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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Expedia-PricelineThe global economy is a complex machine, the result of many small transactions that take place in different markets and sectors. When a particular sector is down, another may be up, and vice versa. Money moves around as things change, and in our world, change is a constant. When changes are taking place, opportunities abound. The key is in understanding the present without losing perspective on the past.

Some of the most recent dynamic changes in our economy have opened the door of opportunities in a variety of sectors that were not attractive just few months ago. As I mentioned here, the energy sector is currently a very interesting sector for value investors with a long-term view. Another sector that I believe is becoming interesting is the tourism/travel industry. There are few reasons for this:

Low Fuel Prices

Thanks to low gas prices, airlines are profiting from traveling like never before. When oil prices shot up a few years ago, many transportation businesses started adding fuel surcharges. Now, fuel prices are plunging, but many of those surcharges remain. As the year progresses and airlines start reporting big increases in revenues year over year, stock prices should move up quickly. The drop in the cost of oil is always a huge factor in the airline industry where 30 percent of all expenses are fuel related. Airlines that are still down now are down because they locked in the price for a portion of their total fuel spending in 2015 through hedging. Delta reported $180 million in fuel-hedge losses in the last three months of 2014 as price declines accelerated, while United lost $237 million and Southwest lost $13 million. American Airlines decided not to hedge last year is profiting at a record levels. That decision has allowed American Airlines to take full advantage of the steep plunge in fuel prices. This year’s net income for American may be above $5 billion.

Thanks to the consolidation of the airline industry there is no pressure to lower prices anytime soon. In 10/24/2014 I acquired shares of Copa Airlines (CPA) and since then the stock is up 13.55%, the company is paying 3.3% dividend and the return of equity is at 22.61%.

Low fuel prices have also had a positive impact on travelers. People are suddenly enjoying more disposable income, and may are spending this on travel. Any increase in travel will benefit both hotels and online travel agencies (OTAs). I expect that sector to outperform the S&P 500 in 2015.

Consolidation

The other factor that makes the tourism/travel industry interesting right now is the industry consolidation. Hotel chains are buying other hotel chains, and online travel agencies are buying other online travel agencies at an increasing rate. In 2010 Marriott acquired AC Hotels, then in 2012 Gaylord Hotels for $210 million, and most recently in 2015 they acquired Delta Hotels in Canada for $135 million. On the online travel agencies side similar takeovers are occurring. In 2013 Expedia acquired Trivago, and this year they also acquired Travelocity for $280 million. Expedia currently owns Hotels.com, Hotwire, Venere, and a few other major brands. Priceline, which is the other major competitor in the market, owns Booking.com and Agoda. In 2013, Priceline acquired Kayak for $1.8 billion, and they may now be targeting Orbitz that recently hired bankers to find a buyer. New entrants will have a hard time getting any share of the market if this trend continues. These companies will also benefit from economies of scale.  Online travel agencies (OTAs) are the fastest growing distribution channel globally, and the two largest, Priceline and Expedia, outpace the market by no small margin. Combined gross bookings of the two jumped from 38% of global OTA sales in 2011 to 47% in 2013. The continued, super-charged organic growth of Priceline’s Booking.com, as well as Expedia’s assumption of the Travelocity volume largely in 2014, mean that global share of the two leaders will only accelerate in 2015.

Channel shifting

Hotels in general use four different channels to acquire guests. The first is property direct or when future guests book directly through the hotel, either booking on-site or through the commercial department of the property. The second channel is the reservation center, which is the segment of future guests that call the hotel to make a reservations. The other two channels are online: web direct, when the customers book through the hotel’s direct website, and online travel agencies (OTAs), which is when reservations come to the hotel from third party sites.

According the U.S. Travel Advertising Marketplace: Industry Sizing and Trends 2015, in 2013, 42% of gross bookings came through online channels. This represents a tectonic shift for the industry, as of 2013, online channels captured more travel ad dollars than offline for the first time. Bookings coming from online travel agencies are growing at double-digit rates per year, while direct bookings from properties and reservation centers are having an increasingly hard time keeping up. I expect this shift to continue for the next few years, which will benefit any company participating in or facilitating an online booking channel.

