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Robert C. Merton is perhaps one of the most brilliant financial theorists in the world.  He received the Alfred Nobel Memorial Prize in Economic Sciences in 1997 for a new method to determine the value of derivatives, Merton’s research focuses on finance theory, including life-cycle finance, optimal intertemporal portfolio selection, capital asset pricing, pricing of options, risky corporate debt, loan guarantees, and other complex derivative securities. No doubt, he is an incredibly brilliant man, but at the same time, he was the principal of Long-Term Capital Management, a speculative hedge fund that collapsed in the late 1990s after losing $4.6 billion.  Not only was he extremely smart, but all 15 of his partners were super smart too.

Long-Term Capital Management did business with nearly everyone important on Wall Street. Indeed, much of LTCM’s capital was composed of funds from the same financial professionals it traded with. After its collapse on September 23, 1998, Goldman Sachs, AIG, and Berkshire Hathaway offered to buy out the fund’s partners for $250 million, to inject $3.75 billion, and to operate LTCM within Goldman’s own trading division. The offer was stunningly low to LTCM’s partners, because at the start of the year their firm had been worth $4.7 billion. Warren Buffett gave Meriwether less than one hour to accept the deal; the time period lapsed before a deal could be worked out.

Unfortunately similar to the case of Robert C. Merton and LTCM, the stock market is full of smart people and companies doing stupid things… the list is long: Jeff Skilling of Enron, Bernard Madoff, AIG, Lehman Brothers, Fannie Mae, Freddie Mac, and so on.

As Warren Buffett mentioned in this great speech–what is important are the qualitative factors of a person, because everyone has the intelligence to do just the right thing.

When asked about Long-Term Capital Management just 4 weeks after the final call to agree on the bailout, Warren Buffett recounted one of the most valuable lessons I have ever heard in financial advice: [click to continue…]

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Ted Williams Ted Williams

The Science of Hitting was a book that attracted Warren Buffet’s attention. The book was written by Ted Williams, one of the greatest baseball hitters of all times. His impact on the game, both as a player and as an inspiration to generations of hitters who followed, continues to this day. Williams combined the following:

  • Power (521 lifetime home runs)
  • Patience (he received more walks than any batter in his day); and
  • Control (a .344 lifetime average) that no player had ever done before.

He had the intelligence of a lead-off hitter and the brawn of a power hitter; the patience of a bench warmer, and the bat control of a single hitter.

His contribution to the game was to reduce the waiting time to hit a perfect pitch; he said that a good hitter can hit a pitch that is over the plate three times better than a great hitter with a questionable ball in a tough spot. Williams knew, for example, that a high and inside strike pitted his weakness against the pitcher’s strength. If he consistently swung at those pitches, his batting average would suffer. A low and outside pitch produced the same results – a success rate far below Williams’ lifetime batting average. However if Williams received a pitch in his optimum strength zone, he put all his muscle into it, knowing that he could consistently produce a higher batting average. In constructing a template for success, Williams outlined a pattern of patience. He realized that it was often better to take a pitch on the fringe of the strike zone rather than swing for a low average. A called strike was better than making an out.

Buffet extends the same reasoning to stock picking. The stock market is like a major league pitcher who fires thousands of pitches a day, with each pitch representing a certain stock at a certain price. As the batter, you must decide which of the thousands of pitches to swing at, and which you will let whiz by. What distinguishes you from a baseball player, however, is that you don’t ever have to swing. The game of investing doesn’t force you to take the bat off your shoulder and swing, unlike the batter in the stadium. No one will “call you out”. Buffet says: [click to continue…]

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In my February letter to investors I explained why I was a believer in the JC Penny (JCP) rebound. I cited some cases throughout history where struggling companies have rebounded, making millions for smart value investors. Warren Buffett did this in the seventies with Geico. By 1974, the company was not fairing well. The government had introduced no-liability insurance in some areas, the company had extended its clientele to higher risk categories, and there were inadequate provisions made for future claims.

