Mid-Year Review Of Ideas

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Includes: AAPL, ABM, BRK.B, BTI, ERM, FDX, HWKN, MDR, MU, MWK, MYL, OMI, POWL, PZZA, RES, RYAAY, SIG, SLB, SPLV, STT, TAP, THO, TIF, TROW
by: Cory Cramer
Summary

Twice a year I review the ideas I've presented at Seeking Alpha which I am still long.

Since I tend to sell my medium-term winners, these are typically the stock ideas that are in the red.

I also review the stocks I've taken profits in during 2019, and I check in on the general performance of all my ideas since I started writing for SA.

performance review Source: Pixabay

Introduction

Since I started writing for SA in 2015, I've been dedicated to tracking the performance of my ideas as best I can. Because of the way the stock market works, I've noticed that there is often a disconnect between the power of a narrative behind an investment idea and the actual results the idea produces. Stocks with good stories behind them tend to become overvalued, and when they correct, investors who bought too high on the basis of the great story, often lose money. At that point, the analysts who bought into and promoted the narrative, quite often, disappear. This dynamic is made even stronger because many readers of stock investing articles already own the stocks themselves. They are naturally attracted to positive narratives and the writers who provide them because they reinforce what the stockholders already believe (that the stock they own is a good investment). This creates a strong disincentive for stock writers or analysts to track their results and a strong incentive to write bullish articles on widely held stocks. So, I have respect for any stock writer or analyst who actually tracks their results, regardless of how the results turn out, because readers can often learn something either way.

My preferred measure of performance are ideas in which I have both written a 'buy' article on, followed by a 'sell' article, tracked over time and compared to the S&P 500. The reason these realized returns are my preferred measure of results is that they completely eliminate both the cherry-picking of dates from which to measure, as well as eliminating the short-term randomness of the market from quarter to quarter or year to year. The start date for realized ideas is the publication date of the 'buy' article, and the end is the publication date of the 'sell' article. Pretty simple, and hard to manipulate. In this article, I will include the ideas that were realized during the first half of 2019.

There are two potential problems, though, with my preference for using realized ideas over those that are still running. The first is that if I totally ignored the ideas I haven't sold yet, then I could simply hide my bad ideas from public view by never selling them. The second problem is that quite often, even though I'm still waiting for an idea to fully play out, there might be something I could learn if the stock is down a lot from when I bought it. Sure, maybe the stock price will come back up, but it's worth examining closely if it is losing a lot of ground unexpectedly. By occasionally taking a look at my unrealized ideas, I might be able to spot some things to be cautious about moving forward, even if I don't know for sure whether, over time, I'll be proven right or wrong on my investment.

One of the ways I address the first potential problem of hiding my losers from public view is to put a 5-year time limit on how to treat the investment ideas. So, if after 5 years I am still holding a stock, whether it's up or down, for tracking purposes, I will treat it as a realized idea. For example, even though I have never written an article about Apple (AAPL) for SA, it is a stock I have owned for over 5 years. If I had written about it back in 2013 when I first bought it, last year I could have moved it over to my 'realized' column and reviewed it each year with my 'realized' stocks because enough time had passed for my thesis to play out one way or another. If I had a losing stock I was still waiting on to improve for some reason, then I could do the same with it.

So that is one way to deal with my preference for focusing on realized ideas. Currently, my longest held stock in the 'unrealized ideas' column is Mylan (MYL), which has been running for about 3 years now. The next closest is Signet Jewelers (SIG), which has been running for almost 2 years. All the rest of the ideas are from 2018 or 2019, so they are still quite new. I don't really have a lot of old ideas that have been hanging out in the closet year after year.

