This is the fifth year-end portfolio review I’ve written on GuruFocus – as they say, time flies when you’re having fun!
I’ll start with the usual disclaimers: First, I have no idea how these stocks will do over the next week, month or year; and second, I wish they would move lower so I could buy more at appealing prices (I plan on being a net buyer of stocks for a long time).
Despite my wishes, U.S. equities continued to march higher in 2016. The Standard & Poor's 500 reported another year of double-digit returns, finishing up 12% (including dividends). Over the past five years, the total return for the index has been nearly 15% annualized; the majority of those gains have been attributable to a higher price-earnings (P/E) multiple, not earnings growth or dividends. The past few years have been quite kind to investors; this will not continue in perpetuity.
As I noted in my 2015 year-end portfolio review (here), I started 2016 with 22% of my portfolio in cash and short-term Treasurys. While I found a few opportunities in 2016, I made the mistake of moving gingerly; in each case, Mr. Market moved against me in short order, limiting my opportunity to keep accumulating shares. In addition, I reduced a few positions during the year and continued making cash contributions to my portfolio. As a result, my cash and equivalents balance at the end of 2016 increased to roughly 29% (on which I'm earning essentially nothing).
In a rising market, holding cash has been a material headwind to my portfolio performance. As I’ve noted in years past, that’s a price I’m willing to pay if I can’t find attractive opportunities – regardless of how long or how far this bull market runs. When I find ideas that exceed my return requirements, I’ll use excess cash (hopefully in a big way). Until then, my plan is to wait.
Equities
With that, let’s look at the remainder of the portfolio – equities. The numbers discussed below are as a percentage of my equity portfolio (as opposed to measuring them as a percentage of my overall investment portfolio). I’ll discuss my largest positions with the top five collectively accounting for just over 60% of my equities. Afterward, I’ll discuss my overall results for 2016.
Berkshire Hathaway (BRK.B) (~23% of equity portfolio) – As with each of the previous four years, Berkshire Hathaway was my largest holding at year end. It increased marginally as a percentage of my portfolio for the year with solid gains for the stock (up 23% in 2016) offset by continued cash contributions to my investment portfolio.
In my 2015 review, I said the following:
“I accumulated my entire position over a two-month period in 2011 and have not bought (or sold) a single share since. If the stock continues to move lower in 2016, that will change.”
Mr. Market obliged, pushing Berkshire down a few percentage points in early 2016. My reaction? Nothing. I sat around and missed an opportunity to add additional shares when they were quite cheap. The market didn’t wait long to show just how dumb that decision was.
Microsoft (MSFT) (~12% of equity portfolio) – Despite a roller-coaster ride in the stock market, especially around quarterly earnings, 2016 was another strong year for Microsoft’s business. Satya Nadella has done a great job disproving the naysayers who questioned his ability to effect change as an “insider.” The commercial cloud businesses continue to grow and are on pace to exceed management’s goal of $20 billion in run rate revenues by 2018. At the same time, Microsoft continues to have a fortress balance sheet that will ultimately be used for the benefit of investors.
As happy as I am with these developments, I also recognize that the investment thesis has changed. The overwhelming pessimism that drew me to buy Microsoft in 2011 has largely disappeared. Simply averting disaster isn't enough from here. In recognition of this change, I sold a few shares at the end of 2016. If the gains continue, I’m likely a seller in 2017 as well.
PepsiCo (PEP) (~10% of equity portfolio) – Pepsico increased by roughly 8% in 2016 (inclusive of the dividend), which is roughly comparable to the fundamental returns (EPS growth plus dividends) I expect the business to generate over time. The valuation didn’t budge much last year so I’ll continue waiting; I don’t plan on selling Pepsico unless I find another place to invest that looks much more attractive (the tax implications if I did sell would require that the alternative be priced for much higher returns). A more likely scenario is that the position size will decrease over time as my overall portfolio grows at a faster pace than the stock appreciates.
IBM (IBM) (~9% of equity portfolio) – Despite taking a nice tumble to start the year, IBM shares ultimately climbed more than 20% in 2016. As I noted last year, some of the concerns about revenue growth from quarter to quarter are a bit overblown in my opinion (especially after accounting for currency headwinds and large divestitures a few years ago). At the same time, I don’t take comfort in much of what I read about the continued success of emerging competitors like Amazon (AMZN); this is exacerbated by the fact that I do not have the industry expertise required to understand the potential developments in this business over the next five-plus years.
In the past, I’ve accepted that reality by leaning on two crutches: one, the valuation, and two, Warren Buffett (Trades, Portfolio)’s continued ownership of the stock. The first point is less compelling if the stock continues to climb; the second point isn’t the way I prefer to operate either, regardless of how cheap the stock appears. That’s a long-winded way of saying that I’m likely to sell shares of IBM in 2017; I think my time and efforts could be better spent elsewhere.
21st Century Fox (FOXA) (~8% of equity portfolio) – Unlike the four names mentioned above, 21st Century Fox is a new addition to my top holdings. I wrote an article in August (here) that is worth reviewing if you’re interested in my thoughts on the company. The carriage deal signed with Comcast (CMCSA, Financial) a few days ago reaffirms the investment thesis: Even in negotiations with the largest MVPDs, owners of high quality content have the upper hand.
I don’t plan on buying more 21st Century Fox unless it falls back towards the low $20s, but I won’t be selling anywhere near current prices either. Heading into 2017, this is one of my favorite ideas.
Conclusion
Last year, my largest holding fell more than 10%, creating a sizable headwind for my portfolio returns. In 2016, the opposite happened: Berkshire’s significant gains for the year provided a notable tailwind. Generally solid performances among my other top holdings helped as well.
The few purchases I made in 2016 – Yelp (YELP), Union Pacific (UNP), Moody’s (MCO) and 21st Century Fox – quickly worked, too (Yelp ended the year ~150% above its February lows). These gains were offset by the sizable “cost” (relative to the index return) of holding cash.
All in, my pretax investment return for the year, including transaction costs, was roughly 17%. Hopefully Mr. Market will become more skittish as we move into the new year. Significant bouts of volatility, and the investment opportunities that they offer, would be greatly appreciated!
As always, I look forward to the thoughts of fellow investors. Best of luck in the coming year!
Disclosure: Long Berkshire Hathaway, Microsoft, Pepsico, IBM, 21st Century Fox, Yelp, Union Pacific and Moody's.
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