Natural Growth

The travel industry, and the hotel industry both continue to grow every year. In 2014 U.S. hotel industry’s occupancy was up 3.6 percent to 64.4 percent.  The average daily rate rose 4.6 percent to US$115.32; and revenue per available room increased 8.3 percent to US$74.28. Stocks of these industries are still being traded at reasonable prices, but may grow naturally as a result. Of course there may be hiccups along the way because the travel industry is very sensitive to forex exchange variances and also because some of these industries may over spend on expansions or acquisitions. For example, Expedia is making key investments in Trivago’s top-line growth, sacrificing near-term profits to fund global expansion. Trivago benefited from an estimated $108.5 million TV advertising campaign in the U.S. alone — the largest of any online travel brand — and generated just $4 million in adjusted EBITDA in 2014. In the long term, it is an attractive industry where interesting changes currently taking place. As long as these companies continue to grow at a double-digit rates, it may be an attractive sector to examine more closely.

Summary Portfolio Performance

Since inception (01/19/12), the model is up 42.4%, versus the S&P 500 68.3%. The return of the S&P 500 in January 2015 was -3.11%, as compared with -2.10% for my Dividend Paying Large Caps portfolio. My portfolio had a good start in 2015, beating the S&P 500 by 1.01%.

Gainers

In January, JC Penney (JCP), and Lukoil (LUKOY) performed well. They were up 12.2%, and 5.4%, respectively. While JCP it is not out of the woods yet, at least revenues have stopped declining. Revenues dropped -8.23 billion from 20.19 billion to 11.96 billion between July 2007 and October 2013. However, since then, revenues have been up, and have not fallen below that level again. The full recovery of JC Penny may take few years more, but those who have the patience to wait it out may reap the rewards. Lukoil (LUKOY) in one of the biggest global oil companies and have been suffering through the crisis the same as the entire sector. However, it appears that Lukoil may be recovering faster than other oil companies. When compared with other oil companies such as BP, Exxon Mobil or Chevron, Lukoil was the one with the biggest gains in January. So far this trend continues in February as well.

Losers

In January, my worst performing stocks were Adidas (ADDYY) down -13.3%, and Ralph Lauren (-9.9%). Adidas was down as a consequence of the bad economic news coming from Europe. Also the re-valuation of the US dollar against the Euro was not good news for Adidas, receiving less in dollar amounts for its products will certainly have a negative impact on Adidas’ financial performance. Ralph Lauren (RL) was down ahead of its earnings report that took place on February 4th when the company reported disappointing earnings and lowered its sales forecast for the remainder of the fiscal year. That day the stock dropped an additional 18.22%, the lowest closing level since July 12, 2012. I believe Ralph Lauren is one of a kind in the apparel sector, and I’m sure the company will recover in no time. Here are some of the reasons why I’ll continue to hold my investment in Ralph Lauren.

Acquisitions in January 2015

No positions were added in January.

Liquidations in January 2015

No positions were liquidated in January.

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2014 is over and the stock market did well for the third year in a row. The market was up 16% in 2012, 32.39% in 2013, and 13.69% in 2014 (including dividends). In other words the S&P 500 is up 62% since 2012. This is an impressive comeback after the -37% drop of 2008. Unfortunately, not every sector has enjoyed this upswing. The utilities sector did fairly well in general, up 19.09%, but other sectors such as Energy, Industrials, Materials and Consumer Cyclical underperformed the market in 2014. The energy sector was down -5.82%, materials -3.98%. Both industrials (+7.95%) and consumer cyclical (+3.38%) were up, but both underperformed the S&P 500 in 2014.

So the big question now is what to expect in 2015? Well, I believe the biggest opportunities remain in the sectors that underperformed in 2014. Some of the stocks in these sectors are very attractive at current valuations, and many of them were dumped in 2014 by individual and institutional investors for the wrong reasons.

I see some interesting opportunities especially in the energy sector, where many companies are being traded under book value. My position in Ecopetrol (EC) has a price to book value is 0.8, my position in Lukoil (LUKOY) is being traded at an even lower price to book value – 0.3. These stocks are down over the past three months (as are most other energy stocks) mainly because of the sudden drop in oil prices, which is putting enormous pressure on the entire sector as well as global economies.   

As the economy improves in the US, I expect the energy sector to recover as well. A growing economy demands more energy, and that can quickly turn things around. The other reason I believe that the energy sector has the potential to do well in 2015 is because the sector continues to deliver healthy dividends (as a consequence of the drop in stock prices). If the FED increases interest rates this year, the stock market will shake. Investors will likely reallocate some of their capital to fix income instruments and will look for protection by investing in utilities, healthcare, or energy companies that are currently paying generous dividends.

I strongly believe that very bad news will come from Venezuela this year, the economy is on the verge of collapse due to drop in oil prices. Venezuela owe China $50bn that the Chinese loaned them since 2006, and if oil prices remain low, the likelihood of repayment decreases exponentially. While this would likely have a major impact on the global economy, a cut in production in Venezuela due to social tension can immediately send oil prices back up.