In 1976, GEICO announced a loss of $126 million. The company’s shares, which had traded as high as $42, were down to just under $5. The 1976 Annual General Meeting was a near riot with angry shareholders challenging management – by that point, the shares were down to about $2.

Buffett had always kept his eye on the company and took the view that despite its problems, the company’s core business was sound.

Following the annual meeting, there was a change in company management with JJ Byrnes taking over the key role. Byrnes made some drastic changes, cancelling high-risk policies, laying off staff, and moving the headquarters. Through Katherine Graham, of the Washington Post, Buffett arranged to meet with Byrnes and was apparently impressed enough to buy (via Berkshire Hathaway) 500,000 shares in the company with a standing order to buy more.

The company started to improve, managing to offload much of its reinsurance risk. Salomon Brothers came to the party with an underwritten preferred stock issue (of which Berkshire took 25 per cent) and Buffett interceded with the insurance regulators to ensure that GEICO kept its licenses.

Six months later, shares had risen to $8. Warren Buffett made 300% on this deal, in just a few months.

The same strategy of buying shares in companies that are temporarily struggling, but with sound core businesses, is paying off for me in 2014. Two of my biggest holdings this year, JC Penny (JCP) and Ecopetrol (EC), were up more than 18% in March, bringing my total portfolio up 5.94% for the month.

Summary Portfolio Performance

Since inception (01/19/12), the model is up 46%, versus the S&P 500 50.2%. The return of the S&P 500 in March 2014 was 0.69%, compared with 5.94% for my Dividend Paying Large Caps portfolio. Year to date my portfolio is up 4.87% compared with 1.3% of the S&P 500.

All of my positions in March 2014 were in positive territory, except Aflac (AFL) down -1.6%, and American Express (AXP) down -1.4%.

Acquisitions in March 2014

In March 2014, I didn’t add any new position to my portfolio, but I increased two of my current holdings: JC Penny (JCP) and Ecopetrol (EC). As it turns out, these holding increased by more than 18% in March alone, contributing to a stellar performance of my portfolio with +5.25% more than the S&P 500. Only two positions in my portfolio went down: Aflac (AFL) -1.6% and American Express (AXP) -1.4%. Both positions were up in February, and I’m not concern about the small decrease in March. Both Aflac (AFL) and American Express (AXP) are still fantastic companies with bright futures and they are still very reasonably priced.

In April, I don’t anticipate selling any of my current positions. I will only sell if I find another opportunity I believe is better than what I currently have. The positions that I am monitoring closely are JP Morgan (JPM) and Intel (INTC). JP Morgan (JPM) has the lowest price/book value ratio in my portfolio, and is still paying good dividends, so for now it is a keeper. Intel (INTL) is also paying great dividends, PE ratio is low at 13.77, and debt to equity is also the second lowest in my portfolio after Apple (AAPL). So I will continue with this one as well.

In summary this quarter, and more specifically this month, was great for my portfolio. My strong portfolio is now prepared in the event that the stock market goes south in 2014. Something that may happen the minute the Fed relaxes its monetary policies. I plan to keep a close eye on that of course and make any adjustments to my course as necessary.

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Increasing my position in JC Penny

by admin on April 1, 2014

In February, JCPenny (JCP) had a stellar month, up 23%. While this stock is extremely volatile right now and not paying dividends (two points of concern for me), I think JCPenny is on the right track for recovery, and that the stock may soar later this year or in 2015. This is an investment I plan to have long term, and I’ll be patient enough to wait for a turnaround.

At different moments in time, companies face serious challenges – sometimes they fail, sometimes they succeed. The key for investors is to identify the companies that can pull it off versus those that will fail. A simple example of this is the story of Apple vs. the story of Palm. In the mid 90’s, Apple was no longer a technological leader.  In fact they were struggling just to stay afloat as the company lost money throughout of 1994, 1995, 1996, and 1997. The first quarter of 1997 marked a nadir, as Apple’s stock hit a 12-year low of $4, and the company reported a $708 million loss. At the time nobody wanted to hear about Apple stock, but it turned out that those who chose to invest would be rewarded with a 13,209% increase in 17 years.

