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The Science of Hitting
The Science of Hitting
Articles (489) 

Year-End 2017 Portfolio Review

A look at my top holdings and 2017 results

This is the sixth year-end portfolio review I have written for GuruFocus. It is an article I always look forward to because it has historically generated a lot of quality feedback from readers.

I will start with the usual disclaimers: First, I have no idea how these stocks will do over the next week, month or year. Second, I hope they move lower so I can buy more (in addition to holding dry powder, which I will discuss in a moment, I will be a net buyer of stocks for a long time).

Despite my wishes, U.S. equities continued to march higher in 2017. The S&P 500 notched a total return, including dividends, of 22%. As in recent years, an expanding P/E multiple was a significant contributor to returns in 2017. What will happen next year is unknowable. Stock prices may outpace intrinsic value growth yet again. The one thing I do know is this will not continue in perpetuity.

As I noted in my 2016 year-end review, I started the year with nearly 30% of my portfolio in cash and short-term treasuries (I do not own any other fixed-income securities). I found a few opportunities in 2017, which brought my cash balance down to 20% of my portfolio at year end.

Holding cash has been a material headwind to portfolio performance. As I have noted previously, that is an outcome I am comfortable with. I will continue to wait for the right opportunity, regardless of how long or how far this bull market runs. The one thing I must admit (painfully) is I have probably moved too gingerly when new opportunities appeared in the past 12 to 18 months. In the cases of Union Pacific Corp. (NYSE:UNP), Yelp Inc. (NYSE:YELP) and Moody’s Corp. (NYSE:MCO), that has been quite costly.

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 will discuss my largest positions with the top five collectively accounting for roughly 55% of my equities. Afterward, I will discuss my overall results for 2017.

Berkshire Hathaway Inc. (NYSE:BRK.B)(approximately 19% of equity portfolio) – As with each of the previous five years, Berkshire Hathaway was my largest holding at year end. Despite a solid year for the stock, Berkshire decreased as a percentage of my equities as I made new contributions to my portfolio and put more cash to work. I write about Berkshire all the time, so feel free to review my other articles if you want to know why this is my largest holding (and why that is unlikely to change).

Microsoft Corp. (NASDAQ:MSFT)(approximately 11% of equity portfolio) – Microsoft, like Berkshire, has been a top holding for as long as I have been doing this. 2017 was another big year for Microsoft’s business. Satya Nadella has proven he is exactly the right person to lead this company. The commercial cloud businesses continue to grow at an astounding pace and recently passed $20 billion in run rate revenues (ahead of management’s projections). At the same time, Microsoft continues to have a fortress balance sheet that will ultimately be used for the benefit of investors.

Microsoft has provided an interesting learning experience over the past 12-24 months. I should note that I do not think the stock is particularly cheap. On the other hand, this is a wonderful business with a best-in-class leadership team. I think the bias of most value investors (myself included) in this situation is to head for the exits a bit prematurely. I am not sure that's the correct course of action, particularly if that means incurring a significant tax liability. I like the idea of being Satya Nadella's business partner for the long-term, even if I'm not in love with the price I'm being asked to pay for that privilege. For that reason, I feel comfortable being "slow" to recognize gains and continue holding a sizable position in MSFT.

I may trim a bit if the stock keeps moving higher, but I don't plan on doing too much.

Under Armour Inc. (NYSE:UA)(approximately 9% of equity portfolio) – I wrote my first article about Under Armour back in March. Here is the conclusion from that analysis:

"Even relative to normalized earnings power, the stock doesn’t appear to be a screaming bargain (by my math it’s somewhere in the range of 20 times pretax earnings). You could probably make a reasonable argument I’m stretching a bit on this one; I’m comfortable being early. My hope is Under Armour falls further so I can make it a larger position at a more attractive valuation."

Mr. Market granted my wish: the stock ended up falling from $18 to $11, or 40% below where it was in March. I added a bit more near the end of August and then bought a big slug in early November.

I have no idea what will happen in the short-term for Under Armour (the business or the stock price). It could be a year or two before it gets back on track. There is no question some of the current issues are self-inflicted wounds. These company-specific issues have been exacerbated by industry headwinds in North America. While the financial results have been ugly as of late (and may continue to disappoint in the near future), I think these issues are temporary.

By my math, I bought most of my Under Armour shares for somewhere around 10 times normalized pretax earnings (it is worth noting they will benefit from lower corporate tax rates).

I think the risk-reward looks pretty good, assuming you have a long-term perspective.

PepsiCo Inc. (NASDAQ:PEP) (approximately 8% of equity portfolio) – PepsiCo had another solid year, with help from a stock price that outpaced the gains in intrinsic value (at least in my mind). This is a great business, but it's another stock that I don't find particularly cheap at current levels. That said, it's unlikely that I'll sell unless I find something much more attractive (the tax implications would require the alternative to be priced for much higher forward rates of return). As I suggested last year, a more likely scenario is the position size will fall over time as my overall portfolio grows at a faster pace than the stock appreciates. That happened in 2017.

21st Century Fox Inc. (NASDAQ:FOXA)(approximately 7% of equity portfolio) – Fox was a new addition to my top five in 2016. Since I bought the stock, my read is the thesis has largely played out as expected, even if Mr. Market did not seem to agree at times. I think the recently announced deal with The Walt Disney Co. (DIS) is intriguing, so I will probably keep holding shares of the combined company (assuming the deal closes). I am also intrigued by the valuation Mr. Market is applying to “New Fox,” which looks cheap by my math (assuming Disney is reasonable at ~$107 per share). Heading into 2018, this is a situation I am keeping a close eye on.

