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My Portfolio Review to Start 2013

The Science of Hitting

The Science of Hitting

234 followers
A new year is upon us, and the financial media didn’t disappoint: articles touting the top stocks for 2013 could be found far and wide (conveniently, most fail to remind readers what they said in 2012, 2011, and beyond). I’ve had readers ask about my holdings in the past, so I figured I’ll throw my hat into the ring this year and discuss my favorite stocks; however, this comes with the addition of two disclaimers: one, I have no idea how these stocks will do over the next 30, 90, 180, or even 365 days; and two, I hope that they go down (I’ll be a net buyer of stocks for a long, long time). With that said, here’s a list of my top four holdings, by size:

Berkshire Hathaway (BRK.B) – 25% of net assets – Berkshire has been my largest holding by far since August to September 2011, and that won’t be changing anytime soon. While this stock has done well for me (up over 30% on a cost basis of $71), I peg intrinsic value north of $110 per share, and will continue to accumulate shares if we get back to the mid-80s per share – a level that looks increasingly unlikely since Warren bumped the share repurchase to 1.2x book.

Microsoft (MSFT) – 15% of net assets – Microsoft has been a large holding of mine for just over a year, and the stock has gone all of nowhere. My aversion to tech has been materially heightened by this position, and it causes me serious angst (I’ve learned that tech news, more than anywhere else, is littered with full of doom and gloom) yet my fundamental analysis continually suggests that MSFT remains significantly undervalued due to solid franchises in Office and Windows, the growing importance (and profitability) of Server & Tools, and the potential in other areas throughout the enterprise (and I love R&D accounting – a significant expense at Microsoft – that misaligns the expense and the eventual economic benefit of the investment).

J.C. Penney (JCP) – 15% of net assets – I’ve written about J.C. Penney extensively, and my interest in the company shouldn’t come as any surprise to regular readers. I used the recent pullback in the stock to average down (yet left myself with no cash when the stock got really attractive – a mistake that I’ve made previously and am hoping to learn from one day) and have a cost basis in line with the current price. The biggest update as of late has been a clear increase in the amount of discounting at the retailer, a change that should provide for some interesting commentary on the upcoming conference call (namely, if the pricing transformation was required to attract top-tier brands, will they still be interested in coming to JCP after the recent spate of clearance activity). I still see an attractive balance of risk and reward – from my view, there’s limited downside even if the strategy fails (management’s willingness to adjust is KEY), yet material upside (2 to 3x) in 24 to 36 months if the transformation plays out as anticipated.

PepsiCo (PEP) – 12.5% of net assets – I haven’t written about Pepsi as much as JCP and I think that speaks to the investment: slow and steady is the name of the game, with limited change from quarter to quarter or year to year (they still sell a lot of soda and potato chips in case you missed the last few years). The company has hit a rough patch lately, most noticeably as Coca-Cola (KO) has flat out dominated PEP in most competing categories (namely in the US). On the plus side, the company continues to dominate and grow in salty snacks (share leadership around the globe remains mouth watering), and didn’t listen to analysts who wanted a snacks/drinks split to give the stock a quick boost (it has since reached the levels expected by the analysts if the change happened). I’m not too tempted by the valuation, and simply consider myself content at this time; if the market lopped off 15% tomorrow and brought it back towards its’ 2012 lows, I would be accumulating shares of PEP in a heartbeat.

As you can infer from my position sizes, my portfolio is pretty concentrated by most standards – I have a total of eight holdings at this time, and find that’s a manageable level for me to stay on top of the SEC filings, conference calls, analyst events, etc. My activity over the past year came in the form of small additions to currently holdings and a few new adds (FRFHF and FLIR) that I wanted to start keeping a closer eye on (both of which I’m still very, very fond of); my only sale was of Travelers (TRV) common stock, which I dumped as it ran past my fair value measure (if I get the chance, I’ll happily partner up again with Mr. Fishman and his shareholder-friendly team).

As I noted above, what these stocks will do in the next 12 months is a mystery to me; for my money, these four companies are a great place to be for the years and decades to come.

About the author:

The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.

I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.

Rating: 4.1/5 (22 votes)

Comments

tonyg34
Tonyg34 - 1 year ago
last time i commented on one of your articles we were talking about moats with regard to retailers, i was wondering what you see as JCP's advantage versus other retailers, or is it just a turnaround story - them getting back to basically average (I believe I lobed a comparison to SHLD at you, for your sake I hope things don't get that ugly).

