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The Science of Hitting
The Science of Hitting
Articles (494) 

2018 Year-End Portfolio Review

A look at my largest holdings and some thoughts on the year

January 02, 2019 | About:

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. What started as a short break for a few weeks 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 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. (NASDAQ:FOXA)

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. (NYSE:BRK.B)

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. (NYSE:WFC)

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 timewe’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. (NASDAQ:MSFT)

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. (NASDAQ:CMCSA)

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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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 (11 votes)

Voters:

Comments

Grahamites
Grahamites premium member - 2 weeks ago

Science: Congratulations on your deserved great performance! Simple but not easy. Well done!

The Science of Hitting
The Science of Hitting - 2 weeks ago    Report SPAM

Thanks Grahamites! Hope the next few years will be as kind as the last few! :)

Thomas Macpherson
Thomas Macpherson premium member - 2 weeks ago

Well done Science. The past five years have not been so kind to value investrs. Congrats on a great performance and best wishes for the future. - Tom

batbeer2
Batbeer2 premium member - 2 weeks ago

Good job!

Also, thank you for sharing your thoughts.

The Science of Hitting
The Science of Hitting - 2 weeks ago    Report SPAM

Thank you gentlemen! Best of luck to you in the coming year!

jtdaniel
Jtdaniel premium member - 2 weeks ago

Hi Science,

I always enjoy reading your perspectives and portfolio updates. Congratulations on your fine results. I haven’t calculated my annual portfolio return, but I am pretty sure that Exxon’s <18.5> contribution (dividends excluded) didn’t help. Exxon accounts for 18% of my total investment portfolio and 27% of the stock portion. On the brighter side I have 32% in cash and treasuries and a few interesting ideas coming more into focus. Exxon and Wells Fargo are certainly among them.

Our portfolios continue to have Berkshire, Microsoft and Wells Fargo in common. 51% percent of my stock portfolio value is in Exxon (27%), Berkshire (15%), and Microsoft (9%), with 80% in ten positions. Best wishes for a great 2019.

stephenbaker
Stephenbaker - 2 weeks ago    Report SPAM

Hi Science,

Thanks for sharing. Year end is always a time when we look back and reflect on the prior year's performance but I wonder if that is not the result of our income tax system rather than any other legitimate reason.

Let me pose a question: If you owned a portfolio of (say 10) stocks that had an average dividend yield at the beginning of 2018 of 3%, finished the year with an average dividend yield of 3.3% (or a 10% increase in their cumulative dividend payout), and all the companies continued to perform in line with your expectations, how would you rate your investment performance last year?

Let's further say that you made opportune stock purchases (prices at or below IV) with dividend proceeds or idle cash during the course of the year and those new companies are performing as per your expectations.

Did you do well? If your investments were in real estate, private businesses or other less-liquid income producing assets rather than public equities, you could say you hit it out of the park. Do the same for a few more years and you know what the outcome will be. Best wishes.

The Science of Hitting
The Science of Hitting - 2 weeks ago    Report SPAM

Jtdaniel - Thanks for the kind words! Best of luck in 2019 to you as well.

The Science of Hitting
The Science of Hitting - 2 weeks ago    Report SPAM

Stephenbaker - On your question about the dividends, it would all depend on how we got there. If you're suggesting that earnings power increased 10% (i.e the payout ratio was unchanged to get from 3.0% to 3.3%), I wouldn't care that the stock price was flat for the year. As long as intrinsic value is increasing at a reasonable clip I think all will be well over time. Thanks for the comment!

stephenbaker
Stephenbaker - 2 weeks ago    Report SPAM

Yes, rising IV over time is what matters. Dividends historically contribute to about one-half of stock market returns so rising dividend payouts matter. Price drops also help - not hurt - long term investors. Would you be happier if prices rose or dropped 50% from here this year on your best ideas?

