As I noted last year, this review comes with 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, let’s dive right in.
I’ll begin with a portfolio review before diving into individual equities. At year end, my cash and equivalents balance accounted for just under 20% of my entire portfolio. As I’ve alluded to in the past, I’m at a position in my life where I’m currently a net saver, and expect that will continue for many years to come. If I had not added any additional funds to my account through the year, my cash position would’ve stayed in the single digits (and much lower if LUK had not been sold, which I discussed here). Without any purchases for the year, my cash balances accounted for a material portion of my overall invested assets, and was a drag on portfolio performance; please read my most recent article (here) for a discussion on why I’m perfectly fine with that outcome.
Now let’s look at the remainder of the portfolio – equities. The percentages provided below are as a percentage of my equity holdings (i.e. they’ll add to 100%, not approximately 80%). I’ll discuss my four largest positions, which collectively represent approximately 85% of my overall equity investments (that’s what I mean when I say "fairly concentrated" in my bio at the bottom of these articles). After, I’ll discuss my overall results.
Berkshire Hathaway (30% of equity portfolio) – I began purchasing Berkshire Hathaway (BRK.B) in a serious way back in August and September of 2011; since that time, both the company and the stock have put together a stellar performance. The results since the purchase of Burlington Northern have hit the cover off the ball, Warren and Charlie are still on top of their game and Todd and Ted continue to look like sound additions for the future (with recent news on Matt Rose raising some interesting questions as well). As a result of the strong gains in 2013 (up about 34% for the year), Berkshire has slightly increased as a percentage of my overall holdings. Last year, I said the following:
“Berkshire has been my largest holding by far… and that won’t be changing anytime soon."
I would be a buyer if we retested the repurchase threshold (around 1.2x book); beyond that, what I said last year still holds – BRK.B is my largest holding, and that won’t change anytime soon.
Microsoft (26% of equity portfolio) – Here’s what I said about Microsoft (MSFT) last year:
“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 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).”
Well, 2013 was the year I was waiting for: MSFT increased more than 40% for the full year (before dividends), with continued strength in (the former) Microsoft Business Division and Server & Tools. These segments collectively reported more than $24 billion in operating income in fiscal 2013 – nearly $10 billion more than their collective operating income just five years ago. Other segments have their fair share of positives and negatives alike (with PC sales still hurting), but the overall results for the business continue to reflect solid underlying operations (particularly for the two segments I mentioned earlier, with some encouraging signs for Xbox, Bing, market share gains in tablets and phones, etc.).
I remain concerned about the capital allocation policies at the company (more cash should be returned to shareholders – they should've been issuing debt and buying back stock under $30 per share when they had the opportunity); I hope that the incoming CEO will seriously consider what Value Act and Jeffrey Ubben bring to the table (their track record suggests that they should listen closely). I’m also increasingly reticent about competing with GOOG (and to a smaller extent AMZN), and the valuation is much different than it was when I made my initial purchases in 2011. If we end up moving above $40 to $42 per share, I’ll likely start to sell MSFT; it is pretty difficult for me to be comfortable with an investment in this industry as such a large percentage of my portfolio unless I think it is really safe and undervalued – as I felt in 2011. Both of those requirements seem to be on shakier ground today (with recent reporting on Chromebook market share, while a bit misleading, still worrisome in my mind).
Johnson & Johnson (14% of equity portfolio) – JNJ was another solid performer for the year, with a gain of roughly 32% before dividends. A few years ago, JNJ’s stock was implying a much more difficult future for the company than what had been achieved in the prior decade; while there were clear reasons for some concern at the time, these were generally short-term issues that were unlikely to have a material impact on JNJ (even prior to the recalls, the Consumer division accounted for only a mid-teens percentage of the company’s operating income). After increasing by about 60% in just over three years, that is no longer the case in my opinion; Mr. Market is once again optimistic about the future for Johnson & Johnson. While I’m comfortable holding the shares at the current valuation, I’m a long way away from being a buyer. Hopefully Alex Gorsky will break away from some of his predecessors' shortcomings and use his experience in Medical Devices & Diagnostics to help navigate JNJ’s most important business segment (one that has faced litigation and recalls on a seemingly endless basis for years).