Given that backdrop, most of this article will focus on the second reason for providing this update, and that reason is to see if there are any themes or patterns I can learn from and potentially make adjustments for going forward. Where should I be more aggressive? Where should I be more cautious? Where should I apply future research time? These are the things I'm after in this type of review. That said, just because I decide I made a mistake with a stock and adjust my strategy because of it, it doesn't mean that I immediately sell the stock (and I am personally long all of the long ideas I share on SA). Sometimes, if it is clear that my original thesis is broken, like with Papa John's (PZZA) in 2018, then I will sell immediately. But most of the time I only apply my strategic changes for stock purchases going forward and I will at least try to get back to even on a stock that has inspired a strategic change. The reason for this is that I don't want to be perpetually changing my mind. When I do my research, for most stocks I focus on a minimum of a 5-year time frame, so I expect that it could take 5 years for the thesis to play out. A lot of times when things look the worst for the stock and it appears that there is no reason to hold it is when it bottoms. And the stocks I write about are typically cyclical stocks with prices that can move a lot in a short period of time, so it would not be out of the ordinary for them to rally a lot in a few months time with a couple of good earnings reports.

I share suggested weightings in my articles so the performance of the ideas will be based on those weightings, and sometimes there is more than one purchase of the stock made. In those cases with more than one purchase, there will be two charts shared, one for each purchase, based on the publication date of the article unless otherwise noted. During my last update, at the beginning of the year, the unrealized ideas were down -15.81% compared to the S&P 500's -2.37%. Keep in mind these updates don't include any of my rotational strategy ideas from the "How far could they fall series?", or performance of my warning articles like with Thor (THO) or Micron (MU) before I eventually bought them after the prices fell, or several other stocks I warned about big downside risk like with Owens & Minor (OMI). This only includes individual stocks that I am still long or that I was long and sold in the first half of 2019.

2019 Realized Ideas

This idea "Buying Cummins for a Bounce" came on July 8th 2018. Cummins is a great example of how combining a cyclical strategy with one's current strategy (particularly dividend growth investing) can increase both one's wealth as well as one's income.

The July 8th article was not the first time I had written about the company. I had previously written two other articles about it in 2018. The first one, titled "How Far Could Cummins' Fall?" was a warning to investors that it would be wise to rotate out of the stock. The second one, "Why Cummins Fell (And When I'll Start Buying)," was written after the stock had fallen about -20%, and that article was basically saying "Not yet. Wait for a lower price before you start buying." A couple of months later, Cummins hit the price I was looking for, and I bought some looking for a bounce of about 20%. Here is how the stock has performed since the July 8th, 2018, article was published until I sold in February 2019 compared to the S&P 500:

Chart

Data by YCharts

So, we were able to do quite well with Cummins.

About a month later, I took profits in Tiffany (TIF)Chart

Data by
YCharts

It was another stock I had warned about before it fell big, and then I bought it during the December sell-off.

Next was Emerson Electric (ERM) which I took profits in a couple of weeks later:

Chart Data by YCharts

That worked out pretty well, too.

Next was T Rowe Price (TROW). I actually didn't recommend buying TROW for most investors in my original article, but I did buy some myself because my kids had received some money from their grandparents and their accounts were over 50% cash. So, even though the market was high at the time, I wanted to at least be 50% invested so I bought some TROW because of that.Chart Data by YCharts

That initial purchase didn't perform very well, but during the December correction, TROW did hit my first 'buy price' and I made another purchase.

Chart Data by YCharts

It performed a little better but mostly traced the S&P 500 up from the bottom.

And the last stock I've sold in 2019 is Powel Industries (POWL), which I actually had a 3% position in since 2017.

Chart Data by YCharts

Powell got a big bump from good earnings report so I decided to go ahead and take profits a little early in this one.

These ideas carried an 8% portfolio weighting and returned +20.76% versus the S&P 500's +13.85%. This is pretty solid performance, and I included the bad initial TROW investment even though it wasn't a blanket recommendation to buy the stock at the time.

Now, let's get into some of the ugly stuff I'm still holding.

Actions One Can Take After Buying A Stock

I have four main actions that I can take when the price of a stock is down after I have purchased it. The first potential action is that if I can clearly identify that something with the original thesis was wrong, then I can sell. The second is that I can identify things I will do differently strategically in the future, but I will still hold the stock, and only sell if it eventually becomes profitable, time runs out on the idea, or I determine that a recession is imminent. The third is that the thesis is still intact, but the price is down, and I just have to wait for the market to change its mind about the stock and potentially be prepared to add to my position. Next, is that the stock price is up, but I'm waiting for it to rise higher before selling. And last, the stock has hit my sell price and I sell the stock to take profits.

