Total USD Portfolio Review - January 2019

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Includes: AAPL, AMGN, BRK.A, BRK.B, CACC, CHKP, CLX, CNI, DEO, EGOV, FB, FII, GOOG, HESAY, HRGLY, ISRG, JNJ, MCD, MO, MSFT, NKE, NTNTY, NVO, NVZMY, PAYX, PM, ROL, ROST, SEIC, SPY, TCEHY, TSM, WAT, WMMVY
by: Steven Chen
Summary

As a new year initiative, I would like to issue this monthly review for my USD portfolios in aggregate.

In January, the total portfolio gained 7.5% vs. S&P 500 7.9%.

Valuations are still rich, and investors should get more cautious.

Background

People love to have new things to start the new year. As the new initiative in 2019, I start to write reviews of my portfolios on a monthly basis. This can be regarded as the "upgrade" to my previous quarterly reviews, such as:

2018 Q4 Non-Taxable Portfolio Update

My Quarterly Global Portfolio Update

My Quarterly Non-Taxable Portfolio Update

As you can see below very soon, I would like to issue updates on a more frequent basis in order to review my portfolios at a more detailed level. The purpose of doing this has always been to learn more lessons and refine my strategy over time.

Another difference from before is that I would like to issue updates for all the portfolios that I managed (instead of some of them one by one) in aggregate if possible, now that they just have the same goal: beat the market consistently in the long term. Because of the issues relating to calculation complexity and data availability, the monthly updates start with my USD portfolios (i.e., those that are denominated in USD and contain tradeable securities on US Exchanges only, including ADRs of foreign companies and OTC stocks). I call them my total USD portfolio.

Please note these are "real-money" portfolios, whose performances count in real-life costs, such as fees, commission, and even some taxes.

Taxation

Here, you may have already realized one issue in terms of such benchmarking. That is, I am comparing my after-tax performance to gross returns (assuming no taxes) of equity indices.

To be clear about the taxation impact, we are only looking at the dividend withholding taxes here - e.g., 10-30% for dividend payments from companies in most countries, including the US (as I am not a US resident or citizen). Additionally, roughly 25% of my portfolios are exempted from withholding taxes. If we assume the total portfolio has a yield of 2% and the average withholding tax rate of 18%, then the impact would be an annual loss of 27 basis points (i.e., -0.27%). This number seems negligible to me while the compounding effect would certainly work less favorably to my performances for the long run (this was one of the reasons why I used to favor comparing the performance of my non-taxable portfolio only to indices).

Benchmark

My total (NYSEARCA:USD) portfolio is managed with the aim to outperform by beating the following four indices:

  • S&P 500: this is the prevailing benchmark although most fund managers find a hard time to beat it;
  • Wilshire 5000: this is to supplement the S&P 500 with the addition of small-caps and mid-caps;
  • MSCI World Equity Index: this is to supplement the S&P 500 with the addition of international exposures;
  • Warren Buffett Index: this is simply the Berkshire Hathaway Class A Share (BRK.A), which replicates the performance of the greatest active capital allocator.

Strategy

In order to achieve superior returns, my portfolio construction reflects the combination of the following strategies:

  • Focus on wonderful businesses that have been and will be earning high cash returns on capital;
  • Patiently look for favorable pricing to accumulate shares over time;
  • Patiently hold shares for the long run unless fundamentals deteriorate.

Most of the stocks in my portfolio are selected with the help of my factor-based quality ranking model. For those who are interested but have not done so, feel free to check out:

Updated Lists Of Stocks Topping Our Ranking Model

Performance Review: Stocks That Topped My Factor-Based Quality Ranking Model

13 Stocks That Top My Factor-Based Value Investing Ranking Model

January Overview

January was a great month for equity investors almost around the world: following one of the worst Decembers in history, the market bounced back.

According to SigFig, my total portfolio gained 7.5% during the month, compared to the 7.9% gain of S&P, 8.5% of Wilshire 50My total portfolio gained 7.5% during the month, compared to the 7.9% gain of S&P 500, 8.5% of Wilshire 5000, 7.8% of MSCI World Equity (see below), as well as 3.2% of Berkshire Hathaway A Share.

Source: SigFig

At the time of writing, I have not received a reply from SigFig regarding whether their published index returns include dividends reinvested or not. But some of them appear to be the price returns (instead of total returns) due to slight differences compared to other sources. Hence, I am listing the January performances of total return indices from Yahoo Finance, Wilshire, and MSCI below:

  • S&P 500 TR (Yahoo ticker: ^SP500TR): 8%;
  • Wilshire 5000 TR (Wilshire Index Calculator): 8.65%;
  • MSCI World Equity TR (msci.com): 7.8%.

Clarifications will be made in this regard once I hear more from SigFig in terms of their data.

I am okay with the investment result of January, as my investment approach would usually outperform the market during downturns while underperforming a bit during upturns.

If we take the previous quarter (2018 Q4) into consideration for a picture of the full market swing recently, my portfolio outperformed these three market indices (see below) but underperformed Berkshire Hathaway (down 3.24% during the period).