Conclusion

All in, my pretax investment return for the year, including transaction costs, was roughly 19%.

With any luck, Mr. Market will become more skittish in 2018. Some significant bouts of volatility, and the investment opportunities that they present, 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, Under Armour, PepsiCo, 21st Century Fox, Yelp and Moody's.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 5.0/5 (10 votes)

Voters:

Comments

snowballbuilder
Snowballbuilder - 9 months ago    Report SPAM

Hi science thanks for sharing ,
I always wait and apprecciate your year-end article. Thanks for share your holdings and experience.

As always i think your are invested in first class companies and solid compunders: berkshire , msf , pepsico, 21th ... and the new entries moody and union pacific are best in class too.
You are growing up a dream team that will patiently work for you for years/decades.

Onestly i dont follow under armon and yelp

I understand you could be a bit unconfortable with msf price ... But i think, in the long run, you have made a good choise by selling ibm (who can look ceap) and holding msf (who can look a bit expensive) ... for what is worth i would have done exactly the same.

Looking at my year end
I ve made no new buy and no increments during the year.
For the first time i have little trimmed (10%) my long time holding of Recordati and 5% of diasorin.

I share and a bit readapt your disclaimers: First, I have no idea of how any of my stocks will do over the next week, month or year... and onestly i dont even care much. Second i dont make any suggestion/raccomandation.
All that sayd
I have 6 holdings, with the biggest 3 accounting for ~80% of my equity portfolio.

The major positions (%of equity) are:

Recordati (Rec.mi) ~40%
Holding Since 2009 ,

Diasorin (dia.mi) ~21%
Holding since 2010 ,

Tamburi (tip.mi) ~18%
Holding since 2015 ,

2017 (9 m) Result of the major holding

Rec.mi: ebit/share growth+21%, ebit margin 31%

Dia.mi: ebit/share growth +15%, ebit margin 31%,

Tip.mi (investment holding): Bvps growth ~+35%

Even more important (in my opinion) all the 3 are very well runned by entrapreneur skilled and with long term vision, growing internally and via selective bolt on acquisition and have strong Balance sheet with little or no financial debt.

For what Is worth the 2017 return of my equity portfolio was >30%.

The other money are sitting in cash on bank earning nothing. As you i dont own any bond ( i dont want any " returnfree" risk ... ;) ).

I ve no idea of how the share price of my holdings will perform in 2018 and , as usual, i dont event care much.

I think they are first class companies and very well and conservative run, i m comfortable sitting on and i sleep like a baby.

Best for the 2018 both in the market and outside

With friendship
Snow

The Science of Hitting
The Science of Hitting - 9 months ago    Report SPAM

Snow - Thanks for the kind words as always, and congrats on the solid business performance of your top holdings. I'm not familiar with those companies, but it sounds like they're best in class. Finally, here's to hoping that Mr. Market gives us a chance to use some of that excess cash this year :)

stephenbaker
Stephenbaker - 9 months ago    Report SPAM

Thanks for sharing, Science. In case you're wondering, I, too have a very limited equity portfolio (most of my excess $ is used in my businesses). In order of weighting, they are BRKA & B, MSFT, AAPL, TGT, ETN and T. No sales last year; initiated position in TGT in early '17 and added thoughout. I did hold a longstanding position in LUK that I sold earlier this week. Best of luck to you and please continue posting.

The Science of Hitting
The Science of Hitting - 9 months ago    Report SPAM

Stephen - Sounds like a high-quality portoflio.

Thanks for the kind words; I'll do my best to keep posting :)

jtdaniel
Jtdaniel premium member - 9 months ago

Hi Science,

I really enjoyed your portfolio review and the excellent comments it generated. One thing our portfolios (and Snow’s) have in common is that the same companies are held year after year. I think the quality and focus of your portfolio is first rate.

Another similarity is Berkshire and Microsoft, which helped me navigate a somewhat difficult year for Exxon.They are my second and third largest positions behind Exxon (31%). Following XOM are Berkshire (14%), Microsoft (7%), cash (6%), Home Depot (5%), WFC (5%) and AXP (4%). That amounts to 72% in six stocks and cash, which I suppose qualifies as a focused approach. I don’t foresee selling a single share of any of these stocks in the next several years and would be eager to buy more at a reasonable price. Have a great 2018.

The Science of Hitting
The Science of Hitting - 9 months ago    Report SPAM

Jtdaniel - Looks like we're on the same page. Also, it sounds like I may need to do some updating on XOM! Have a great year as well.

jtdaniel
Jtdaniel premium member - 9 months ago

Hi Science,

I definitely consider Exxon to be a high conviction hold, and an ideal stock for retirement portfolios. Exxon successfully weathered a dramatic cyclical downturn in oil and natural gas prices and emerged with a better balance sheet than its peers (also long RDS.A). Rex Tillerson probably over-paid for XTO Energy (company line is “bad timing”), but I think he was correct in foreseeing natural gas as a long-term place to be. In short, I see Exxon as a measured play on more favorable commodity prices and a retirement annuity.

As for valuation, my last meaningful purchase was at $69 per share in 2014. I consider the prevailing price to be on the conservative side of fair value and suitable for dollar cost averaging. Best, dj

The Science of Hitting
The Science of Hitting - 9 months ago    Report SPAM

dj - Thanks for the thoughtful reply!

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