As we now know, Apple was one of the companies that could pull it off.  Don’t get me wrong, identifying these companies is not easy.  If it was everyone would be making a fortune in the stock market.  It requires a deep understanding of the economy, the environment in which the company operates, market trends, competitors, and more than a little bit of intuition.  Companies on the verge of collapsing is like catching falling knives that only smart value investors with a lot of courage and instinct can take advantage of.

The other side to this story is the story of PALM.  PALM turned out to be a cautionary tale of a company in dire straits that didn’t have the resources necessary to succeed, operating in a hostile ever-changing environment, and making one bad decision after another. PALM created the first broadly adopted PDA (personal digital assistant) in the world, and was very successfully for a short while. Palm Inc. had its IPO during the dotcom bubble and on its first day of trading shares of the new company hit an all-time high of US$95.06.  However, this success was short lived – increased competition and the bursting of the tech bubble caused Palm’s shares to lose 90% of their value in just over a year.

By June 2001, the company’s shares were trading at US$6.50, making it the worst performing PDA manufacturer on the NASDAQ index at the time. After a series of events including a merger with Handspring in 2003, PALM’s stock surged back up to $18 in 2009, coinciding with the hype over WebOS. While reviews of the Palm Pre generally were positive, the decision to launch the product with only one U.S. carrier (Sprint) proved to be a crucial mistake that limited sales, and ultimately wasn’t enough to keep the company alive.

At the time they had only $250 million in cash and no financing in sight. In 2007, Palm was facing fierce competition from Apple and Windows phones. It was a much smaller company and made several critical mistakes at the worst possible time. Nobody was interested in the survival of PALM and the company was not diversified enough to pull off a turnaround. By 2010 the share price of Palm dropped to below $4 USD, and in April 2010 PALM was finally delisted from the stock market after their acquisition by Hewlett-Packard (HP).

Catching knives is only risky if you don’t know what you are doing.  If you know what you are doing it can be very rewarding in the long run. JCPenny is a company that is currently struggling big time, but it is also not a company that will disappear anytime soon.

The current transition out from the last economic crisis is called “deleveraging.”  Deleveraging can be achieved by cutting spending, reducing debt, transferring wealth, and printing money (See Day Dalio video for more information on this). Generally speaking, companies and people behave no differently than the macro economy. Just think about it in human terms for a moment – if you are out of work, living off of unemployment, and have $50K in credit card debt, the first thing you should do is to cut spending, reduce debt (you can pay off your credit cards by getting a loan with a better interest rate), and ask your family for help (transferring wealth). Of course, if individuals were able to print money I’m sure you would be doing that too…

Now think about what some other people might do in this situation.  You likely can easily recognize who will get back on his or her feet and who will not. How? Well, how much experience and education do they have? How much support do they have from their families? Have you checked to see if the debt they have is a good debt (mortgage, educational loans) or a bad debt (credit cards, personal loans)?  How big and powerful is their professional network? Do they have collateral that they can sell and keep them afloat for longer? If you think about an individual on these terms, it will be easy for you to identify who is the Apple and who is the Palm in this analogy right? This same type of analysis that works on the human level, works just as well when applied to the corporate and macro levels.  Needless to say, while turnarounds don’t happen overnight and the road is far from smooth, only certain companies have what it takes to make it to the other side.

The 23% increase JC Penney enjoyed in February can easily be reversed in March or at any other point this year. I’m not concern about that though because I’m not looking at the short term. I know that for JCPenney, the turnaround process may take a few years, perhaps even five or more. I also know JCPenny is one of the companies that can pull it off, and my portfolio has the potential to be greatly rewarded. Stay tuned.

Now a quick look at my portfolio: The return of the S&P 500 in February 2014 was 4.31%, as compared with 4.10% for my Dividend Paying Large Caps portfolio. I was a little short in February due to smaller than average increases in Ecopetrol (EC) up only 0.2% and Intel (INTC) up only 0.9%. I bought Pfizer (PFE) in February because I think Pfizer is a company that is committed to their investors through an aggressive stock repurchasing program and a nice dividend. With the Pfizer acquisition, I completed 12 positions in my portfolio, which was my original goal for 2014.