Source: SigFig

Again, here are the TR performance data from other sources (my portfolio, even after withholding taxes, still beat the benchmarks during the 4-month period):

  • S&P 500 TR (Yahoo ticker: ^SP500TR): -6.93%;
  • Wilshire 5000 TR (Wilshire Index Calculator): -7%;
  • MSCI World Equity TR (msci.com): -6.5%.

Another explanatory number regarding the performance of my strategy is short-term volatility (almost 20% less, as you can see below). While I do not treat Beta as the risk my investments are taking, some studies do show that low-beta equities outperform in the long term.

Source: SigFig

Top 10 Holdings

Source: Personal Capital

The top holdings of my portfolio reflect the strategy of owning wonderful businesses with the durable competitive advantages of earning superior free cash flow on capitals employed. For example, Novo Nordisk (NVO) enjoys patent protections for its already established leadership in diabetes care; the businesses at Hermes International (OTCPK:HESAY) and Clorox (CLX) benefit from their branding powers every day selling products to their customers (although in different segments, respectively).

Most of the names are market leaders in their domains (or niche domains). For example, NIC (EGOV) is leading the digitization of government services in the States; Paychex (PAYX) is the leading provider of integrated human capital management solutions for small- and mid-sized businesses; Credit Acceptance (NASDAQ:CACC) is the key player in subprime auto loan sector in the US.

Moreover, a lot of the above businesses show defensive characteristics during recessions, like the tobacco giant, Altria (MO), and the discount retailer, Ross Stores (ROST).

I look to add more shares to the positions above when the price is right.

Position Changes

In January, I sold all positions in Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) and Taiwan Semiconductor Manufacturing Company (TSM). Although having been admiring the wide moat of Google, I started to get uncomfortable with increasing CapEx and decreasing margins in this highly competitive tech sector. In terms of TSM, while I do like their market leadership and differentiated market positioning, the capital-intensive business model, along with the cyclicality of the industry, persuaded me to reallocate this capital onto something else more attractive.

In the meantime, I added more shares to my existing positions of NIC, Credit Acceptance, and Berkshire Hathaway (BRK.B). I believe that all of these three would suffer less if facing an economic downturn and their valuations seemed just reasonable (if not attractive) to me.

Asset Allocation

Source: Personal Capital.

As demonstrated above, my portfolio is full of equity holdings, with the biggest exposure to the US. This does not say that I would not raise the cash level or adding fixed income instruments in the future. At this moment, if new capitals come in, I still would deploy them to buying stocks first (especially overseas). However, it does seem to have been harder and harder to find sensible price tags on the businesses that attract me since last year.

Sector

Compared to the S&P 500, I am most overweight in Consumer Defensive and most underweight in Technology (see below). The tech sector is a dynamic, fast-moving and sometime self-disruptive one, where I usually have a lot of cautions. If I cannot understand a certain business well or see the future of it in 10 years, I would pass. Most of the technology names could not pass this test.

Source: Personal Capital

You could notice that I do not own any stocks in Basic Materials, Communication Services, Energy or Utilities. Stats show that there has hardly been any company in those fields that are able to earn superior returns on capitals consistently over time. It is also worth mentioning that I do not invest in any bank for the same reason.

Market Cap

From below, you can see that I am most overweight in large caps and most underweight in small caps. Leveraging (small) size advantages, I plan to give small- and mid-cap stocks the priority of considerations with respect to deploying future capitals. Studies show that small companies outperform in aggregate.

Source: Personal Capital

Geographic Area

Here is the detailed breakdown of my geographic exposures:

  • US: 65.63% (the largest holding is Berkshire Hathaway);
  • Europe: 23.08% (the largest holding is Novo Nordisk);
  • East Asia: 4.47% (the largest holding is Tencent (OTCPK:TCEHY));
  • Canada: 2.47% (the only holding is Canadian National Railway (CNI));
  • Middle East: 2.34% (the only holding is Check Point Software Technology (CHKP));
  • South America: 2.01% (the only holding is Wal-Mart De Mexico (OTCQX:WMMVY)).

In total, Emerging Market stocks take around 8.8% of my portfolios, which is a small percentage compared to many others' portfolios. Although the Emerging Market offers higher growth potentials, my concerns like many other investors' have always been political instability, immature business environment, and less shareholder-oriented corporate government and management team.