The Science of Hitting
The Science of Hitting - 2 weeks ago    Report SPAM

Stephenbaker - Happy! I would like to buy more at 50% below today's price (but not sure I would have the money to do so because I would've spent it all when it was down 20% - 30% from here!)

stephenbaker
Stephenbaker - 2 weeks ago    Report SPAM

Science, for many reasons I believe prices will go much lower - not necessarily in the coming year but in the next few years for sure. The beauty of a (mostly) growing dividend portfolio is you always have an increasing amount of cash coming in with which to invest. In your article you alluded to the issue of holding cash; I don't believe buying anything but your best ideas at sensible prices ever makes sense and therefore when prices do get expensive, I'm willing to let cash build up and await better buying opportunities, or alteratively use the money in private business investments, real estate or other more attractive options to cash. (As a 57-year old, having been through several cycles of peaks and troughs, I speak of experience). Unless you are in the money management business wherein your success lies in attracting and satisfying investors, your only competition is yourself and your own long term objectives.

The Science of Hitting
The Science of Hitting - 2 weeks ago    Report SPAM

Stephenbaker - Hard to argue with that! Have a great weekend :)

snowballbuilder
Snowballbuilder - 2 weeks ago    Report SPAM

Hi science

Your year-end article is an update i m always waiting for

Tanks for sharing your experince, your thoughts and your holdings

I thinks you own a group of dominant companies and solid compounders that will continue to benefit their long term oriented shareholders.

How long are you invested in BRK? Still own MCO and UNP?

The same for my friend JT: holding BRK, MSF, WFC, XOM is (my opinion) a great and “simple” way to preserve and built wealth

As for me,

First the usual disclaimers: I have no idea of how any of my stocks will do over the next week, months… and onestly i dont even care much. Second i dont make any investments suggestion/raccomandation of buying or selling anythings.

All that sayed i have only 4 holdings at year end (they were 6 an year earlier).

One (YNAP) has been taken over and delisted in the first half of 2018 and i ve sold the other one after loosing the confidence in his top management (especially in term of full/fair disclosure to the shareholders).

I ve made no new buy and no increments during the year (the same in 2017)

So i m left with:

Rec.mi holding since 2009

Dia.mi holding since 2010

BC.mi holding since 2012

TIP.mi holding since 2015

The 2018 (9 months) operating result of my holdings were solid

Even more important (just my opinion) all the 4 are very well runned by entrapreneur skilled and with long term vision, growing internally (BC, REC e DIA) and via selective bolt on acquisition (REC e DIA) and have strong Balance sheet with little (BC e REC) or no (DIA) financial debt.

As for TIP i think the fonder and CEO (Mr Tamburi) is one of the best investor and capital allocator around.

For what is worth the 2018 return of my equity portfolio was around 0% (really impressive ;))

(as a result of a strong YNAP OPA return and a weak REC annual performance)

The other money are sitting in cash on bank earning substantially nothing.

As you i dont own any MT/LT bond (I dont want any " returnfree" risk ... ;) ).

I ve no idea of how the share price of my holdings will perform in 2019 and, as usual, i dont even care much.

3 out of the 4 holdings are multibaggers and i think also the fourth will sooner than later join the club.

I havent calculate the 5 year return but simply looking at the cost and the market value of my portfolio (also without adding the growing dividend and realized gain) i m sure i m doing fine

Best for the new year both in the market and outside

With friendship

Snow

“A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind, loving diagnosis involving multiple variables. And then all that is required is a willingness to bet heavily when the odds are extremely favorable, using resources available as a result of prudence and patience in the past.” Munger

The Science of Hitting
The Science of Hitting - 1 week ago    Report SPAM

Snow - Always good to hear from you! I've owned Berkshire since 2011 I think (around when I started investing "for real"). And I still own MCO but not UNP. Thanks for the details on your portfolio and your most recent thoughts. Best for the new year as well friend!

jtdaniel
Jtdaniel premium member - 1 week ago

Hi Snow,

Great to hear from you. Nice work on your very focused and high-quality portfolio. It is a testament to Science's writing and investing skills that so many obviously dedicated value investors added such insightful comments. I can easily relate to Stephen's comments as I hope to turn 60 this year.

Now if anyone knew in advance that MSFT would be up 59.40% and XOM down <22.30%> in 2017/2018 they forgot to tell me. It is all part of managing a focused portfolio, even if the largest holdings are super-cap Dow stocks. The endless sequence of "okay, now what?" moments continue to fascinate me, even if the correct answer is usually "hold tight". Have a great new year.

The Science of Hitting
The Science of Hitting - 1 week ago    Report SPAM

Jtdaniel - You're too kind :)

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