GuruFocus readers – it’s been a while! Over the past month I’ve been busy with work and haven’t been able to add my two cents in what has been a volatile and interesting (read: scary) period for many market participants. While I plan on getting back on my normal writing schedule in the coming days, I figured I would start off with something simple: Here’s a quick list of what I’m seeing in the markets in addition to a quick summary of recent developments for some of the companies I’ve previously discussed.
“The Death of Equities” continues to be on the precipice – As noted in a USA Today article from May, the average investor is frustrated with volatile and falling markets, and is increasingly convinced by the following claim (from the article): “Wall Street's long-running story about how stocks are the best way to build wealth seems tired, dated and less believable to many individual investors.”
I’m not sure what lies around the corner, but feel safe in saying the following – another big dip in the indices in combination with continued volatility could be enough to push many individual investors to abandon equities entirely (they've already pulled more than $260B from U.S. equity mutual funds since 2008, while moving $800B to bond funds over the same period); if that comes to fruition, I’ll be salivating as I scoop up quality businesses priced to deliver 15-20% annualized returns for years to come.
The disconnect between equities and fixed income is striking, and widening – Ten year treasury yields fell to all-time lows under 1.5% at the start of June, compared to yields near 2% in the first few weeks of the year; compare this to the dividend yields for four AAA rated U.S. corporations – 2.94% for ADP (ADP), 2.82% for Exxon (XOM), 3.87% for Johnson & Johnson (JNJ), and 2.70% for Microsoft (MSFT).
In addition to holding a more attractive credit rating than the U.S. government, these companies' payouts are expected to grow over time (like they've done for decades) and the underlying businesses offer some level of protection against inflation. While I think that there are other places that offer more attractive price/value disconnects, I find it truly astonishing that people would pass on a name like Procter & Gamble (PG) at the current valuation and instead choose bonds offering "return-free risk."
Value investing is alive and well – As the markets focus on short-term developments in the macroeconomic environment, value investors are left to scour the universe for a growing list of undervalued equities. Volatility, which is risk to the trader and opportunity to the investor, is rampant, creating plenty of opportunities.
An example from a name I’ve discussed previously is Staples (SPLS), which is incorrectly categorized as "just a retailer" and is being dragged down by weakness in Europe. Despite these short-term headwinds, the company expects to generate more than $1 billion in free cash flow for the year (FCF yield of over 13%), and is looking to buy back hundreds of millions in stock and boost their dividend (the yield is already approaching 3.5%).
Leucadia (LUK), which I recently wrote about in a value contest submission, has been obliterated since I discussed it back in April, falling 15% compared to the 5% drop in the S&P over the same period (to say LUK is volatile is putting it lightly). As I noted in the comment section on the article, the company reported strong first quarter earnings, with book value increasing 4.2% in the quarter to $26.29 per share (though it’s lower today when Jefferies and Mueller are marked to market); most importantly to investors, there have been no further announcements in regards to the Fortescue litigation.
FLIR Systems (FLIR), the other company that I’ve recently submitted, has also been quiet since the write-up (besides some small government contracts signed in the past couple weeks); since the article was published, the stock has fallen about 4%, about in line with the major indices. The more I read about FLIR, the more excited I become about the commercial applications for the company’s technology as the unit costs decline; my focus continues to be on competition within the industry and on the competitive advantage FLIR holds from their vertically integrated supply chain and their resulting 60% market share in thermography products.
Lastly, I thought I’d take a second to discuss J.C. Penney’s (JCP), which has been a roller coaster than Ron Johnson came on board as CEO. I continue to be amazed by the resumes of executives being brought into the company by Ron, and think that their ability to cut costs and attract brands to the store vision is still the early innings; one can only hope that the stock continues to get slapped by the indiscriminate selling of traders; for anybody who hasn’t looked at Ackman’s most recent presentation on JCP, look at this (scribd.com/doc/94429025/AckmanJCP).
It feels good to be back, and I look forward to your comments.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, "Patience followed by pretty aggressive conduct."
I run a concentrated portfolio, with a handful of positions accounting for the majority of my equity holdings (currently two). From the perspective of a businessman, I believe this is adequate diversification.