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Managing A Portfolio In Uncertain Times

May 12, 2014 | About:

Gordon Pape

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Contributing editor Ryan Irvine is with us this week with some thoughts about portfolio management and updates on three of his winning stock picks. Ryan is the CEO of KeyStone Financial (www.keystocks.com) and is one of Canada's top experts in small-cap securities. He is based in the Vancouver area. Over to him.

Ryan Irvine writes:

The bull market reached its fifth anniversary last month and is now the fifth-longest bull market since 1928. In the United States, the upward move of the S&P 500 marks the fourth-strongest bull ever, with a gain of more than 170% over the past five years. While not as steep, and on a more volatile path due to our heavy weighing towards the resource sector, Canadian markets have also produced strong gains since the 2009 lows. All of this is undoubtedly reason for celebration. But for anyone with even a modest stake in the market, the startling increase in asset prices also raises difficult questions.

Over the first quarter of this year, we saw the average investor become greedier as fear dissipated. Broader valuations increased and sector bubbles emerged - this is a red flag. At present, a number of pundits are calling for a correction and the "sell in May and go away" crowd is out in full force. This has increased volatility and investors are asking what they should do. Again, we remind readers that pundits and so-called experts have been calling for corrections for two to three years at this stage. Right or wrong, it is good to remember that you can always find many a prominent market commentator calling for a bull or a bear run.

Anecdotally, with the broader success of our recommendations, on a weekly basis we get asked for more picks. This can be a sign of greed creeping in as investors become too comfortable and expect 50%-200% gains on each stock. The expectation then becomes for this to be replicated over and over again in every stock recommendation. We are here to say that this level of return cannot be done in volume. Nor will every recommendation perform as intended and produce strong gains over time. It is more about selecting great companies with a higher probability of success in the long-term - quality, not quantity.

For example, holding just one quality stock such as The Boyd Group Income Fund (TSX: BYD.UN; OTC: BFGIF), which has been on our Recommended List for almost four years after originally being picked at $5.50, can have a huge impact on your overall portfolio. Boyd currently trades at just under $40 and has paid us over $1.50 in distributions for a total return of over 600%. We have taken profits along the way but still recommend holding this stock.

In 2010, when we first recommended Boyd in the IWB, investors were fearful and still feeling the hangover from the market crash. We were greedy and, while it is a tough path to follow when most are telling you to sit on the sidelines, it was the right path at that time.

But greed isn't always good, and with greed again creeping into the markets we have outlined a simple action plan for the small-cap growth stock area of your portfolio.

Take a deep breath. A healthy degree of fear keeps you grounded within your portfolio and less prone to greed, which is your enemy. Try to block out the noise - daily market moves, Fed meetings, the latest data from China, etc. You can always find a reason to not buy a stock. Personally, if I found two or even five cheap stocks today with great value and growth prospects, I would buy them without hesitation (correction calls or not). Our current lack of buying is not due to a big call on a correction, it is just a factor of limited value in North American stocks. Remember, investing is not a race, it is a lifelong journey for the savvy stock buyer. If there is not a stock to buy, be patient and wait. Greed is your enemy and discipline is your friend.

A few great stocks remain. Constructing your growth stock portfolio is not about volume or timing and it is certainly not a race. It is about buying the right number of quality stocks at attractive prices. Keep it simple. That means buying 8-12 quality, high growth, low valuation small-caps over a 6-18 month period and having a realistic time horizon (holding period) of 1-5 years.

Layer into positions. When filling a position in a stock, you don't have to do it all in a single trade. You have the option of breaking up the trade into two or more pieces. If the price is great, go ahead and fill the position. If the price is questionable or starts to move away from you, be patient. There is a good chance that it will come back down to your target level, correction or not. For example, say you want to buy $10,000 worth of XYZ Corp. Initially take a $5,000 position and add to it in a month or so.

Create a watch list. My organization, KeyStone, has a list of great companies with solid growth and strong balance sheets that we constantly monitor for attractive entry points. We suggest any good investor should do the same (or allow us to do it for you). At present, most companies on our monitor list appear expensive, but if the market or the individual stock corrects, we have a potential entry point. Applying this approach, we will buy some of the stocks on our list at a future time but some will never hit an appropriate entry point. We are disciplined and patient with these stocks.

Remember to take profits. You will never go broke using this strategy. Taking half or a quarter of your initial position in a strong winner can leave you with only market money in the stock, thus allowing you to sleep soundly during a correction. When evaluating a current stock in your portfolio, ask yourself if you would buy it today. If you see it as overvalued or the reason you bought it originally has changed (e.g. the outlook for earnings growth is now negative), then you should look at selling. If they are not, continue to hold.

Parex Resources Inc. (TSX: PXT)

Originally recommended on July 29/13 (#21328) at C$5.38, US$5.23. Closed Friday at C$11.02, US$10.59 (May 7).

We introduced Parex Resources in July 2013 at C$5.38, US$4.23. With the stock currently over $11 and up more than $2 since our last review in March, we will take another look at the company.

