March was a good trading month for our overall portfolio and year-to-date we're up. Our buy and hold portfolio performed really well and has returned so far. We did get very nice option premiums worth €21,046 with more to appear in April, which is a good thing to pile up the cash reserves I want to opportunistically invest during steep market corrections. Since the market rally seemed to be far from running out of fuel in March, I don't see that much undervalued companies I'd like to allocate these premiums in. Don't get me wrong, it's great seeing your portfolio going up significantly, but you will always make the most money by purchasing solid companies that are trading at desperate multiples as the odds of a rerating (multiple expansion) are then much more elevated. Fortunately, I do see some opportunities for my buy and hold portfolio, but they are less pronounced than a few months ago.
As such, I keep re-investing my cash flows received from selling options in other covered call trade setups to leverage the compound effect. Throughout this article, I'll share my views on the overall market and how I'm going to position my covered-call trades. As for buy and hold investors, I'll shed light on both my real-life portfolio and fictive American version that consists of 15 SWANs trading at attractive multiples.
My Covered-Call Writing Portfolio
Market Sentiment: Is The Rally Drawing To An End?
With the S&P-500 (SPY) being locked in stalemate, but still in bullish chart territory, investors surely question which path the markets will follow over the next month. First of all let's dive in the economic data. Housing starts tumbled 8.7 percent last month, indicating developers continue to struggle with rising costs.
Based on preliminary data, the IHS Markit US Manufacturing PMI fell to 52.5 in March of 2019 from 53 in February, which is another bad omen for softening rises in output, employment and orders.
Probably the most talked-about topic was the inverting yield curve, indicating a recession may occur within the next months. To me, it seems to be a storm in a teacup and I'm in good company as James A. Kostohryz recently published a thorough write-up on the inversion of the 10Y-3M yield curve. He concluded:
In this article, I have shown that, even if you take the 10Y-3M yield curve inversion "signal" at face value, as advocated by its proponents, this does not imply an immediate end to the ongoing cyclically-associated bull market. To the contrary, the history of 10Y-3M yield curve inversions strongly suggests that the ongoing cyclically-associated bull market still has a fairly significant amount of room to run and that there is still significant potential upside for the S&P 500 for the rest of 2019, and/or until the end of the current cyclically-associated bull market cycle. (Source: Yield Curve Inversion Suggests New All-Time Highs For Stocks)
The economic indicators are mixed, create uncertainty among investors and put the Fed in an uncomfortable position. It's now very unlikely that interest rates will be hiked in the near term and Jerome Powell stepped even back from reducing the obese balance sheet. So, nothing to be positive about as to what the economic outlook looks like. Maybe a breakthrough in trade talks could support the rally we've seen in the first quarter, however, lingering talks could easily obliterate most of those gains. In terms of earning growth, the outlook for the first quarter fell deeper into the red, which would mark the first year-over-year decline in nearly three years. With a P/E ratio of 21 for the S&P-500, we'll need several catalysts to justify today's expensive valuation and to push indices to even higher levels.
Looking forward, I remain cautious and don't believe today's rally is durable and will keep going on next month. Covered-call writers who took advantage of the latest run-up should consider shifting from OTM calls to ITM calls to get some downside risk protection of their time value profits. Even combining covered calls and buying puts resulting in a net cash inflow should bode well for defensive investors, though, when proceeding with this strategy, called the collar strategy, you will be forced to reduce your one-month targeted returns.
We did get very nice option premiums worth €21,046 with more to appear in April as we re-invest most of these cash flows in new covered-call trade setups.
(Source: Author's work)
(Source: BinckBank account)
When selling options, the actual account position will appear in brackets as a "negative" because it represents an obligation. This is a standard brokerage accounting method. Once the option is closed, exercised or expires worthless, the brackets will disappear and your account will reflect the profit (loss). Right now, all of the options contracts I sold are out-of-the-money, so the actual value of our brokerage account will be much higher on expiration Friday than indicated now. As mentioned previously, I'm leery about today's market rally and currently favor in-the-money calls.