Some consolidation may also occur in the energy sector in 2015 as smaller companies won’t be able to survive if oil prices continue to fall. An example of this consolidation occurred in the financial sector during the financial crisis of 2008 when Wells Fargo (WFC) acquired Wachovia, Bank of America (BAC) acquired Merrill Lynch, and JPMorgan Chase (JPM) acquired Bear Stearns. These acquisitions helped increase productivity, and reduce operational costs and marketing. A similar process can happen with this oil crisis, consolidation takes place when things are bad, and in the long term it can be very beneficial for the companies making the acquisition(s). It is just a matter of time until the energy sector stabilizes – making this sector a good opportunity for value investors looking for long term investments.

Summary Portfolio Performance

Since inception (01/19/12), the model is up 35%, versus the S&P 500 64.6%. The return of the S&P 500 in December 2014 was -0.42%, as compared with -4.68% for my Dividend Paying Large Caps portfolio. In 2014 my portfolio was up 0.94% as compared with 11.39% of the S&P 500. For the most part of 2014 my portfolio outperformed the S&P 500, but after September when oil prices dropped dramatically, my portfolio lost most of the gains accumulated throughout the year. The loss of gains in my portfolio was due in large part to the fall of Ecopetrol (EC) and Lukoil (LUKOY), two positions in the energy sector that I acquired too early just as prices started to go down. I never anticipated oil prices would go as low as they have.  However, as the old adage says, stocks can’t continue go up forever, and I believe the same is true of when they are going down. Oil prices may drop even lower but I don’t expect getting it for free anytime soon. China won’t probably leave Venezuela lead to default and certainly Russia still have a lot of power to pressure Europe and force higher oil prices again. If those things take place at the same time, the beginning of the recovery may be around the corner.

Below is a graphic showing my Performance in 2014 vs the S&P 500. As you can see, from October through December I lost some ground due to my exposure to the energy sector.

portfolio performance 2014

Gainers

In December Oracle (ORCL), and Bed Bath & Beyond (BBBY) performed well. They were up 6%, and 3.8%, respectively. Oracle is a company that will continue to benefit as the economy recovers. In general technology, and energy sectors move up when market conditions improve. I like Oracle for many reasons, one of them being the excellent record of acquisitions they have had in the past. I expect Oracle will continue to do well, and it is a stock that I plan to hold for the entirety of 2015. Bed Bath & Beyond (BBBY) is probably one of the most efficiently run companies around, and I expect them to recover as the housing market continues improves – making it another position I’ll hold onto in 2015.

Losers

In December, my worst performing stocks were JC Penny (JCP) down -19.1%, Ecopetrol (EC), down –15.6% and Lukoil (LUKOY) down 16.2%. As I mentioned above, the last two positions are in the energy sectors, the worst performing sector of the stock market in Q4 2014. I opened these positions when the sector was down about 20%, but surprisingly the sector continued to slip further in 2014, bringing down my entire portfolio. Despite this drop my portfolio ended up 2014 in positive territory. I plan to keep my investments in the energy sector in 2015 as I expect things to start turning around mid-year.

Acquisitions in December 2014

No positions were added in December

Liquidations in December 2014

No positions were liquidated in December

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Oil Pump2014 is coming to an end, and if anything is becoming crystal clear at the end of this year it is that economies around the world are deeply and intrinsically linked.

Since June a roller coaster of events has pushed up the price of the Dollar in Russia by 38%. This is the biggest increase since 1998 when the Russian Ruble plummeted to historic records. The main reason for Ruble’s current fall is the drastic and quick decrease in oil prices. At least 35% of the Russian economy is funded by oil, without that income, Russia would have a deficit close to 10%. This emerging problem is even more dramatic for smaller economies such as Venezuela and Colombia. In Venezuela oil accounts for 95 percent of export earnings, when you combine this with gas earnings, it’s 25% of Venezuela’s gross domestic product. In Colombia the situation is also becoming very critical. Oil makes up between 20% and 30% of Colombian exports and accounts for 4% of its GDP. To put this emerging crisis in perspective, the Colombian 2015 national budget was calculated with an oil price of $98 per barrel, the price per barrel is now at $70 and trending lower, which means Colombia is now facing a budget deficit of $3.6 billion in 2015.