2019 Unrealized Performance

The current portfolio weighting of all my unrealized ideas from public SA articles is 23%. (I also have a 13% weighting worth of ideas in the Cyclical Investor's Club.) The rest, approximately 64%, is presumed to be held in a defensive ETF like Invesco S&P 500 Low-Volatility ETF (SPLV). So, as you can see, based on my SA ideas, I think it's prudent to be positioned fairly defensively here, and I haven't found many large-cap ideas this year. In fact, I've only written one public 'buy' article in 2019, for Ryanair (RYAAY) last month.

I'm going to group these unrealized ideas into different themes based on the four of the main actions I can take that I outlined in the last section.

Mistakes in the original analysis

After reviewing my holdings, so far, I only have one stock that I think belongs in this category which hasn't already had most of the bad news priced in, and that's State Street (STT).

Chart Data by YCharts

One of the things I've added to my strategic cyclical analyses since I wrote my 'buy' article on State Street last October, is that if we are late in the business cycle as I believe we are now, I check to make sure revenues and earnings have at least reached the same levels they were during the last cyclical peak. As you can see in the chart above, State Street still hasn't reached the TTM revenues it had back in 2010, and they are ticking down a bit this year even though the market is reaching new all-time highs.

This is a sign of either disruption or secular decline, and it means that State Street's stock price might not recover as it has in the past. When I combine that with the fact that State Street is already a highly cyclical stock, and that during the last recession the stock price fell -70%, I think it's reasonable to sell it here.

Chart Data by YCharts

We can see that State Street hasn't recovered from the December lows with the rest of the market. I think it's time to cut my losses with this one. I was able to successfully warn investors about State Street's dangers near the top of the market, and would have saved investors about a -26% loss, but I don't think I properly assessed the disruption danger of the shift to passive investing.

Now let's move on to those stocks in which I plan to keep holding, but which I have made strategic changes to my investment strategy going forward because of their performance.

Stocks for which I've made future strategic adjustments

Starting in early 2018 I wrote about three dozen bearish articles on cyclical stocks that I thought could fall quite far from where they were trading. Since I was writing so many bearish articles, I decided to force myself to find at least one bullish idea per month to write about. Some of those ideas, like Hawkins (HWKN) and ABM Industries (ABM) returned solid profits and beat the S&P 500, but others like MolsonCoors (TAP) and British American Tobacco (BTI) haven't done so, yet. (TAP had a 1% weighting and BTI two 2% weighted purchases.) All charts run through the end of June.

Chart Data by YCharts

TAP is down about 20% since I wrote about it while the market is up 11%. I think eventually I'll probably do okay with this one, but the main adjustments I've made since writing this article is that I now avoid the stocks of businesses that have gone through recent M&A that amounts to more than 20% of the market cap of the acquiring company and is mostly financed with debt. The second adjustment I've made is that I no longer buy individual stocks for 'defensive' positions. I've discovered through my work on the 'How far could they fall?' series, that ETFs are a superior way to establish a defensive position. If this stock gets back to even or if it appears a recession is imminent, I will sell it.

Chart Data by YCharts
Chart Data by YCharts

Much like TAP, BTI was supposed to be defensive during a downturn, but I think the debt that it took on to buy Reynolds, and the decline of tobacco use generally, has led the stock to underperform. The gigantic dividend helps with this one, but in the future, I will avoid both acquisition stocks and purchasing individual stocks for defensive purchases. The second BTI purchase was made at more 'value' levels, and after rallying the past few days, it is now beating the S&P 500. But in the future, while a stock price is still falling for 'less-cycle' stocks, I wouldn't make such highly weighted purchases. It would have been better if I wanted a 4% position, to make two 1% purchases on the way down, and then wait for the stock to bottom before making the other two purchases.

I am going to be integrating something like this into my cyclical purchase strategy in the future but I haven't worked out the details yet. One of the pitfalls of making a second purchase is that if a stock turns out to be a loser, you need two big winners just to make up for the one loser. Fairly often, on my first purchases, which are made while a stock is falling, I can come pretty close to catching a bottom. However, that is much harder to do with the second purchase price, in which it is much easier to buy too soon, or, potentially buy a stock that is unlikely to recover in a timely manner. So, in the future, I'm going to be adding some shorter-term technical analysis for making a second purchase. This would be in addition to the normal second 'buy price' I establish. So, for example, if the second 'buy price' was $100 per share for a stock, then the price would both need to be lower than that and also pass the additional technical test. I think this will help me avoid a lot of downside with some of the cyclical stocks that are still rapidly falling.

