and [3] AT&T.

The top performer, Twitter, is constantly in the news and most pundits are concerned about the company's ability to grow its user base. The concerns have resulted in Twitter's stock falling out of favor in the second half of 2018 (TWTR shares still significantly outperformed the broader market).

Chart TWTR data by YCharts

I believe that Twitter is a unique platform that is the new-aged news outlet for many people, especially in the financial world. Moreover, the platform gives people the opportunity to connect with others that would not have been possible a few years ago. 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.

For Bank of America, the top under performer for the portfolio, I want to start out by saying that I am still very bullish about this bank's long-term business prospects. I have an overweight BAC position so this is the main reason why the stock was the worst performer for Q4 2018.

I recently highlighted the 3 main reasons to stay long Bank of America in this article: (1) Rising Rates, (2) Valuation, and (3) Capital Return Story. These 3 factors still hold true today. Moreover, I believe that Bank of America has the best risk/reward setup out of any other stocks held in the portfolio.

Noteworthy Quarterly News:

General News:

  1. General Electric's board removed Mr. John Flannery as CEO and replaced him with Mr. Larry Culp (the former CEO of Danaher Corp). The company also announced that it would take an approximately $23B write-down to goodwill in its power division.

Buybacks And/Or Dividend News:

  1. United Tech. increased its quarterly dividend by 5% (from $0.70 to $0.735), which brings the forward dividend yield 2.78% based on today's price.
  2. Merck increased its quarterly dividend by 14.6% (from $0.48 to $0.55), which brings the forward dividend yield 2.92% based on today's price.
  3. Principal Financial increased its quarterly dividend by 1.9%% (from $0.53 to $0.54), which brings the forward dividend yield 4.91% based on today's price.
  4. General Electric cut its quarterly dividend by over 90% (from $0.12 to $0.01), which brings the forward dividend yield to 0.55% based on today's price.
  5. Disney increased its semi-annual dividend by 4.8% (from $0.84 to $0.88), which brings the forward dividend yield to 1.65% based on today's price.
  6. Amgen increased its quarterly dividend by 9.8% (from $1.32 to $1.45), which brings the forward dividend yield to 3.05% based on today's price.
  7. Pfizer increased its quarterly dividend by 5.9% (from $0.34 to $0.36), which brings the forward dividend yield to 3.36% based on today's price. Additionally, the board added $10B to the company's buyback plan.
  8. AT&T increased its quarterly dividend by 2.00% (from $0.50 to $0.51), which brings the forward dividend yield to 7.25% based on today's price.
  9. Wabash National increased its quarterly dividend by 6.7% (from $0.075 to $0.08), which brings the forward dividend yield to 2.49% based on today's price.

Merger, Acquisitions and Disposals:

  1. Honeywell completed the Garrett Motion and Resideo spin offs during the most recent quarter.
  2. After the Rockwell Collins deal was approved, United Technologies announced that it would split into three separately traded public companies. A breakup date was not announced but, as described here, investors should be excited about owning a leaner, more-focused company (or stubs).
  3. As previously described, General Electric plans to complete GE Healthcare and Transportation spinoffs in 2019.

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:

  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.

See the Q3 2018 update article for detailed explanations for my thoughts on each of the major trends.

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:

  1. Digitalization - Cisco, Intel, Apple, Accenture, General Electric, Honeywell, GM, AT&T, and Verizon
  2. Rising Rates - Bank of America, Citigroup, KeyBank, AIG, Principal Financial, Prudential and MetLife
  3. Media Shift - Disney, Twitter, AT&T, Facebook, and Verizon.

Lastly, based on historical data, the next 12 months could turn out to be a good year if the future follows the pattern that has typically occurred after 10%+ down months for the S&P 500.

Source: Bespoke

I am not overly optimistic about what the next 12 months may bring - i.e., the probability of a recession in the U.S. has increased over the last few months, as described here - but, in my mind, things could change in short order.

Final Thoughts

I am looking forward to 2019 and what the next few quarters may bring. I have been in risk-off mode for most of the second half of 2018 and I believe that it will pay huge dividends over the next 12-18 months. While the broader market may not rise as much as some experts are calling for (for example, Wharton's Jeremy Siegel recently predicted that the S&P 500 will return 5%-15% in 2019), I do believe that equities will post solid returns over the next four quarters.

The portfolio's value-tilt, including the heavy investments in the financial sector, were out of favor in 2018 but I believe that it will be a different story in the new year. Based on my internal valuation work, I believe that the following two positions will have the greatest impact to the portfolio's out-performance in 2019: [1] DowDuPont - as I recently described, the spinoffs (i.e., the company will split into three separately traded entities over the next year) will create a significant amount of shareholder value, and [2] AT&T - the debt and cash flow concerns are more-than-priced into the stock and, in my opinion, T shares are attractively valued at today's price.

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, DGRO, DGRW, BRK.B, UTX, DIS, DWDP, SFY, TGT, KR, SBUX, PFE, MRK, CAH, MET, AIG, BHF, PFG, PRU, TWTR, FB, CLDR, ACN, GM, PG, 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.