This is the seventh year-end portfolio review I’ve written for GuruFocus. It’s something I look forward to because it usually generates a lot of quality feedback from readers. As a quick aside, this also marks the first time I’ve written in some time. For whatever reason, I haven’t felt the urge to sit down and put pen to paper lately. What started as a week off eventually became months. That’s going to change. I intend on writing more often in the new year.
With that, here are the usual disclaimers: First, I have no idea how these stocks will do over the next week, month or year. Second, I wouldn’t mind if they kept trading lower so I could buy more (I will be a net buyer of stocks for a long time); in addition, many of these companies will spend billions on share repurchases in the coming year, so I hope they can do so as cheaply as possible.
As we all know, 2018 was an interesting year. The first three quarters were kind to investors, with the total return for the S&P 500 crossing 10%. That all changed in the fourth quarter, with the peak-to-trough drawdown for the index approaching 20%. With help from a lower effective tax rate, 2018 was the first time in a few years that S&P 500 earnings growth (a proxy for intrinsic value) meaningfully outpaced stock prices. Said differently, U.S. stocks are more attractive than they were a year ago. After years where the opposite was true, I think that’s a welcome (and healthy) change.
As I noted a year ago, I started 2018 with roughly 20% of my portfolio in cash and short-term treasuries (I do not own any other fixed-income securities). I put a lot of dry powder to work throughout the year and brought cash down to about 10% of my portfolio. In terms of portfolio construction, I continue to debate the rationale for holding cash if you have a long-term horizon (call it 10 years or longer). It’s something I’ve written about in the past, so I won’t rehash the discussion here. You should read this letter from the team at Semper Augustus if you’re interested in further thoughts on the topic. I think they make a number of compelling points.
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 two-thirds of the total. Afterwards, I will discuss my overall results for 2018.
21st Century Fox Inc. (FOXA, Financial)
Fox became my largest holding in 2018 (17% weighting at year end). As I noted in my 2017 review, I felt the valuation Mr. Market was applying to “New Fox” was too cheap at the start of the year. I’m also happy with the “currency” I’ll receive as part of the deal. In addition, I’m assuming a large percentage of the value when the transaction closes will be in cash (I’m voting for 100% equity, but I don’t think that will happen); as a result, the deal structure provided downside protection in the event of a market correction (that theory played out over the past few months). For those reasons, I meaningfully increased my Fox position in July. From here, I don’t plan on doing anything with the position until the deal closes.
Berkshire Hathaway Inc. (BRK.B, Financial)
I write about Berkshire Hathaway (16% weighting) frequently, so feel free to review my other articles if you want to know why this has been and will continue to be a large position. I think the valuation is attractive and expect the stock to outperform over the long run, particularly if the environment worsens (between acquisitions, purchases of publicly traded securities and share repurchases, I would expect Berkshire to invest tens of billions of dollars if unease deteriorates into a full-blown panic). No matter what the future brings, I’m comfortable with a sizable position in Berkshire.
Wells Fargo & Co. (WFC, Financial)
Wells Fargo (13% weighting) is a new addition to the top five. I wrote an article about the company last year that outlines my thesis. Wells is in the early innings of a significant capital return program. By my math, the share count should decline by more than 20% over three years (the repurchases have already begun). This is a classic example of a stock where investors should cheer when the stock price moves lower, not higher.
I think Wells can earn somewhere around $6 per share in a few years. Even if we haircut that number, the stock is trading at roughly 8x earnings. Personally, I don’t think that makes any sense. With the stock anywhere near current levels, my hope is management will spend a significant percentage of capital on repurchases (something they are already committed to as part of bringing down their CET1 ratio). Warren Buffett (Trades, Portfolio) said at the most recent Berkshire Hathaway shareholder meeting that Wells “is a wonderful bank that’s going to do very well over time… we’ll make a lot of money.” Since that time, the stock has fallen approximately 15%. In my opinion, the story is unchanged (customer data supports that conclusion). If you Wells for the long run, I think there’s a good chance you’ll be happy with the outcome from here.
Microsoft Corp. (MSFT, Financial)
Microsoft, like Berkshire, has been a top holding for as long as I’ve been doing these reviews. Fiscal 2018 was another strong year for Microsoft’s business. In the most recent quarter, the commercial cloud business reached $34 billion in run rate revenues (amazingly, it still grew 47% year over year). CEO Satya Nadella has proven he is exactly the right person to lead Microsoft (remember that many commentators were certain an internal hire would be a huge mistake; they were wrong).
Microsoft continues to have a fortress balance sheet that will be used for the benefit of investors (the pace of repurchases increased meaningfully last quarter). However, as I noted last year, I do not think the stock is particularly cheap (though it looks better after the recent selloff). 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 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 Nadella’s business partner for the long term, even if I'm not in love with what 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.
Comcast Corp. (CMCSA, Financial)
Comcast, which accounts for 10% of my equity portfolio, is a leading provider of video, internet and voice services to residential and business customers in the United States. I think the company has a sustainable competitive advantage in this segment and believe that cord cutting is a manageable long-term risk for the business. In addition, I’m willing to give management a longer leash on M&A than others (or at least, that’s my perception). I think they’ve earned that right based on the track record they’ve established over 20-plus years.
Rather than rehash what I wrote last year, I’ll reprint the conclusion from that article:
“Comcast is a well-run, high-quality business. Management has proven adept at navigating a changing landscape, in addition to demonstrating intelligent capital allocation and operational ability over many years. Over the course of an investment lifetime, you will do quite well if you partner with high-quality individuals like Brian Roberts and Steve Burke.”
I think that’s still correct. At $34 per share, Comcast trades at a material discount to my estimate of intrinsic value. If the stock price continues to decline, I will add to my position.
Conclusion
All in, my pretax investment return for the year, including transaction costs, was roughly +3%. That’s certainly not what I’m looking for on an absolute basis, but I can take some comfort in holding up decently in a market that was down more than 4% (including dividends) for 2018. Considering how I structure my portfolio and the kind of companies I own, that’s the kind of outcome I would expect when the market has a down year.
With a few years behind us, it probably makes sense to start presenting return data beyond the past 12 months. Over the past five years, my portfolio has compounded at 11.4% per annum, compared to 8.5% per annum for the S&P 500. It’s probably still too early to draw any meaningful conclusions from those numbers, but it’s at least an encouraging start.
I don’t have any idea what Mr. Market has in store for us in 2019, but I’d be happy if we see more volatility and lower stock prices. Those are the prerequisites for compelling opportunities. As always, I look forward to the thoughts of fellow investors. Best of luck in the coming year!
Disclosure: Long FOXA, BRK.B, WFC, MSFT and CMCSA.
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