If oil prices continue to decline, these governments will get hit badly setting off an unfortunate chain of events. First currency and government bonds will decline, as investors lose confidence in these governments and start pulling out money and hold off on any new investments. As their currencies lose value, exporters across industries will begin to receive less money for the same goods they are producing, and as a consequence they will spend less in their own countries. When they spend less, the whole economy is impacted and social unrest can emerge (which we have already seen in Venezuela). Eventually these economies will enter into recession and an austerity programs will be necessary. All this will happen while at the same time the US consumer economy benefits from cheap oil prices, and Americans start to spend more on a broader range of non-essential goods or services. These economies that benefited from the economic crisis in US that started in 2008, now see how things can go south quickly. As the US economy recovers and the Dollar strengths, these economies will start to feel the pain.    

Considering that oil prices will stay low for a while, I see a difficult 2015 for these international economies, and related energy stocks. Oil companies’ prices will continue to go down (although not as quickly as in Q3 2014). But eventually they will stabilize. Sooner or later investors will realize how cheap these stocks have gotten and they will start accumulating again. The price of these stocks will recover when the US economy improves further and the Central Bank starts increasing interest rates. That is expected to begin by June 2015 if everything goes as planned. As the US economy gets healthier, productivity will increase along with demand for more energy. Ultimately, this will drive oil prices and energy stock prices up and that will be the perfect moment to cash out.

We won’t see this happening in the next few months, it may even take a couple of years to get there, but ultimately the gains can be rewarding. With that in mind I will continue to hold to my positions in the sector for quite some time. Specially because dividends are high, and I’m positive they won’t go much lower than where they currently are. If the Venezuelan economy collapses, that alone would be sufficient to send stock prices up again. Every time there is a major economic crisis in a top oil producing country, oil prices tend to increase quickly.  By the simple logic of the economics of supply and demand when a top producer is out, this means less available supply and higher prices.

In 2015 the energy sector will play a key role worldwide, which will definitely benefit the US, but there is one important principle that we still need to keep in mind… Too much of a good thing, is almost always a bad thing.

Summary Portfolio Performance

Since inception (01/19/12), the model is up 43.8%, versus the S&P 500 68.1%. The return of the S&P 500 in November 2014 was 2.45%, as compared with 1.65% for my Dividend Paying Large Caps portfolio. Year-to-date my portfolio is up 5.89% as compared with 11.86% of the S&P 500.

Gainers

In November Ralph Lauren (RL), Apple (AAPL) and Adidas (ADDYY) performed well. They were up 12.2%, 10.12%, and 10.10% respectively. As I mentioned here Ralph Lauren is a strong brand with little debt and a clear international strategy for expansion. Apple continues to be having a good moment after releasing the new and very well received iPhone 6 in September. They also announced the new Apple watch for next year, and it seems that they are building a new momentum. Finally Adidas is recovering after the stock decline among European stocks in September and October. Adidas is -40.8% YTD due to continuing weakness of emerging-market currencies as compared with the Euro (in particular the Russian Ruble as Russia is one of the most profitable regions for Adidas), and restructuring at TaylorMade-Adidas Golf. It may take some time to recover, especially as the Russian economy contracts in 2015, but I believe it will be worth the wait. Adidas is a strong brand with a wide international presence.

Losers

In November, my worst performing stock was Ecopetrol (EC), down -24.3%. Because of this, my portfolio underperformed the S&P 500 for the month. Ecopetrol is one of the largest oil conglomerates in the world that has been affected because of the drop in oil prices and devaluation of the Colombian currency.  Patience will be required before we see this stock climbing back to the $60’s of 2012. I outlined above why I plan to hold on to it for a while longer. It also doesn’t hurt that the company is paying a healthy dividend of 11.6%.   

Acquisitions in November 2014

No positions were added in November

Liquidations in November2014

No positions were liquidated in November

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Why I increased my investment in Energy?

by admin on November 7, 2014

Stock Ecopetrol ECWhile there has been a lot of talk these days about the energy prices, specifically about oil and gas prices, two of my largest holdings are in this sector (Ecopetrol EC and Lukoil LUKOY). In October, I increased my position in Ecopetrol, so the question is why?
In order to explain why, first we need to answer a few questions:

  1. Why are oil prices going down?
  2. How low they can go?
  3. When can we expect to see a rebound?

Why are oil prices going down?
The media has covered this point rather frequently lately so I’ll keep this brief. There are basically two major factors that are currently impacting the price of crude oil worldwide. The first is the spread of Ebola in Western Africa and other parts of the world, and the second is that the US has overtaken Saudi Arabia as the biggest oil producer in the world. Oil extraction from shale formations across the US in places like Texas, Pennsylvania, and North Dakota has caused a surge in supply, which combined with restrictions on exporting crude is curbing the price of West Texas Intermediate, America’s oil benchmark.