Parex is a Canadian firm headquartered in Calgary. Through its direct and indirect subsidiaries, is engaged in oil and natural gas exploration, development, and production in South America and the Caribbean region, primarily in the Llanos Basin of Colombia and onshore Trinidad.

As we have noted in the past, Parex has an impressive and positive multi-year track record of year-over-year growth in reserves and cash flow. We believe the management team is solid, with extensive Latin America experience and the management group's interests are aligned with those of shareholders because they own 8% of the company.

We view oil and gas producers as cyclical in nature and typically do not have a long-term buy and hold strategy with these companies. Given the cyclical nature of the business, we are more apt to take profits with oil and gas producers than with a less cyclical business such as The Boyd Group (auto repair).

Following significant appreciation of its share price recently in the wake of the company's positive operations update, we now view Parex as trading at a premium to its closest peers on net asset value metrics. At current levels, the stock price is at 4.6 times this year's expected cash flow as compared to the 1.8 times expected cash flow when we recommended it less than a year ago. While not expensive on a cash flow basis, it no longer trades at a significant discount. As such, we are recommending that readers sell half or a quarter of their original positions to remove risk from the stock. Remember, you will never go broke taking profits, particularly when they are this strong.

We continue to view Parex as a sound company with solid growth prospects, and a potential takeover target. As such, we continue to hold a half position in the stock near and long term.

Action now: Take half profits for a capital gain of 104.8%.

Athabasca Minerals Inc. (TSXV: ABM)

Originally recommended on Jan. 30/12 (#21204) at $0.485. Closed Friday at $1.70.

Athabasca Minerals was originally recommended in the IWB in January 2012 at $0.485. With the stock surging to the $2.40 range in the early fall of 2012, driven by two sets of record quarterly earnings to a gain of almost 400%, we recommended investors sell half their positions and hold the rest to continue to participate in the solid long-term potential Athabasca possess.

With the stock closing this week at $1.70, we provide our updated rating.

Athabasca is a resource company involved in the management, exploration and development of aggregate projects. These activities include contract work, aggregate pit management (Susan Lake), new aggregate development, and acquisitions of sand and gravel deposits. The company also has industrial mineral land holdings in Northeast Alberta for the purpose of locating and developing sources of industrial minerals and aggregates essential to high growth development of the energy and infrastructure sectors.

The company recently reported results for the first quarter of 2014 and they showed a significant drop in consolidated revenues and profitability. This was largely a result of frozen conditions and periods of extreme cold and snow resulting in very little construction activity requiring sand and gravel - primarily from the company's Susan Lake gravel pit (managed on behalf of the Alberta government).

Despite the soft first quarter, the Athabasca is observing increased activity at Susan Lake. Second-quarter Susan Lake sales to date have already surpassed what was sold during all of the first quarter. Indications from its customers point to a return to solid demand for aggregates in the current quarter, with strong sales continuing for the rest of this year.

As a result, we continue to advise holding our remaining half position in Athabasca. We do not consider the stock cheap on a cash flow basis at current levels and, as such, we would not recommend entering new positions. But a coming uptick in the company's managed operations and the potential of its wholly-owned projects give us reason to continue to hold half of our original position.

Action now: Hold.

The Caldwell Partners International Inc. (TSX: CWL)

Originally recommended on Feb. 25/13 (#21308) at C$1.04. Closed Friday at C$1.10, US$0.96 (May 6).

Finally, we update The Caldwell Partners International, a company we introduced in February to IWB readers when the stock traded at $1.04. Today, with the company recently releasing its second-quarter 2014 results we review the numbers and update our rating.

The company is a true micro-cap and, as such, is not suited for all investors. Founded in 1970, The Caldwell Partners International is an executive search consulting firm. The company, through a predecessor corporation, became the first retained consulting organization in Canada to specialize in representing employers in the recruitment of executives. Today, Caldwell is one of North America's premier providers of executive search. The company has built a solid reputation for providing successful searches for boards, chief and senior executives, and selected functional experts. Caldwell has offices in Vancouver, San Francisco, Los Angeles, Dallas, Calgary, Atlanta, Toronto, Stamford, New York City, and a strategic presence in London and Hong Kong.

Revenues for the first six months of 2014 rose to $19.5 million from $14.24 million in the same period of 2013. Net income jumped to $436,000 ($0.024 per share) from a loss of $709,000 ($0.041 per share) in the first six months of 2013. This marked the fourth consecutive quarter in which the company has seen year-over-year growth. Caldwell is also experiencing positive gains in important metrics such as average fee, number of searches per partner, and overall billings per partner.

The company declared a quarterly dividend of $0.0175 per share payable June 13 to shareholders of record on April 2. The current yield is 6.4%.

At 20 times trailing earnings, Caldwell does not look cheap. However, the company has about $11 million in cash and investments or just over $0.50 per share in net cash. Stripping out the cash, the company trades at a more attractive 11 times trailing earnings. We also expect reasonable growth in the second half of 2014. As such, we continue to hold existing positions for a strong yield and decent growth potential. Expect the stock to be volatile due to the low public share float.

Action now: Hold.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

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