PepsiCo (14% of equity portfolio) – Here’s what I had to say about PepsiCo (PEP) last year:
“The company continues to dominate and grow in salty snacks (share leadership around the globe remains mouthwatering), 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.”
Since that time, PepsiCo has advanced by about 22%, and the snacks and drinks business are still together (and at this point Nelson Peltz doesn’t appear to have the support he desires to try and shake things up at PEP). While people continue to point to struggles in the U..S CSD business, they should really be focusing on the bigger picture: Despite the fact that soda consumption has been declining at home for many years, PEP has turned out 9% annualized EPS growth over the past decade; food accounts for the majority of PepsiCo’s revenue, and developing / emerging markets accounting for more than one-third of the company’s overall sales. Looking forward, the trend should continue in that direction: Recent success in the company’s Chinese strategic partnership with Tingyi is encouraging, and PepsiCo continues to benefit among retailers and other customers due to the product portfolio’s relevance and scale (as was recently revealed when the company won the Buffalo Wild Wings account from Coca-Cola).
That isn’t to write-off the struggles in the US, or the larger trend that the declines represent: consumers are increasingly looking for healthier alternatives, and politicians have found an easy target in soda (with chips also in their crosshairs: in October, Mexico’s congress passed special taxes that will ultimately be applicable to both product categories; to put that in perspective, Mexico is KO’s 2nd largest market by volumes). Product and category innovation must continue, and Pepsi must find a way to replace and grow their share of stomach as consumers continue to slowly move away from CSD’s (to juices, sports drinks, ready to drink coffees & teas, etc).
It’s also important to note the exposure to Russia: PepsiCo is the largest food & beverage company in the country, with a more than 2X scale advantage over their nearest competitor; of the country’s 25 largest food and beverage brands, Pepsi controls 10 of them – again, more than 2X the next closest competitor. The country accounts for a mid-teens percentage of PepsiCo’s international revenue; naturally any issues in the region would be a negative for PEP (with poor long-term demographics and a concerning political environment noteworthy in my mind).
These four names have all done well over the past few years, and as a simple average they’ve done marginally better than the S&P 500 in 2013 (+32% and +29%, respectively); after adjusting for their respective weightings within my portfolio (namely MSFT & PEP), that would leave this ~85% of my equity portfolio a bit ahead of the S&P 500 for the year (the DJIA finished a few points behind the S&P in 2013). I’m honestly quite surprised by that result in a year like 2013; my lack of experience may be showing (I haven’t been investing long enough to see a runaway market like this), but I would’ve expected that these type of names would underperform by a wide margin in this type of market.
The remainder of my portfolio doesn’t look as good compared to the index: while FLIR has done well (+36% for the year before dividends, with solid business results justifying those gains in my opinion), Fairfax (FRFHF) lagged pretty substantially (it's living up to expectations as a hedge), and JCP has been an unmitigated disaster - and a tough lesson learned; unfortunately for me, that “lesson” has come at the cost of a more than 50% haircut over the last 12 months. This has deteriorated my overall returns for the year by nearly eight percentage points (concentration, like leverage, works both ways); naturally, on an overall view, my cash position has also impacted my relative return versus the index (on a ~12% average weighting it was a three and a half point headwind in 2013), leaving me well behind the S&P 500 as a whole. The impact from holding cash is a small price to pay for the optionality offered by these reserves in what logically becomes an increasingly precarious investment environment as market values rise beyond increases in underlying value – as was the case in 2013.
I’m hoping the New Year will bring surprises and opportunities (with a few starting to catch my eye on the short side); in all of 2013, I executed a single trade. If I’m lucky, maybe I can get all the way to two in 2014…
About the author:
I hope to own a collection of great businesses; to ever sell one, I 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.