This is the third year-end portfolio review I’ve written on GuruFocus; as I noted each of the prior two years, this review comes with two disclaimers: one, I have no idea how these stocks will do over the next 30, 90, 180, or 365 days; and two, I hope they go lower so I can buy more at attractive prices (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 discussing individual equities. At year end, my cash and equivalents (short-term treasuries) balance accounted for 16% of my entire portfolio, with upward pressure on that percentage from excess funds held in other accounts (checking) that I’ll transfer in the coming weeks; that change will push the number towards 20%. As I’ve alluded to in the past, I’m at a position in my life where I’m consistently adding additional funds to my account, and expect that will continue for many years to come. Overall, my cash and equivalents balance (percentage) declined slightly during 2014, as purchases and portfolio gains (increase equities as a percentage of the overall portfolio) outweighed the impact of contributions and equity sales (I had a few) throughout the year.
As was the case in 2013, this was a drag on portfolio performance in a rising market (relative to the index); as I did last year, I’ll point you to an article I wrote at that time (here) on why I’m perfectly fine with that outcome. I’m continuing to have trouble to find enough investments that I believe can meet / exceed my return requirements with an adequate level of predictability.
With that, 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 add to 100%). I’ll discuss my largest positions, with the top five collectively representing roughly 75% of my equity investments (my top three account for 60% of the total). Afterwards, I’ll discuss my overall results.
Berkshire Hathaway (BRK.B)(~30% of equity portfolio) – 2014 was another strong year for Berkshire Hathaway, with GEICO (in particular) and the other insurance businesses putting up another stellar performance. Burlington Northern spent most of the year dealing with weather / service related issues - with the underlying issue at hand pointing to the strength of BNSF’s competitive advantage. On investments / M&A, Warren was pretty quiet for the year; we should see that change relatively soon as a confidential treatment request with the SEC is ultimately revealed (if I had to make a bet, I’d put my money on an increase in Exxon (XOM) or IBM (IBM).
According to Morningstar, Berkshire shares increased by 26.6% for the full year; the gain in the stock outpaced the increase in intrinsic value by a pretty wide margin in my opinion. I’m still a buyer near the repurchase threshold (likely to be ~$120 per share at the end of the year), but that’s a long way off at this point. I’ll reiterate what I’ve said each of the past two years:
“Berkshire has been my largest holding by far… and that won’t be changing any time soon."
Microsoft (MSFT)(~18% of equity portfolio) – Readers with a good memory might remember that Microsoft was more than 25% of my equity portfolio at the end of 2013; as I noted in my 2013 year-end review, I was likely to reduce my stake if MSFT moved much higher:
“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.”
Throughout the course of the year, I sold one-quarter of my MSFT shares (at an average cost of ~$46.50 per share). If we continue moving higher, my ownership stake will continue to decline.
As it relates to the fundamentals, I continue to be impressed by the company’s strength in the commercial business: in addition to Office 365 adoption, Azure growth rates continue to outpace any of its large competitors (though coming off a smaller base than AWS). On the other side of the equation, the consumer business (most notably devices) continue to be a bit of a headache: Satya Nadella and ValueAct both had no interest in owning Nokia (or so I believe based on their public comments around the time of the purchase), and now have to figure out where to go from here. Kevin Turner’s recent comments have also raised questions on the Windows strategy (pricing) going forward.
MSFT shares have made a strong run in the past few years, with a 27.2% gain in 2014 helping fuel an increase of ~80% in the shares over the past three years (total return). While I don’t believe the shares are nearly as attractive today as back in 2011, I’m still content with holding MSFT near current levels; as noted above, I’ll continue to reduce my stake if we move higher.
PepsiCo (PEP) (~12% of equity portfolio) – The company’s snack business continues to lead the way, with Frito-Lay North America (FLNA) having another strong year. The concerns I raised last year on PepsiCo’s exposure to Russia are looking increasingly relevant as recent events suggest they're in some trouble near term (long term demographics remain worrisome, too).
Much like the other names mentioned above, the valuation has come a long way in the past few years – but it’s far from the point where I would be cutting in a big way. Even with the 17.1% gain for the year, I haven’t sold any in my taxable account – but I have trimmed it slightly at an average in the high $90s per share in an IRA that I manage for a family member. They’re a bit more concerned with short term movements in the stock than I am, and the tax implications of the account type makes realizing some gains less burdensome. Personally, I considered selling a small percentage of my stake when we crossed $100 per share, but didn’t pull the trigger; it’s unlikely that I’ll do any selling of PEP shares unless we get back above those levels in 2015.
Johnson & Johnson (JNJ) (~8% of equity portfolio) – Besides Microsoft, Johnson & Johnson is the other name among my top four holdings that I trimmed in 2014. A few years ago, the stock price was implying a future that was decidedly worse than what the company had historically reported; my conclusion was that Mr. Market had become too pessimistic. Today, it’s not that I think we’ve moved to the other end of the spectrum (though closer than before): the problem is that I have a tough time wrapping my head around the company’s businesses. I don’t understand all I need to know about the Medical Devices & Diagnostics or Pharmaceuticals businesses, and have some concerns about the Consumer business as well. Those concerns were manageable in my mind at a low-teens multiple on normalized earnings; as we’ve seen an appreciable increase in the shares (up 17.2% in 2014 after climbing 34.4% in 2013), I’ve become less comfortable with the position size (similar to my thinking on Microsoft).
Miscellaneous (remainder of equity portfolio) – Beyond these four names, there's a few other companies that I have small positions in; I’ve discussed most of them with readers at one point or another. At their current size (low single-digit percentage of equity portfolio), I generally view them as tracking positions: I’ve done the requisite research to warrant an investment, but I’m waiting for the right valuation and/or more time following the company closely before getting too aggressive.
One exception is JC Penney (JCP), which started as a large stake in my portfolio and has shrunk materially due to (1) a significant reduction in the share price over the past two years and (2) the sale of half the position in 2014 at $10.90 per share (which looks like fortunate timing currently); it’s ~1.5% of my equity portfolio, on the way to zero. I plan on writing a more detailed article on my failed JCP investment in the coming months. A quick preview - it has been painful.
In order by size, my next five largest holdings are Markel (MKL), Walmart (WMT), IBM (IBM), Fairfax (FRFHF) and FLIR Systems (FLIR). A recent addition, Weight Watchers (WTW), rounds out the top ten; WTW is likely to move up the list if recent price action continues.
Conclusion
The beauty of a concentrated portfolio becomes apparent when you find a handful of companies that are attractively valued and they perform as expected: with Berkshire Hathaway and Microsoft collectively accounting for more than 50% of my equity portfolio at the start of 2014, their ~27% gains for the year (each) went a long way in boosting my returns. PepsiCo and Johnson & Johnson, which represented nearly 30% of my portfolio at the start of the year, helped as well with their ~17% gains (each). From their starting weights (as a percentage of my equity holdings), the return attribution from these names was ~20%.
Based on my math, my all-in investment return for the year (including cash and equivalents) was in the same ballpark: up 19-20%. The math suggests that the impact of the remaining equities (with help from MKL, WMT and WTW to year end) offset the impact of a large cash balance.
While the relative results looked good for the year, I’m less enthusiastic on an absolute basis going forward: Berkshire Hathaway and Microsoft aren’t nearly as cheap as they were 24-36 months ago, and I can’t find comparable replacements (cheap and a very high probability of success) that can meet my return requirements at this point in time. I’ll keep selling if my equity holdings continue higher, creating a growing headwind relative to the benchmark.
As always, I look forward to the thoughts of fellow investors; best of luck in 2015!