All of my positions in February were in positive territory, some of them above the S&P average increase in February such us Apple (AAPL) up 5.1%, American Express (AXP) up 7.4% and Oracle (ORCL) up 6%.

Summary Portfolio Performance

Since inception (01/19/12), the model is up 39.8%, versus the S&P 500 50.1%. In January, my portfolio went up 4.1%, as compared with 4.31% from the S&P 500. Year-to-date, my portfolio is up 0.01%, as compared with 0.03% for the S&P 500.

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Focusing on dividends and buybacks in 2014

by admin on February 6, 2014

Just as the Super Bowl had an awful start last Sunday, so did the stock market in January after the largest annual jump in 16 years (29.6%).  This is a year to be conservative and focus on established companies paying large dividends and implementing wide buybacks programs.  Monetary policies will most likely tighten this year and that’s going to be bad news for the stock market. It was easy for the stock market to outperform in 2013 with interest rates at 0%, but as economic conditions improve, we move closer and closer to the end of the stimulus.

As I mentioned in my previous post, financial problems continue at all levels – in banks, the private sector, and the government, so in my opinion, last year was an exception, not a trend. We likely have years ahead before we see the light again.

The S&P 500’s return in January 2014 was -3.56%, as compared with -4.95% for my Dividend Paying Large Caps portfolio.  Certainty not a good start for me, already down -1.39 against the S&P 500. Regardless, I am confident in my choices for 2014, and comfortable with my decisions. I have holdings in 12 quality companies with great potential, all selling at a reasonable price.

The main issues that dragged my portfolio down in January were:

Apple (AAPL) -10.77%

In January, Apple announced better-than-expected first-quarter results, with net income of $13 billion, or $14.50 per share, which was ahead of the $14.07 analysts expected for the fiscal first quarter. Revenue of $57.6 billion also exceeded estimates. Believe it or not, despite all that, the stock was down. In just one day the stock went down 8%, the biggest drop in a year. The reason? A silly one.  Apple sold fewer iPhones than analysts were expecting (54 million vs 56 million). With the stock down -10.77%, the dividend yield is now higher at 2.38%. Very attractive for a company that is at the same time buying back stock and still has a lot of business opportunities ahead. If the Apple Watch or Apple TV ever take off it could easily return Apple to their previous $700 stock price. Since Apple took a big hit in January, and their stock represents 9.9% of my entire portfolio, it is easy to understand why my portfolio underperformed against the S&P 500 this month. I’m not selling Apple now, and I probably won’t this year. I’m still a believer.

Ecopetrol (EC) -10.90%

Ecopetrol took a double hit in January. The first was the “flu” affecting emerging markets, in Colombia the home of Ecopetrol, the stock market lost 9.5% in January.  This was more than twice the loss we saw in the United States. Other emerging markets also experienced big drops in January, which in turn made investors switch on the panic button and pull their money out of these markets. The second problem was that the entire oil industry is taking a hit. As the economy lags, oil prices are being pressured, and revenues drop.  All together, Exxon Mobil (XOM), Chevron (CVX), Ecopetrol (EC) and ConoccoPhillips (COP) lost more than 8% in January. The good news is that as a result dividend yields have shot up – Ecopetrol is now at 8.07%, ConoccoPhillips (COP) is at 4.35%, Exxon Mobil (XOM) is at 2.81%, and Chevron (CVX) is at 3.65%. As the economy improves worldwide, oil prices will rise and these stocks will outperform the market once again.

Liquidated Positions

In January, I liquidated 4 positions: Dupont (DD), JPMorgan Chase (JPM), Microsoft (MSFT) and Sprint (S). The timing for Sprint could not have been better, as the stock was down -23.1% in January. All of the other stocks I sold in January with the exception of Microsoft (MSFT) underperformed the S&P 500. I may come back to Microsoft or JPMorgan in the future if I see that the business conditions for these companies have improved or their price has become more attractive.

None of my stocks were in positive territory in January 2014, but four stocks outperformed the S&P 500.

