Q1 Update: Asset Allocation and Portfolio Details

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The first quarter of 2019 was a great quarter, not just because I delivered my retirement notice, but also because the market rebounded from its year-end levels!  The US Stock Market  Index is within 5% of its all-time high and we all experienced one of the best recoveries from a bear market in the history of the US Stock Market.

I’m sharing the details of our portfolios for others that may like to do some additional tinkering. Most of our “non-boring” portfolio is held in a taxable brokerage account to track its performance and have tax losses for when I completely screw up. This update will be much longer than previous updates as I’m no longer carry the concern of my employer stumbling across this blog and viewing it as providing financial advice.* Through March of 2019, our 5yr return has beat the S&P 500 by 1.38% annually in the tinkering account.

Before reading further, please know that I endorse a simple portfolio consisting of a Total Stock Market Index, a Total Bond Market Index, and Cash. Alternatively, you could purchase the Vanguard Wellington Fund (0.19% expense ratio for admiral shares) and get a professionally managed balanced portfolio consisting of stocks, bonds, and cash. We have 60% or more of our assets in this strategy and I encourage you to do the same!

Asset Allocation:

Stock Index Funds: 44% The stock index funds are mixed between Large Cap, Small Cap, Mid Cap, and International Index Funds. I’ve utilized Fidelity & iShares when I’m making the purchase and utilize the two index options inside the various employer plans.  20% of our total portfolio is in international index funds, which may be a little on the high side and worth review.

Active Mutual Fund: 7% held in the Vanguard Wellington Fund.  This is Vanguard’s flagship balanced fund and carries a 0.17% expense ratio for a balanced fund between stocks, bonds, and cash.

Bonds/Cash: 17.5%. The biggest opportunity in our portfolio was to raise our cash and bond allocation going into early retirement.  In the Q4/Year-End Update, I shared that I utilized all available cash starting in late November and kept buying as the market went down, even going into a negative cash position (margin) by the second week of December.  I sold enough to cover the margin debt early in the quarter and slowly raised cash throughout the quarter.  There is a specific cash option available in my 401k which is paying a better interest rate than other cash equivalents and I’ve concentrated this allocation here.  I shared my Investment Policy Statement back in January and getting closer to my target cash/bond allocation was a priority in this quarter.

Individual Stocks/REITs 31%

At the end of the quarter, our Individual Stock and REITs accounted for 31% of our investment portfolio.  Before going through the holdings, I want to review some of my general strategies for buying individual stocks:

– Traditional Value Investing: I read Benjamin Graham’s work early in my investing career and believe that securities are fundamentally purchased for its future cash flows. I track around twenty companies and look for opportunities to purchase them at a reasonable price. Its rare that you can find a company the way Graham did with the freedom of information and market participation out there.  When one of the companies I follow becomes a “value”, there’s usually something scary about their fundamental business.  Someone once said “Stocks go up more often then they go down, but they go down faster than they go up”.

Tracking companies I would like to own long term and finding opportunities to purchase these companies at a discounted price is how I value invest.

– Buy What You Know: The stocks that are on my watch list are generally companies I’m familiar with for more reasons than just finding a name on a stock screen.   What companies put out a product people are loyal to?  What do you use that you find value in every day?

– Follow the Activist: I have one holding I keep courtesy of following an activist investor and have a Google Alert for activist investor.  I’ve owned ADP and Darden Resturants during prior activist campaigns with decent success.  You can read more details in this post.

– Founder or Builder Leadership: I love owning companies that are run by the founder or a CEO who’s been transformational for the company. These leaders can often look past quarterly earnings and confidently make long-term decisions for the company. I had the pleasure to work for one of these founder leaders for the first six years of my career and some of the best performing companies over the last ten years are still run by their founder (Netflix, Amazon).

Be warned, founder led companies can be rough rides when someone is growing into the role of a Fortune 500 CEO or they do something completely opposite what the market expects.  Just ask Jim Senegal of Costco how the analysts reacted when he cut prices or when Howard Schultz at Starbucks said he was going to stop reporting certain metrics quarterly just because they were a distraction.  (Berkshire Hathaway doesn’t even have a conference call, how’s that for a founder’s confidence!)