The Reasoning Behind My Buy And Hold Investing Philosophy
The (Non)Sense Of Diversification
After writing a thought-provoking article about diversification in a buy and hold portfolio - and I want to make sure we're talking about this type of portfolio strategy - I'd like to stress the importance of setting up a tailor-made strategy that fits your own personal risk tolerance and time horizon. Personally, my goal is to play out the mechanism of under- and overvaluation by concentrating on a few value stocks (most investors will pick more stocks to smooth out the overall portfolio risk) which provide an attractive mix between dividends and acquisitions. In other words, companies that provide their shareholders with well-balanced capital allocation. Therefore, sustainable and growing free cash flow generation is critical to make this strategy work. As opposed to option selling, which I bet big on to generate that type of cash flow I require for safe future retirement, I don't care about short-term price fluctuations, temporary losses or irrational market behavior because in the long run, undervalued stocks tend to revert the mean.
Long-Term Focus On Free Cash Flow Generation
As a youngster, I have decades to go and there's one powerful weapon I should definitely take advantage of: time as to how I can leverage the effect of compounding. Simply stated, the more you can let your profits run, the better as time and return reinforce each other over the long run. Therefore, you need to select companies/assets that will bring forward durable returns and never touch the principal (barring unforeseen circumstances). Also, let your profits run rather than starting to cut the flowers to water the weeds! In the end, good things come to those who wait.
Now, how do we find the right stocks? I'm actually a big fan of conservatively managed small family businesses, as can be read in my article about my favorite strategies. That lays the basis I build upon in search for companies that may meet my system requirements. The number one metric that stands out from other commonly used parameters in measuring operational performance is free cash flow, the driving force behind ultimate shareholder returns. In contrast to traditional P/E multiples that are based upon paper profits, free cash flow doesn't suffer from the pitfalls of 'creative' accounting, making it a trustworthy to rely upon as long-term value investor.
As research of Seeking Alpha contributor Kurtis Hemmerling points out, FCF is by far the best predictor of future long-term returns and this case, the numbers speak out loudly.
(Source: 123 Portfolio)
The first red bar is the annualized return of the S&P 500 ETF (SPY) between 1999 and today. The next blue bar represents the annual return for the 50 stocks with the lowest free cash flow yield. The green bar on the far right represents the 50 stocks with the highest free cash flow yield.
So, over the long haul, a company's value will be dictated by the free cash flows it has generated over a particular time period, though, the market hardly ever tracks these FCF figures in the short term. Or, by quoting Benjamin Graham's legendary remark, I'll immediately get my point across that irrational market behavior often interferes with our rational way of calculating free cash flow yields, and, thus theoretically forecasted long-term returns. As long as we know how to deal with these emotional circumstances, it shouldn't pose any problems to our long-term investments.
In the short run, the market is a voting machine but in the long run it is a weighing machine.
Bearing in mind that small caps underperform the broader market from time to time, I'll be far better off holding onto these undervalued shares and loading up opportunistically rather than buying fair valued and well-known companies because of good momentum. When multiples come down significantly and stay low for a long period of time as a result of either increasing cash flows or a declining share price (or maybe both), undervaluation allows you to accumulate more shares at steep discounts.
For this to work, the fundamentals may not deteriorate over a long period of time otherwise my investment thesis will break and I will be forced to sell off the shares. That's why we have to look out for companies with a weak balance sheet that will have trouble withstanding the next economic turmoil. This certainly represents a huge red flag for the whole concept of sustainable and effective capital allocation. Additionally, dividends should be backed completely by a company's adjusted free cash flow, if not, it doesn't deserve a place in our buy and hold portfolio. Which leads me to the biggest reason to like family firms: management's skill of focusing on long-term goals and steering the company in the right direction. Most Belgian family businesses don't squander free cash flows, but chase after opportunities to grow their business and create shareholder value rather than allowing debt to spiral out due to irresponsibly high dividend payments.
