Wednesday, September 2, 2009

Six Stock Portfolio Update

Portfolio performance since mentioning on April 9, 2009 that I like these six stocks as long-term investments if bought near prevailing prices at that time (or lower, of course).

While I never make stock recommendations each of these, at the right price, are what I consider attractive long-term investments for my own capital.

Stock|% Change*
WFC|+47.3%
DEO|+36.3%
PM  |+19.2%
PEP |+8.0%
LOW|+6.7%
AXP|+91.9%

Total return for the six stocks combined is 34.9% (excluding dividends) since April 9th. The S&P 500 SPDR ETF is up 21.1% since that date. This is a conservative calculation of returns based upon the average price of each security on the date mentioned. Better market prices were available in subsequent days so total returns could have been improved with some careful accumulation.

The purpose is not to measure returns over such a short time frame. It's meant to be, in part, just an easy to verify working example of Newton's 4th Law.

Most equity investors would get improved returns if they: 1) bought and held shares in 5-10 great businesses (if time permits stock research), 2) avoided the hyperactive trading that is so popular these days to minimize mistakes & frictional costs, and 3) sold shares in a business only if the core long-term economics become impaired or opportunity costs are extremely high.

A six stock portfolio is very concentrated but this approach rejects the idea that vast diversification is needed. I've noted this in a previous post.

"We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it." - Warren Buffett in the 1993 Berkshire Hathaway Shareholder Letter

Having said that...the less experienced you are as an investor the more diversification may be a necessity. Those that fall into this group probably need to diversify holdings more but still keep trading and frictional costs to a minimum. Index funds may make more sense than buying individual stocks. It's important to know which camp you fall into before investing a penny.

The above concentrated portfolio of six stocks won't outperform in every period. In the long run it has a reasonable probability of doing well compared to the S&P 500 due to lower frictional costs and the quality of the businesses. The growth in value comes from the intrinsic value created by the businesses themselves...not some special aptitude for trading or timing the market. It probably won't outperform the very best portfolio managers but should do very well against many mutual funds** over a period of 10 years or longer.

In any case, this simple experiment is designed so it's easy for anyone to check the results. If this six stock portfolio*** isn't performing well against the S&P 500 (it'll take a few years, at least, to meaningfully start judging performance) it will be obvious.

Finally, an opportunity may come along where the capital from one of these stocks is needed.

My view is under such a scenario the threshold for making changes needs to be high. That hypothetical new investment must have clearly superior economics.

In addition, if something appears to fundamentally threaten the moat (ie. the effect of the internet on the newspaper biz) of one of these businesses a change may also be warranted.

So I may rarely add or switch some of the stocks in this portfolio but I will only make a change if the situation described above exists (ie. if the core long-term economics of one of these stocks become impaired or opportunity costs are extremely high).

Adam

Long position in DEO, AXP, PEP, PM, WFC, and LOW

* As of 8/31/09.
** 
There's no shortage of evidence that many actively managed equity mutual funds underperform the S&P 500. Also, DALBAR's Quantitative Analysis of Investor Behavior (QAIB) study released in March 2009 revealed that over the past 20 years investors in stock mutual funds have underperformed the S&P 500 by 6.5% a year (8.35% vs. 1.87%). Beyond the performance of the funds themselves, it shows that much of these poor returns come down to investor behavior. The tendency of investors to buy the hot mutual fund that has been going up while selling when the market is going down out of panic or fear (the same is true for stocks).
*** I don't think these are necessarily the six best businesses in the world, but I believe they are all very good businesses that were selling at reasonable prices on April 9th. At any moment, there is always something better to own in theory but I don't think you can invest that way (as if stocks are baseball cards) and have consistent success. So there are certainly quite a few other shares in businesses that would be good alternatives to these six. The point is for me to get a handful of them at a fair price and then let time work.

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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here are never a recommendation to buy or sell anything and should never be considered specific individualized investment advice. In general, intend to be long the positions noted unless they sell significantly above intrinsic value, core business economics become materially impaired, prospects turn out to have been misjudged, or opportunity costs become high.
 
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