Tuesday, December 11, 2012

Barron's 10 Favorite Stocks for 2013

This past weekend, Barron's released their favorite stocks for 2013.

Barron's 10 Favorite Stocks for 2013

Apple (AAPL)
Barnes & Noble (BKS)
BlackRock (BLK)
General Dynamics (GD)
JP Morgan Chase (JPM)
Marathon Petroleum (MPC)
Novartis (NVS)
Royal Dutch (RDS.A)
Viacom (VIAB)
Western Digital (WDC)

Chart: Apple, Barnes & Noble, Blackrock, General Dynamics
Chart: Marathon, Novartis, Royal Dutch, Viacom, Western Digital

Best case, a list like this can be a starting point for one's own research on a particular stock.

I'll focus a bit on just one of them.

Viacom.

Some things worth noting:

- The company plans to continue buying back its stock and rather aggressively.
- Roughly 10% of its stock was bought back in the fiscal year that just ended in September.
- More of the same is planned this year.
- The earnings multiple is ~ 11-12x.
- The shares happen to be a smaller position in the Berkshire Hathaway (BRKa) equity portfolio.
(Though not necessarily small compared to the funds managed by his two investment managers.)

This article provides a summary of which Berkshire equity investments are likely the work of Warren Buffett's two investment managers: Ted Weschler and Todd Combs. According to the article, Viacom was likely purchased by Ted Weschler.

Generally, it is only the very largest equity positions -- usually several billion dollars or more -- that are investments by Warren Buffett himself. These days, his focus is much more on buying entire businesses and, as Buffett said here, continuing to build Berkshire as a business.

Viacom expects to buyback $ 2.5 billion of stock over the next year. It's not just similar to Viacom's buyback levels this past year, where the company bought back $ 2.8 billion.

In the fiscal year before that, it was $ 2.45 billion.*

The amount they plan to buyback this year is consistent with recent behavior. Buyback levels slightly exceed free cash flow (after dividends) so the company took on some debt to make up the difference. It's at least worth noting (though total debt is hardly alarming at current levels) that some modest additional debt has partially funded, along with free cash flow, the recent buybacks.

Bloomberg: Fitch Rates Viacom's Note Offering 'BBB+'

Of course, a buyback is no good unless the shares are bought below intrinsic value (and ideally comfortably below). As I mentioned, the stock currently sells for roughly 11-12x earnings. On the surface, maybe not expensive, but I'll let those who know how to confidently estimate Viacom's per-share intrinsic business value decide whether a sufficient discount exists. I'll also let those who really understand the business figure out how lucrative these buybacks will be for continuing long-term shareholders.

Any investment comes down to knowing whether you really have a handle on a company's future prospects and range of possible outcomes.
(To figure out what the business is conservatively worth per share, and a price that represents a sufficient discount to value considering the specific risks.)

With Viacom, I don't.

A good business selling at a material discount to intrinsic value, with plenty of available funds (cash on hand, free cash flow, borrowing capacity) to:

- meet operational & liquidity needs,
- maintain/increase competitiveness (incl. the flexibility to pursue optional value creating business expansion),

that also has an aggressive buyback plan will usually be of considerable interest.

Unfortunately, Viacom is just not something that I understand sufficiently well to make a sound judgment about the quality of the business or what it is intrinsically worth.
(I understand neither the downside risks nor the favorable prospects, if any, to the upside.)

So Viacom could end up being a great investment but that doesn't matter.

I simply won't buy shares of a business with long run prospects and risks that I don't understand well.**

"The first principle is that you must not fool yourself, and you are the easiest person to fool." - Richard Feynman

Buying shares of a business (with the intent to own long-term) requires more than just a superficial insight (or a good "story"). High levels of justified conviction need to be behind the action.

Knowing what not to be buying -- something that's necessarily different for each investor -- seems a sometimes underappreciated investing discipline.***

Ignore this and, eventually, some pretty big mistakes are likely to be made. In fact, early successes achieved might lead to even bigger permanent losses of capital later on due to unwarranted overconfidence.

I'll follow up on this in a separate post at some point.

Adam

Long position in JPM and AAPL established at much lower than recent prices

* In each of the past two fiscal years, the net amount bought back is slightly less when you include the effects from the exercise of stock options.
** Viacom may have more strengths than it's getting credit for here. In other words, it might be a much better business than I realize. The free cash flow and how they are using it is certainly attractive, but how the core economics are going to change as content is consumed in increasingly varied ways over time is hard for me to gauge. That view is just as likely (if not more likely) to be a reflection of my limitations as it is Viacom's. Still, business models in the media sector seem to be changing awfully fast. Now, eventually a business gets cheap enough to account for all but earning falling off a cliff. Basically, it gets to the point where you are purely buying the cash flow the business produces -- even if declining -- extremely cheap. It's buying a dollar of cheap cash and cash flow for 50 cents (or less) on the basis that it will be put to reasonably good (if not brilliant) use. Of course, even if there is a big margin of safety, you still have to watch out for the really dumb capital allocators. So there are subpar businesses that I'll own shares of (and do own shares of) if I feel I understand the flaws (likely downside) well enough and the price represents a huge discount to just the discounted value of the cash.
*** It's knowing one's own limitations and capabilities. Investing in areas where sound judgment is lacking and a high level of conviction isn't there beforehand is trouble. An investor is likely to make big mistakes and will be unlikely to hang in there when required (if a cheap stock gets even cheaper). Sometimes, an investment might even produce a good result yet still shouldn't have been purchased in the first place. Why? The insight and conviction wasn't there. It was more good fortune than sound judgment that led to the results. Luck mistakenly interpreted as skill. Not a good thing if achieving satisfactory risk-adjusted long-term returns is the objective.
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