– Companies who’s customers line up to spend money: This is self explanatory, but some of my biggest missed opportunities come from NOT buying a company that customers are lining up to give their money. Had I stuck to this idea, I would not have missed some of the great growth stocks of the last decade and would have invested in Tesla and picked up Apple and Chipotle in 2007. Ulta Beauty is the highest performing stock of the last decade ($10,000 invested would have become $61,000,000).  I remember seeing lines at that store because one was next to the local beer store when I lived in Atlanta, but didn’t think to buy the stock.

Now on to some disclosure of our holdings!

Financials Stocks:

8.2% of our portfolio is held in individual bank stocks. This is a little high because I received some restricted shares from my employer on the Friday before financial stocks dropped 10%. Being the cost conscious guy that I am, I refuse to pay ComputerShare $30 to sell the stock and was transferring it to Fidelity for $4.95/share when prices tanked.  The entire sector dropped due to inverted yield curve concerns. Instead of being too grumpy about this, I saw it as an opportunity and did the following:

• I bought a few financial stocks with cash/margin and subsequently sold them four days later for a 4% gain, keeping the shares as a difference.  My risk adverse self should have held out for 10%, but I was already overexposed to the sector.

• I tax loss harvested about 1/3 of the holdings of the company stock and turned around and bought competitors.  This was an industry issue and if/when prices rebounded, all companies would rise.  I bought two companies I knew were good competitors.

I considered purchasing a significant number of shares and utilizing some margin or moving out the cash position, but instead kept the purchases small and stuck to the IPS. I am a big fan of the regional banks when they start trading below ten times earnings. These companies currently return 100% of earnings to shareholders between dividends and stock buybacks. The pay a dividend around 4%, which leaves another 6% for stock repurchases.

As long as their earning can stay flat or decline less than 6%, then each year I own more of the company and receive higher earnings per share. This is also the fourth time since the great recession that Bank stocks have gone down more than the market before rebounding (2011, 2015, late 2018, and 2019). Past behavior isn’t always a predictor of future returns, but it looks like the pain from the bank collapse was so severe in 2008 investors sell this sector off fast at the first sign of concern.

Warren Buffet outlined his ownership increase in American Express and has been buying chunks of most of the top 10 banks.  There are real reasons bank earnings may decline, including funding cost pressures, the yield curve, and credit quality.   Those can result in small earnings change where the bigger risk is in the bank’s loan portfolio.  Today the banks experience heavy regulation on the amount of credit risk they take, which results in slower growth in earnings but better quality.  I expect the companies to perform similar to utility companies with consistent earnings and steady dividends.

New Additions to the Portfolio:

Westrock and International Paper. These two companies have been on my watch list for a while. They are two of the three companies that manufacture corrugated packaging (cardboard boxes – Georgia Pacific is private and the third company) along with nearly anything paper related. The data on the slowing of the world economy pushed these two companies stock prices down to the point they became attractive to start adding.  The business concerns around this industry are real, but these companies make a product we continue to use and it is an expensive business for a competitor to enter.

Kraft Heinz (whoops): I’ve been a long-term fan of Kraft as a stock. When they warned about earnings and the stock plummeted, I took the opportunity to buy the exact same company at a steep discount. Unfortunately right after I purchased it the Oracle of Omaha called his deal for/with the company a mistake and the stock fell further.

What worked best last quarter:

REITs: 5.5% of our Portfolio. I’m not a fan of the REIT index because not all REITs are created equal. I like the basic form of a Real Estate Investment Trust, a fund that buys a diversified tenant mix of properties, takes their 10% management fee, and pays 90% of earnings out in dividends.  Long term these stocks should perform similar to direct ownership of commercial real estate.

The two REITs I like keep their debt reasonable and don’t take significant single tenant risk. These have been the best performers in our portfolio as interest rates continue to fall and I added to the positions heavily in February 2018. The two REITs I own are up 26 and 41% respectively from their February 2018 lows plus pay us between 6.5% and 8% annually dividends (which come in monthly!).  These two companies can have volatility and I plan on purchasing more shares if they fall by 20% or more.

War on Cash: 3.3% of our portfolio. The “growth” stocks we own are part of the War on Cash strategy (credit Jason Mosier @ The Motley Fool). Paypal, Mastercard, Visa, and Square. This basket of stocks did better coming out of the bottom of December of 2018 than the rest of the market and I’m still long on this strategy for the next decade.