Oracle (ORCL) -3.55%

Oracle is my favorite stock for 2014. The company is buying stock back at unprecedented levels. In June 2013, the company doubled its quarterly cash dividend to 12 cents a share per quarter and said its Board approved an additional $12 billion in buybacks. The stock is still fairly priced at 15.30 PE (TTM).

Oracle, much like Microsoft, IBM, and Adobe, stands to benefit immensely from the emerging “cloud computing” model. Among those companies, Oracle is by far my pick.

Qualcomm (QCOM) -0.04%

I am a firm believer in this company. You can find my extensive stock analysis here.  I’ll keep Qualcomm for all of 2014, and plan to keep an eye on what happens with Mirasol displays and Femtocell, two of the most promising technologies being developed at Qualcomm.

US Bancorp (USB) -1.66%

One of Warren Buffett’s favorites, US Bancorp is a solid bank that could rise to new heights once the economy fully recovers. USB makes up 10.5% of my portfolio, and I plan on keeping this stock for a very long time.

Wells Fargo (WFC) -0.13%

This is the largest position in my portfolio, and was the second best performing stock for me in January. This is a stock that I will continue acquiring as long as the PE stays at around 12 and the dividend yield above 2%. This is a strong company selling at a very reasonable price. I may increase my position in Wells Fargo from 19.5% of my portfolio to 25% in the coming months.

Summary Portfolio Performance

Since inception (01/19/12), the model is up 30.8%, versus the S&P 500 40.2%. In 2014, I plan to stick to my guns. I don’t expect another 29.6% increase in the S&P 500 so I’ll be focusing on companies that pay dividends and buy back stocks. This will offer me some stability, and will allow me to be better prepared for what promises to be an uncertain 2014. The pressure on the stock market this year will be high, and I anticipating a lot more of the volatility we saw in January.

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S&P 500 best return in 16 years

January 9, 2014

The return of the S&P 500 in 2013 was a whopping 29.6%. This is something we haven’t seen in the stock market since 1997 when the S&P 500 delivered 31.01%. This is good news for investors, but a reminder that we all should be cautious because we are still far from being out of the […]

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A good year for the stock market

December 10, 2013

The Dividend Paying Large Caps portfolio was up 3.63% in November as compared with the 2.8% gain for the benchmark S&P 500 Index (SXP). The portfolio outperformed against the market in November, due to the following positions: Sprint (S) +24.67% The stock increase was due to three factors: Recent announcement that Sprint will leverage its […]

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Reducing Apple ahead of big business expenses and increasing competition

November 7, 2013

The Dividend Paying Large Caps portfolio was up 4.17% in October as compared with the 4.45% gain for the benchmark S&P 500 Index (SXP). The portfolio underperformed against the market in October, due to the following positions: Ecopetrol (EC) +2.96%, JP Morgan (JPM) -0.29%, Oracle (ORCL) +0.99%, Qualcomm (QCOM) +3.22%, US Bancorp (USB) +2.13% and […]

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Qualcomm (QCOM) is finally getting more attractive

September 6, 2013

I currently have a small stake in Qualcomm, QCOM (0.39% of my Covestor portfolio) that I am planning on increasing in the next quarter. Since I got my first shares the stock is down -2.31%. This year though stock price has increased 7.15%, which is fairly low when compared with the Nasdaq Index, which is […]

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Despite all the drama, DELL turned out to be one of the best investment in my portfolio this year

August 5, 2013

In the last quarter of last year (October 2012), I took a position in DELL for $9.87 a share. As evidenced by my past investing approaches, I’m frequently a contrarian investor who takes positions when companies are in transition and are misunderstood. At the time I invested, DELL was several rather serious problems including: Shrinking […]

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ORACL is down but its fundamentals are still up

July 3, 2013

Oracle (ORCL), one of the latest additions to my portfolio is down 8.32% since I bought it. On June 20th when the stock was going down after Oracle announced that it missed reaching sales expectations for its fiscal fourth quarter, I refused to sell because I still believe strongly in the fundamentals of this company. […]

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