Secondly, i was stopped short by the last part where you said you sold TRV but bought FRFHF, they both trade at the same P/B and TRV seems to be more reliable with regard to earnings, what are you seeing that makes the one more appealing than the other?

every year people say things are getting worse at MSFT and every year they have higher revenues, one or the other will give eventually
jhayes105
Jhayes105 - 1 year ago
Why not sell puts on those names you love and collect the premiums? If they drop, you got paid to name your price. If they don't, you are still cash flow positive!
mohmand
Mohmand - 1 year ago
Do you still hold LUK?
The Science of Hitting
The Science of Hitting premium member - 1 year ago
Tony,

I hear that comparison - the big difference from my view is that JCP is attempting to do something, and that something appears to have a decent chance of working (at least based on early results) and will take significant time and capital to copy (to the extent that it can be copied) if it's eventually successful; if it doesn't work, we very well could have another SHLD on our hands...

In regards to TRV and FRFHF, the historical track record is a bit better and I'm a big believer in portfolio insurance via Fairfax (fully hedged plus potentially meaningful CPI-linked derivatives); besides that, agreed on P/B comparison.

Finally, on MSFT, that's true - time will tell if that continues. I think Microsoft could shock some people and jump 50-100% over a pretty short period of time if a few stars aligned for them...

Thanks for the comment!

Jhayes105,

There's always pros and cons to any strategy, and selling puts meets that criteria; I know many people love to pursue that route, but I like to keep it simple and just buy the security when it gets to my price. Thanks for the comment!

Mohmand,

I still hold LUK; it is one of my smaller positions (along with FRFHF and FLIR). Thanks for the comment!

Nicolas73
Nicolas73 premium member - 1 year ago
Thank you for sharing your top holdings!

I agree with you on the fact that having less than 10 stocks helps a lot in keeping track of what is important to know, but I still consider my experience not enough to run a such concentrated portfolio (I'm currently in the process of reducing it from the low 30s to the low 20s).

I was very interested in reading your articles on JCP, but I think you've risked too much, related to the level of risk involved and the variety of different possibile scenarios.

Nicolas

The Science of Hitting
The Science of Hitting premium member - 1 year ago
Nicolas73,

Thanks! And reasonable people can disagree; I see little risk with a company like BRK.B or PEP over a ten or twenty year period, and feel more than comfortable with 25%+ in those type of holdings.

In regards to JCP, I would be interested in hearing your thoughts on the risk; I certainly can't name the probabilities of every possible scenario (a fake science in most situations, at least as I see it), but I think the recent response has shown management will change as needed - meaning the company's prior earnings power is a reasonable downside target (no brand equity in selling commodity products at 50-70% off, and I would expect customers to return quickly): I peg that at roughly $500M per annum, based on the past decades' results (adjusted for voluntary pension contributions). Compare that to the current market cap and account for the real estate on the books (at well below market value), and I think $4B quickly starts to look way too draconian - but that's just me. Thanks for the comment!

marcolanaro
Marcolanaro - 1 year ago
Science,

BRK is also one of my top positions, FRFHF just toped it. I believe that FRFHF has the right size to continue its growth at a much faster pace than BRK with the plus, as you said, of all the hedging at this moment, After these two my next positions are all european holdings which I find simple and very cheap, like Pargesa Holdings in Switzerland, Exor in Italy, Corporacion Alba in Spain or Marfin Investment Group in Greece. What is interesting is that almost all my positions are holdings, I find them irresistibles at these discounts and double discounts, my feeling is that investing has become quite simple lately with so many opportunities or am I greedy?
The Science of Hitting
The Science of Hitting premium member - 1 year ago
Marcolanaro,

Time will answer that question - for now, I'll defer to your analysis; I'm of the opinion that while markets as a whole may offer a good proxy about the attractiveness of the average security, that doesn't preclude individual companies from being mispriced and being undervalued even in the frothiest of markets - so maybe you've just found some needles in the haystack. In regards to both BRK and FRFHF, I think they'll prove solid investments with time. Thanks for the comment!

swnyc2
Swnyc2 - 1 year ago
Science,

I believe you wrote an article not long ago about how you had purchased SPLS, but wished you had not purchased so much because you could not take advantage of its further drop in price. (I believe you did not want too much in your portfolio.) So, I was surprised that you did not mention it here. Is it a very small position? Or, have you had a change of heart about the stock?
The Science of Hitting
The Science of Hitting premium member - 1 year ago
Swnyc2,