Mylan (MYL) is yet another stock that falls into the acquisition and high debt category. I knew I was testing the limits of my cyclical buying strategy when I bought Mylan in 2016. It was one of the 5 original cyclical ideas I wrote about when I was first developing the strategy. The other 4 ideas that year went on to return 90-110% within two years after I wrote about them. But not Mylan.

Chart Data by YCharts
Chart Data by YCharts

One other adjustment I've made due to Mylan is that I no longer apply my cyclical strategy to drug companies. Several of them do go through cycles, but I think they are too unpredictable to apply the strategy consistently and with confidence. I have about two years left before I give up on this one, but I don't have a lot of confidence in it right now.

I first wrote about McDermott (MDR) in January of 2018 and then later added to the position. The idea here was that McDermott could merge with Chicago Bridge and Iron and turn the company around. So, this was a combination of an M&A idea, and a turnaround idea, both of which I now avoid. Here is how the two purchases have performed:

Chart Data by YCharts
Chart Data by YCharts

The charts on MDR are a little wonky because of the merger, which involved a reverse stock split. The volatility on the day of my second purchase makes using a chart tricky, too, but I think these are somewhat representative of the idea's performance so I'll use them for now. If I go to make a sale at some point I'll dig into it a little more and get the exact performance numbers. I'm actually kind of optimistic that this one could play out okay in the end. I'll keep holding until I see a recession is imminent.

Signet Jewelers (SIG) is another turnaround idea that has been extremely volatile and has yet to 'turn around'. After losing -50%, and getting back to even in 2018 I decided to stick with the stock, but the stock has sold off even further since then. I think if I get back to even again, I'll go ahead and sell. When I bought Signet it had a new CEO and was in the middle of selling part of their credit book. That significantly changed the business model of the company and I should have avoided it for that reason. That's something I keep an eye on now. Signet has a 2% weighting.

Chart Data by YCharts

Ideas that are underperforming, but I would still add to if they fell further

Micron (MU) is a cyclical idea that is playing out pretty much as expected.

Chart Data by YCharts

I'm basically waiting for the cycle to either turn or to get worse. If it gets worse, I plan to load up on more Micron, and if it turns sooner rather than later, I plan to take some pretty good profits eventually.

Thor Industries is a lot like Micron in that the cycle could go either way. My instinct tells me that I could be waiting quite a while for this one, but it's possible that it could surprise and give me good enough returns to take profits before this cycle is over.

Chart Data by YCharts

Just as a side note, I was camping this weekend, and I was pretty impressed with the range of RVs I saw. At the campground I was at I saw everything from tents to big motor coaches, and all sizes in between. The general age of the RVs still seemed pretty new to me, though, so I think that most people who want a new RV, for the time being, probably have one. That said, there were plenty of tents, older RVs, and smaller pop-up style rigs as well. So, I do think there is a new generation of RV owners in the pipeline as they potentially move up to a bigger or newer, more expensive rig, and this means the longer-term picture is pretty good for Thor. Additionally, I think it is becoming clearer that 'lower for longer interest rates' are probably in the cards, and that bodes well for big purchases like RVs.

FedEx (FDX) is a stock that has struggled to recover from the December downturn, but the good news is that I bought it at a pretty good price.

Chart Data by YCharts

I think there is excess fear of disruption as well as issues with an acquisition FedEx made. (Note how tracking these ideas produces themes over time, like avoiding M&A stocks.) FedEx is probably fine over the medium-term, and I plan to continue to hold. But, I also plan to avoid stocks that have had major M&A during this cycle in the future.

The next two stocks are RCP (RES) and Schlumberger (SLB). I have two 2% positions in RCP and two 1% positions in SLB. I recently wrote a full follow-up on these purchases so I'll just post the charts here.