Stocks that Didn’t Perform Well in Q1

1) Cracker Barrel (Follow the Activist): This is my one remaining holding from following an activist. Most of our stock was acquired around $100/share and the stock trades for around $160 at the time of writing. This was a founder led company turned over to a poorly performing CEO after the founder retired. An acitvist investor took a position in this company and did a great job forcing change, including a CEO replacement. The new CEO (Sandy Cochran) has tripled the companies earnings per share while effectively fighting off the activist investor from taking board seats.

The stock price has been under pressure as the activist has been selling out some of his shares, likely for other investment opportunities. In my opinion, this is short term pressure because the lower ownership stake by the activist will now allow the company to do some long overdue financial engineering. If I were at the helm of this company, I would increase its debt to closer to peer average and use the proceeds to reduce its outstanding shares and kick start some additional store growth. The company earns $9 – $10/share and has been returning it to shareholders via $5/year in regular dividends plus a special dividend. Last year the company paid $8.75 in total dividends, which isn’t bad yield on a cost basis of under $100 from five years ago.

I’m still a fan of the company, but there are risks from following an activist if/when the activist decides to sell.

2) Disney: We’ve owned Disney stock since I first saw the lines of people ready to spend near $100/per person to visit their theme park. This is an incredible company, but there are valid concerns around the massive amounts of debt they are issuing to acquire content. This plus the constant “cord cutting” talk has caused the stock to go no-where for the last two years. I still trust Bob Iger and his ability to monetize content, but its been a tough ride for Disney shareholders and the last quarter was no better.

3a) Heinz: You hate buying something then having Warren Buffet call it a mistake.

3b) Heinz Options: The only thing worse than buying a stock then having Warren Buffet call investing in it a mistake is to buy call options in said stock right before Warren calls it a mistake. Guilty as charged!

I’ve sold off most of the options and will hang on to the stock at least through one additional earnings report, but its on my list of stocks to sell if/when I need to generate cash for living expenses out of the regular brokerage account.

What happens next?

Q2 is shaping up to be a big quarter for us.  The house is going to hit the market in late April/early May and if it can sell at the price we want, we’ll be packing up and moving.   Depending on what we rent/buy will determine if we’re adding a chunk of cash to the portfolio or selling off some stock for a home purchase.  There’s a 401k to analyze either leaving where it is, rolling it over into the Wellington Fund with Vanguard, or moving it to Fidelity with our other accounts and buying a couple index funds.  There’s a fee settlement I have to wait on to come in before completing the rollover.  We also start withdrawing from the portfolio instead of adding to it this quarter!   Good times ahead.

Have a question or comment?  Please leave it below.

The information provided in this blog is for informational and entertainment purposes only and everyone’s situation is different. Please refer to our disclaimers for more information.

2 Replies to “Q1 Update: Asset Allocation and Portfolio Details”

  1. How much do you have in ready cash or did I miss that somewhere? Thanks for disclosing your winners and losers in stock picks. Also, I have a real noob question. In the Wellington fund or any mutual fund, is the expense ratio or management fees subtracted from the dividend yield or does the posted dividend yield already include these costs? I’m asking for some of the money market funds out there such as VMFXX which posts a better yield than the Schwab SWVXX. I’m trying to find a place to park some new cash.

  2. We’re currently sitting on 18% cash, but substantially all of that is held inside the 401k. They have an above-market offering that probably sounded like a good idea to the Bank who managed the plan at the time it was written, but is a terrible deal for them today (Fed Funds + 0.50%, currently 2.75%). I’m waiting on the letter to come in the mail to change that. I’m not a huge help on cash because of that and until this past January I was near 100% invested and sometimes even into margin (not recommended). My read on the market for cash is you can get 2.25% from almost anywhere, but its rare to find places paying more. I always look at the 7-day SEC yield when I’m comparing money market funds, which should include the impact of fees.

    On the second question, I think I know the answer. The fees aren’t subtracted from the dividend yield. All mutual funds should hold a small cash position they use for redemption of shares and paying management fees. Dividends are passed through in their entirety, but the fund deducts its fees from the cash position. They’ll reflect the return net of fees inside the Total Return.

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