I should have further clarified those comments - I own it in accounts for which I have beneficial ownership; as you noted, I got a bit too aggressive early on, and got stuck in a spot where I couldn't average down as I wanted because I didn't feel comfortable making it a larger piece of the portfolio. The thesis is unchanged - I still hold the position and may add it to my personal account (if I can stop myself from buying more FRFHF), but it is near the bottom of the list in terms of size as a percentage of the entire asset base I'm looking over (Berkshire, on the other hand, still accounts for about 25% of this larger total); I've learned from SPLS that I'm not a big fan of pure cheapness in a race to the bottom, a common stomping ground for value investors (as compared to great businesses at a reasonable price). Thanks for the comment!

ramands123
Ramands123 - 1 year ago


I think JCP might give you the best returns.. Good look..

Defense is the best offence

lolla
Lolla - 1 year ago
Hi SoH,

I suggest that once you've established your margin of safety price (say 60% of intrinsic cut-off), try to think of an 'out of sample' black swan price that is probably 3-4 std devs below from your purchase price and keep 10-20% of our capital reserved. That will prepare your hitting cells to anticpate days like March 12, 2009 and if and when JCP next takes a bath.

On JCP, those recent clearances don't appear to be that big; their biggest one seemed to be when they were giving away Arizona jeans for $8 to get rid of their existing inventory. I bought 5 of those and they go nicely with my $15 Costco Court Classic sneakers with air-filled soles.

On TRV, I also suggest considering an out-of-sample price that is 3-4 std deviations away above intrinsic value considering that you liked Mr. Fishman's cooking in order to stop you from fasting at the table of a great cook. I am obscenely long TRV and continue to enjoy the good food.

Above all, please read Nate Silver's book to prognosticate better like a fox to id the cells that offer the fattest pitches.

Best,

Lolla.
Nicolas73
Nicolas73 premium member - 1 year ago
Hi Science,

I have no idea of what scenarios JCP could face in the next months or years, for several reasons:

1) First of all, I don't live in the US, so I cannot get a direct customer experience of JCP stores

2) For the same reason, I don't have a direct relationship with most of JCP brands

3) You say that "no brand equity in selling commodity products at 50-70% off, and I would expect customers to return quickly" While I agree with you on the first point, I don't understand the rationale of the 2nd

4) I cannot correctly determine if the real estate on the books is under or over-estimated, so I would not say that if the P/B is very low (compared to the other retailers), you're paying less than how it is really worth.

Of course, I'm not saying that you're not right, but simply that from my position I cannot do my omeworks, so for me it is a pass!

Thank you

Nicolas

The Science of Hitting
The Science of Hitting premium member - 1 year ago
Ramands123,

I think it might as well - time will tell; thanks for the comment!

Lolla,

Thanks for the comment! You're likely right - I may have been a bit quick to dump TRV. In terms of JCP, take a visit to the store - as of my last visit (a few days ago), they had signs posted all over for 30-60% off (don't quote me on those numbers, but I think they're close). My main concern is long term - attracting those brands uninterested in a perpetual game of markup/markdown that are critical to this transformation.

Nicolas73,

On the third point, I simply mean that people show up because they're getting that huge discount - that shopper doesn't really care if it's Kohl's, JCP, etc. That person may have been quick to leave when the coupons disappeared - but I bet they would be back in a heartbeat if/when they return in a big way.]

On your final point, that's the most important one of all - not all investments are for everyone. In a world where everybody thinks they must have a bull or bear case on Apple, Amazon, JCP, etc, being able to say "I don't know" is something that's increasingly rare - but likely a sign of an investor who will outperform the guy who has an opinion on everything.

ramands123
Ramands123 - 1 year ago
JCP is not that difficult to understand. Either there strategy will work or they will change it.

Either ways you make lot of money.

The simple basis is that Ron Johnson and Bill Achman have much more at stake then anyone else.

Not to forget that these Harvard Graduates have an exceptional track record.

Sometimes it could be that simple ..all you need is patience.



Nicolas73
Nicolas73 premium member - 1 year ago
Thank you Science, I hope so!

Did you see the guy who has an opinion on everything? :)

The Science of Hitting
The Science of Hitting premium member - 1 year ago
Nicolas,

I think he's that one guy on CNBC everyday...

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