Chart Data by YCharts
Chart Data by YCharts
Chart Data by YCharts
Chart Data by YCharts

And that wraps up the stocks that are underperforming, but which I think still have a reasonable chance to recover within 5 years.

Stocks I'm still holding that are doing well

My Mohawk (MWK) article came out in the early AM and the stock jumped a lot later that day so this chart starts from the day before publication.

Chart Data by YCharts

I've actually been doing quite well with this one, but I'm waiting for bigger profits before selling.

And finally, my last long idea and the only one from 2019 Ryanair (RYAAY). Since it has only had a couple of weeks to work I went ahead and included the first week of July in the chart.

Chart Data by YCharts

Assessing Performance

The unrealized ideas that I am still long including State Street (which I'm selling soon) are -21.06% while an investment in SPY on the same dates would have returned +13.10%. If we add in 2019's realized returns the ideas have returned -10.27% vs SPY's +13.29%.

Taking a little bit longer view, if one includes all by SA long ideas, both realized and unrealized since I started writing in 2015, my ideas have returned about +7.23% vs SPY's +12.18%. But, since about 2/3rds of my articles are bearish articles which aren't captured in these numbers, if we include the performance of the 29 defensive ideas at a 2% weighting in the "How far could they fall?" series vs the market, then all of my SA ideas have returned about +7.42% vs SPY's +7.65%. This still doesn't include a few warning articles that weren't part of the 'How far could they fall series?', but I think these numbers are reasonably representative of all of my writing on SA so far. That is to say, about the same as the S&P 500.

But here is something you'll probably not hear another analyst or stock writer say: Over the next year or two I expect I'll perform worse than the market. (How's that for a Cyclical Investor's Club sales pitch?) Given the sort of cyclical value investments that I'm looking to buy, I don't expect to be rewarded by the market in the near-term. Here's why.

It has become fairly clear to me that we are very much in a situation similar to 1998 and 1999. That was a period where tech stocks with good stories along with high-quality businesses traded at ridiculously high prices. If we were to toss in dividend payers and high-yield into that mix, we have almost exactly the same thing happening in 2019. Meanwhile, out-of-favor parts of the market (aka value stocks) like oil, tobacco, beer, cyclical industrials, most retail, are being utterly ignored or sent to the rubbish bin. What we are experiencing now is almost exactly like 1999 except with lower interest rates which have made high-yield more attractive to investors this time around.

Chart Data by YCharts

This is a chart of Berkshire Hathaway (BRK.B) from July of 1998 to April of 2000 compared to SPY. I remember this time well because 1999 was when I first started investing. I remember how many were saying that Warren Buffett was washed up and finished as an investor and that value investing was dead. We were in a new age of the internet where profits didn't matter anymore. 'This time it was different!' Look carefully at the chart and you can see that Berkshire stock at one point was down almost 50% while SPY was up 25%. The Nasdaq was up even more than that.

I've examined dozens and dozens of stocks that went through this period and many of them are behaving exactly the same way now. But what many investors don't realize is that many of the value names and the cyclicals that suffered from 1998 to 2000 while the market was making new highs, would actually rise while the market fell for the next three years, in one of the market's worst declines ever.

Chart Data by YCharts

And Berkshire wasn't the only stock to do well the first few years of the 2000s. There were many others that had bottomed by 2000 while the market was making all-time highs on the backs of profitless companies and crowded high-quality names where investors had forgotten that price matters.

So, the upshot here is that while I'm always looking to improve my investment process, and while I have made a few legitimate mistakes along the way, performing about the same as the market over the past 3 years, for a value investor, is pretty good. And if the market has a real blow-off top at some point over the next year or two, there is no way I expect to keep up with the performance of the S&P 500. However, I think I'll more than make up for that when the next market decline eventually comes. I'm willing to suffer the inevitable slings and arrows until then, and I'm okay roughly equally the market as long as I can avoid the bulk of the next decline and perform better during the recovery.

Disclosure: I am/we are long AAPL, BRK.B, RES, SLB, MYL, SIG, MDR, MU, FDX, THO, MWK, BTI, TAP. 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.

Additional disclosure: I'm long all the stocks tracked, just in case I missed any in the disclosure that were mentioned.