Thursday, March 1, 2012

Six Stock Portfolio Performance

It has now been a little less than three years since I first mentioned the Six Stock Portfolio. At that time, I considered those stocks attractive long-term investments, at the then-prevailing price levels, for my own portfolio.*

At the time, I felt the share price of each represented a very nice discount to likely intrinsic value a few years out and said as much. No estimate of value can be perfect, of course, but each seemed oddly cheap back then compared to even the most conservative estimate of their intrinsic worth.

Some are still at a discount to my judgment of their value, but not by enough to warrant buying more shares. To me, the margin of safety is now insufficient.

As a group, the six stocks have a bit more than doubled in price since they were first mentioned.

Stock                           |4/9/09 Price| Current Price| Total Return**
Wells Fargo (WFC)        19.61                31.29                 65%
Diageo (DEO)                  45.54                 95.56              133%
Philip Morris (PM)        37.71               83.52               151%
Pepsi (PEP)                      52.10                62.94                32%
Lowe's (LOW)                 20.32                 28.38                48%
AmEx (AXP)                    18.83                52.89              195%

The combined return is 104 percent (including dividends) for these six stocks while the SPDR S&P 500 (SPY) (also including dividends) returned 68 percent over the same time frame.

Below is a quick summary of current trailing price to earnings ratio and dividend yield of each stock compared to the SPDR S&P 500.

Stock | Trailing P/E| Dividend Yield
 WFC        11.1                   1.5%
 DEO         19.8                   2.7%
 PM            17.1                   3.7%
 PEP          14.3                   3.3%
 LOW        17.1                   2.0%
 AXP         12.9                   1.4%

The combined yield of these six is 2.4% while naturally, since the stocks as a group have doubled, the yield on the April 2009 initial investment would be close to 5%.

The yield on the SPDR S&P 500 is currently 1.9% but would be more like 3% on the initial investment if bought back in April 2009.

So the bottom line for this portfolio is returns have been 104% in a little less than 3 years while the six stocks continue to pay nearly 5% in dividends on the initial investment.

Pepsi's been the laggard and probably will continue to do so as they sort out some of their problems. I still view it as a good business for the long haul but I'll be keeping an eye on their progress in improving business performance.

Intrinsic value of the other five businesses continues to increase at a nice clip. Each business seems to be performing just fine. Unfortunately, so have the stocks.

As far as valuations go, Lowe's certainly isn't cheap but that relatively high P/E is partly the result of where we are in the housing cycle. Philip Morris and especially Diageo are, unfortunately, getting rather expensive (though both look a bit more reasonably valued based upon current year earnings).

The fact that these stocks were that inexpensive back in April of 2009 still seems amazing to me.

So, unfortunately, none are cheap enough to buy more at this point. Some might ask why not switch some of these not so cheap shares into something else that is more plainly cheap.

On rare occasions, I'll consider a switch if: valuation becomes extreme on the high side, I've lost confidence in (or significantly misjudged) the long-term prospects of the business, or I understand an equal or better quality alternative investment pretty much as well that is clearly much cheaper (I mean, it generally has to be something else that is just screaming at me). Otherwise, I'm just not that smart. Each move is just another chance to make a mistake and creates unnecessary frictional costs.

I own these because my judgment is that they have durable advantages that support attractive business economics and it was, at one time, possible to buy the shares comfortably below my conservative estimate of intrinsic value. Once I own shares of a good business at the right price (at least one that I understand), my bias is to not sell for a very long time. That means sometimes holding onto shares of a business I like even if, due to increased market prices, the stock might temporarily no longer be a bargain relative to current estimated per share intrinsic value.
(As long as my expectation is that intrinsic value will still increase over the long haul at an attractive rate.)

I don't expect many to adopt this way of thinking and apply it in their own way but it's, if nothing else, just a recognition of my own limits. Let's just see how these six perform over many years compared to the S&P 500. If I'm an idiot it will clear over time.

The blog is here to make sure of that.
(The other 15 stocks I've mentioned in my Stocks to Watch posts are also as a group up quite a bit more than the S&P 500. That's unfortunate as few of them are easy to buy right now. It would be easier to invest right now if at least some of them became a bit cheaper.)

This concentrated portfolio is meant to be an example of how attractive results can be accomplished with minimal to no trading. I'd imagine it takes a fair amount of energy to learn trading techniques and become proficient (though I don't plan to find out). My interests lie elsewhere. Instead, my energy and focus has always been on judging business quality and value, being disciplined about buying shares at a substantial discount, and minimizing frictional costs of all kinds.

Returns are driven by the economics of each business and always buying with a margin of safety, not some unusual talent for trading.

Of course, some may want or need to own more than six stocks but I generally view concentration as a good thing. At least for me, it's not possible to get a good understanding of 50-100 businesses.

Some may be able to do just that but I can't.

I suspect there are a few who are kidding themselves that they understand so many businesses well enough to risk capital.

So I think attractive results can be achieved without some unusual acuity for trading but, instead, via paying the right price for good businesses with sound economics and owning them for a very long time.

Naturally, like Pepsi, at some point each of these businesses will not perform well for a period of time (and stock performance will suffer). Yet, considering both the quality of the businesses and the price that shares could be purchased for in April 2009, I'd expect this portfolio's overall results to be just fine over the very long haul.

Of course, as noted above, if my view of future prospects were to change action might be necessary. For example, if the economic moat of one of these businesses became materially impaired (or if capital allocation decision-making by management became a serious concern), I will certainly consider switching one of these out.

It's probably obvious for those who have read some of my previous posts that I don't view it as a good thing this portfolio has doubled in value so quickly. Right now, I am comfortable with these six stocks long-term but, at current prices, neither I nor the company can buy shares at an extreme discount to value.

In the long run, as Buffett pointed out using the IBM example in the most recent Berkshire letter, that will reduce returns for long-term owners. So it makes no sense to be happy the stocks have run up this much.

It actually hurts relative and absolute long-term performance.

If these stocks do well over the long haul, it will because the six companies themselves continue to have attractive core business economics and were bought at a discount to per share value in the first place.

Finally, three years or so is still actually not long enough to make a meaningful judgment on relative performance in my view.

Adam

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

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.
** Includes dividends and is based upon the closing price on April 9th, 2009 compared to February 29, 2012.
 
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