Why I Love Obscure Family-Owned Businesses
Most investors will find it scary to solely invest in smaller family-owned companies that generally have low liquidity. For me, that's the biggest trump of being a long-term investor as I look for stocks which nobody has high expectations of, and thus, companies that are flying under the radar. To smooth out portfolio risk, ETFs are the vehicle to acquire the good, but also the bad and ugly stocks. That concerns me enormously since most retail investors jump on the bandwagon without having the slightest idea about which companies they are buying.
My Real-Life Belgian Buy And Hold Portfolio
Let's take a look at how our ultra long-term portfolio fared over the first quarter. Year-to-date, all of our holdings are in the green with WDP and VGP leaving the rest behind, resulting in an overall net gain of 11.29%.
In terms of total return, WDP, the best-performing Belgian REIT, is well on its way to crushing the 50% barrier in just 14 months! On the other side of the spectrum, Melexis continues to experience the headwinds in the automotive industry.
(Source: Author's work)
Today's Belgian Buys
The cornerstone of our buy and portfolio remains logistic real estate, a sector which I believe is poised for secular growth thanks to e-commerce and long-term leases.
(Source: Author's work)
Today, I consider VGP, Ter Beke, Jensen and Sioen Industries the best buys in the Belgian space courtesy of their strong top line growth, improving profitability and long-term focus. More importantly, all of these companies have a relatively low payout ratio, making them more resilient to the next economic downturn. Please note that Ter Beke made a lot of acquisitions in 2017 which took quite some time to fall out. For this year, its EPS is supposed to balloon as one-off expenses fade away, pushing the dividend payout ratio far below 50%.
|Name||Current Dividend Yield||Dividend Payout||Leverage (Net Debt/EBITDA) (e)|| |
Current FCF Yield (Based Upon EV)
|Jensen Group||2.94%||36.38%||Net cash position of € 24M||9.6%|
|VGP||3.70%||32.6%||Gearing of 33%-38%||FFO/P = 12.1%|
|WDP (OTC:WDPSF)||3.43%||at least 80%||Gearing of 50%-55%||FFO/P = 4.3%|
|Moury Construct||3.69%||51.5%||Net cash position (80% of today's market cap)||30%|
|Melexis (OTC:MLXSF)||3.81%||73.43%||Net cash position of € 7.6M||4.8%|
|TINC||4.03%||86.67%||Net cash position of € 25M||-|
(Source: Company reports)
VGP: Our Largest Holding
There are definitely good reasons why VGP already represents 27% of our buy and hold portfolio. First, its business is minting it as a result of a rapidly growing landbank (annualized committed lease contracts have grown by a C.A.G.R. of 58% over the past 5 years). Secondly, with an occupancy rate of almost 100% and a payout ratio of 32.6%, the dividend is well covered by its recurring earnings. Third, the company is well on its way to countering a potential economic slowdown as its warehouses get leased up very quickly, making me feel very comfortable with our current stake of 1,349 shares. Shares are shelling out a dividend yield of 3.7% and that lines up perfectly with the needs of my parents to meet our expenses.
(Source: Author's work based on VGP's reports)
As for our dividend streams, I expect net dividend income to total to €7,927 this year. Should the market correct over the coming month, I could acquire more Ter Beke, Jensen or VGP to pull dividend income above €8,000.
(Source: Author's work)
Introducing My Fictive American Buy And Hold Portfolio
15 SWANs You Should Own For The Long Run
Besides elaborating on my real-life buy and hold portfolio, I also wanted to come up with an American version consisting of 15 decent blue-chip stocks that have pampered their shareholders over the past decade(s). Living off dividends is a dream shared by many investors but few are actually capable of achieving that goal. That's why I put this list together: to provide you with the best buy and hold ideas, helping you sleep well at night while outsized monthly payouts are coming your way.
I'm intended to follow up this selection, track their dividends and earnings, and point out why these companies are supposed to generate market-crushing returns over the ultra-long run. I took March 22, 2019 as starting point to set up this portfolio.