Earnings

Late January kicked off the earnings season in many regions across the globe. Below are the quarterly (or half-year) growth records for some of my invested businesses:

Revenue Growth (YoY) EPS Growth (YoY)
Amgen (AMGN) 8.9% 18.3% (adjusted)
Apple (AAPL) -4.5% 7.5%
Credit Acceptance (CACC) 19.3% 52% (adjusted)
Check Point Software (CHKP) 3.9% 4% or 6% adjusted
Canadian National Railway (CNI) 15.8% 24% (adjusted)
Diageo (DEO) 5.8% (half-year) -1.6% or 13.6% adjusted (half-year)
Facebook (FB) 30.4% 65% or 7.7% adjusted
NIC (EGOV) -5.8% -6.3%
Federated Investors (FII) 10.4% 0% adjusted
Hargreaves Lansdown (OTCPK:HRGLY) 9% (half-year) 4% (half-year)
Intuitive Surgical (ISRG) 17.7% 13.8% adjusted
J&J (JNJ) 0.9% 13.2% adjusted
McDonald's (MCD) -3.4% 15% adjusted
Altria (MO) 1.7% 4.4% adjusted
Microsoft (MSFT) 12.4% 15% adjusted
Novozymes (OTCPK:NVZMY) 1.1% 7.4%
Rollins (ROL) 7.2% 60%
SEI Investments (SEIC) -0.8% -3%
Waters (WAT) 4% 14% adjusted

Normally, I do not pay much attention to guidance (including revisions), Wall Street estimates and earnings surprises against those estimates, as these factors are of more significance to short-term "traders" rather than long-term investors in my view. But I do want to keep track of the growth records over time to gauge the health and prospects of the businesses.

The majority of my stocks that reported in January have demonstrated decent top-line and bottom-line growth momentums. A lot of them, as you can see, cited adjusted EPS (i.e., non-GAAP EPS) instead of GAAP EPS for YoY comparisons, mainly due to impacts from the tax reform legislation in the US.

Dividend

Dividends play an important role in delivering total investment returns. Approximately 70% of my holdings pay regular dividends. Below is the list of dividend payments from my total portfolio in January:

Dividends Paid (per share) Dividend Increase
Philip Morris (PM) $1.14 No increase
Altria (MO) $0.8 No increase
SEI Investments (SEIC) $0.165 (bi-annually) 10% increase
Canadian National Railway (CNI) $0.33 No increase, but 18% increase (in CAD) expected for the next payment
Nike (NKE) $0.22 10% increase

In my view, a low-double-digit growth rate of annual dividends should be not only satisfactory to investors but also sustainable for wonderful businesses.

Winners

As an equity investor with a long-term time horizon, I do not look for short-term price movements. However, in order to get a sense of appropriate entry points, I should analyze and try the best to understand the reasons for stocks dramatically going up and down.

  • NIC: the stock went up 32% in the one month of January, as the decreases in revenue and net profit disclosed at the leading digital government service provider were not as bad as previously thought;
  • Waters: the stock went up almost 26% in January, as the quarterly earnings beat Wall Street Estimate by a wide margin;
  • Facebook: Facebook also beat analyst estimates in terms of its quarterly earnings issued in January, sending relief to investors' concerns over sustainable growth capabilities at the social media giant; the stock went up 22% in January;
  • NetEnt (OTCPK:NTNTY): the ADR of the Swedish gaming software maker went up more than 26% in January; the valuation of the stock has been low at the year-end of 2018, which could cause a price stretch, especially in anticipation of the upcoming February earnings and given the strong fundamentals of the business.

Losers

  • Clorox: the stock went down 0.8% in January after its relatively strong performance in the fourth quarter of last year;
  • Amgen: the share went down 2.5% in January, as the company posted the earnings beat but with lower guidance;
  • Federated Investors: the stock went down almost 1% during the month after a nice price movement late last year; the company also reported the quarterly earnings with a small beat;
  • Novozymes: the world's biggest industrial enzymes producer posted earnings at the low end of expectations in January and warned of uncertainties in the global economic outlook, sending its shares to a near two-month low; the share went down 2.35% during the month.

Valuations Still Rich

At the time of writing, the Warren Buffett Indicator (i.e., Total-Market-Cap-to-GDP ratio) stood near 1.4x, signaling a significantly overvalued equity market (at least in the US). You might recall that I issued this overvaluation warning last year citing this Indicator (see The Warren Buffett Indicator Is Now Telling You Not To Bet On America) before a series of market turmoils.

Source: GuruFocus; data as of 2/15/2019.

I believe that relatively overseas markets may offer more opportunities than the US market. However, as the valuations keep going north, those opportunities could diminish soon. Before that happens, investors should be extremely picky in terms of stock fundamentals, as it is very likely that they pay some premium on the top of historical pricing. I would prefer businesses hopefully with characteristics of recession-proof-ness, market leadership, clean balance sheet, strong cash flow, and little capital spending required to maintain operations. In case such buying opportunities do not emerge and the stock market keeps going up, I would not hesitate to consider putting new money (from new capital inflow and dividend payments) into other asset classes or simply cash.

Summary

This is the first monthly review of my total USD portfolio. The performance of January is satisfactory, although not beating benchmarks, as I expect my approach to outperform the market during downturns and underperform a bit during upturns. I am just a little more confident about the healthy state and growth prospects of my holdings, given the recent earnings reports and dividend increases. The biggest concern here is still the high valuations compared to historical levels.

I hope you enjoy reading my January portfolio review. Should you have any suggestion, feel free to comment below. Thanks!

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