(Source: Author's work)
|Name||Forward Dividend Yield||Dividend Payout|
|Johnson & Johnson (JNJ)||2.64%||63.10%|
|Simon Property Group (SPG)||4.62%||64%|
|Proctor & Gamble (PG)||2.82%||69.13%|
|Philip Morris (PM)||5.00%||88.39%|
|United Health (UNH)||1.46%||28.30%|
(Source: gurufocus, Morningstar, Yahoo Finance)
What do all these companies have in common? The ability of literally printing cash, allowing them to payout secured dividends and even to repurchase own stock. Backing out the two REITs, namely Simon Property and Equinix, they all have robust FCFs that keep up well during economic turmoil and manageable debt burdens (or in Cisco's, Apple's and Microsoft's case, cash piles) which are obviously vital factors for sustainable value creation and market-crushing returns. Adding to those two factors, they also have a long streak of superior Returns On Invested Capital (NASDAQ:ROIC), underpinning management's competence of spending cash flows wisely.
|Name||FCF Margin||Leverage (Net Debt/EBITDA) (2019)||ROIC|
|Apple (AAPL)||23.7%||Net cash position of $101.6B||23.3%|
|Cisco (CSCO)||25.9%||Net cash position of $12.8B||15.7%|
|Johnson & Johnson (JNJ)||22.7%||0.01x||16.9%|
|Proctor & Gamble (PG)||17.2%||1.70x||12.1%|
|Microsoft (MSFT)||26.9%||Net cash position of $58.1B||21.5%|
|Philip Morris (PM)||27.2%||1.88x||-|
|United Health (UNH)||6.1%||0.73x||15.6%|
(Source: Morningstar.com, marketscreener)
AbbVie: Enjoy The Desperately Low Valuation
Let's delve deeper into AbbVie, shall we? With its share price staggering for quite some time, the pharmaceutical company has the odds stacked against it as the debt burden and Humira blues continue to frighten investors. At some point, though, FCF yields become sky-high and start to generously reward investors for the risk they take. First of all, there's no denying that AbbVie has made the most of Humira, the world's best-selling drug. Besides relying upon Humira, management has expanded its pipeline intensively by going after acquisitions and potential in-house blockbusters.
As it relates to its financial position and regardless of goodwill, I think AbbVie's balance sheet is much stronger than most people calling it a debt mountain argue.
After taking into account its investment assets, total net debt equals to roughly $30.8 billion. Let's compare that figure to its normalized free cash flow over FY 2018, which amounted to $13.9 billion. In this case, an extraordinary intangible asset impairment related to the StemCentrx acquisition may fool you into wrong fair value calculations. That's why FCF is by far the cleanest metric to utilize as it vanishes the negative impact of non-cash impairments on net earnings.
(Source: Company's report)
Thanks to a strong cash conversion rate, AbbVie's net debt/FCF metric stands at just 2.2, indicating it would take only 2.2 years to completely pay down debt. Consequently, I'm not in the least concerned about its generous dividend policy and with a FCF yield of 9.2% based upon today's enterprise value (market cap and net debt) of roughly $150 billion, I firmly believe it's high time to board the pharmaceutical company headquartered in Illinois.
We're off a good first quarter as our overall portfolio is up 15.32%, demolishing the broader market by 3.41%. That implies I'm ahead of my own ambitious expectations. Will the iconic barrier of €1,000,000 be crushed by the end of this year?
The rally is clearly drawing to an end and I have positioned myself accordingly. I'm not going to make any changes to my buy and hold selection, but my covered-call writing portfolio is now in defensive mode through the use of in-the-money calls and maybe we lean towards the collar strategy as well.
I've also compiled a fictive American buy and hold portfolio consisting of 15 decently valued blue-chip stocks which I believe are worth looking at. Especially when you're disciplined and patient, these companies should compound investor wealth indefinitely over the next decade(s). Today, there are 15 SWANs that should grab your attention with AbbVie standing out from the rest thanks to its superb cash flows, effective capital allocation (buybacks and dividends), well-filled pipeline and irrationally low valuation.
Thanks for reading, I hope you've enjoyed reading it as much as I've enjoyed writing it. I encourage you to follow me and my website, if you don't already!
Disclosure: I am/we are long ALL BELGIAN STOCKS MENTIONED IN THIS ARTICLE. 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.