How low they can go?
I don’t think prices can go much lower for few reasons. First of all, if prices go too low, a couple of things will happen:

  1. Hydraulic fracking drillers will be under considerable pressure and financial stress. The reason for this is simple, these companies spent more money than they brought in during the boom, and they made up the gap by borrowing. This was fine as long as the oil sells at a high price. When suddenly crude oil becomes inexpensive, their margins decline and they won’t be able to get as much money for their product as they originally though. This industry is massive in the US and Canada, and putting them under pressure is not in the best interest of the US government. If crude oil prices continue to go down ($75 or less), companies that rely on fracking will have a very hard time repaying their debt.
  2. If prices of oil go down much further, this has the potential to very negatively impact not only the US economy, but also the economies of major worldwide power houses like Russia. For many countries, the low price of oil directly translates into economic woes – including, most dramatically, the possibility of a contracting economy. According to a recent article in Bloomberg Businessweek, if pricing remains under $104 a barrel, Russia will face a drop in its gross domestic product by up to 1.5 percent. Prices are currently below $90. If an Economy as big as Russia’s suffers, then other countries around the world will also feel the pain.
  3. There is also a very strong linkage between oil production growth, economic growth, and wage growth across a range of US states. Annual investment in oil and gas across the country is at a record $200 billion, reaching 20 percent of the country’s total private fixed-structure spending for the first time. If this industry gets hit too hard for too long, that will impact other market segments, and the US economy in general. Low prices are good, but prices too low for too long will not be good news for anybody.

If we look at historical prices of oil vs gas, we see that they move in tandem. Oil prices vs gas prices behave very similarly to stock prices vs earnings. They can deviate from the mean once in a while, but at the end of the day, they will eventually always need to correct course. By looking at the graph below comparing % price change between oil and gas, you can easily see a strong correlation. If oil prices increase too quickly when compared with gas prices, there will always be a correction. That’s what happened in 2008, and that’s what is happening now. Based on the graph below, oil prices may go lower, but we are certainly near the bottom of this trend. I don’t think the current low prices will be sustainable for much longer.

Brent Crude Oil Spot Price Chart

Brent Crude Oil Spot Price data by YCharts

When can we expect to see a rebound?
Now that the US is the biggest producer in the world, I don’t expect huge increases in oil or gas prices anytime soon. Gas prices will rise as soon as the economy improves. When that happens, energy stocks will outperform any other market segment, but we may still be a couple of years away from that moment. In the meantime, you can collect strong dividends from most of these companies.
So to answer the question, why did I increase my exposure in the energy sector? I would say:

  • Prices won’t go much lower than current levels because it is not good for the economy or for the fracking companies that the US government is trying to protect. It is a big sector that if it hits a recession has the potential to drag the entire economy down. Certainly nobody is interested in that.
  • These companies pay healthy dividends, in the order of 3% and above. So even if stock prices don’t go up for a while, I’ll be happy to wait a couple of years while collecting the dividends.
  • PE ratios are very low when compared with other segments of the market making this an excellent opportunity to take advantage of before the economy improves and prices start to rise.

Summary Portfolio Performance
Since inception (01/19/12), the model is up 42.9%, versus the S&P 500 63.2%. The return of the S&P 500 in October 2014 was 2.32%, as compared with -2.84% for my Dividend Paying Large Caps portfolio. Year-to-date my portfolio is up 0.47% as compared with 0.91% of the S&P 500.

Gainers
In October Apple (AAPL), American Express (AXP) and Bed, Bath & Beyond (BBBY) performed well. They were up 7.2%, 2.8% and 2.3% respectively. Apple continues to have a good moment after releasing the new and very well received iPhone 6 in September. American Express is doing an excellent job targeting more diverse audiences, and is currently paying better dividends than MasterCard (MC) and Visa (V). PE ratio, and Price to Sales is also way lower than its competitors.

AXP PS Ratio (TTM) Chart

AXP PS Ratio (TTM) data by YCharts

Bed, Bath & Beyond (BBBY) continues its recovery after the big drop that it faced this year from January to May. Although the company still down for the year -15.1%, since August the stock has increased 10.4%. Price to sales ratio is only 1.1 and the company has no debt.

Losers
In October, my worst performing stock was JC Penny (JCP), down -24%. Because of this single position, my portfolio underperformed the S&P 500 for the month. After reaching $11 in August, the stock took a hit and is currently trading at $7.20. This stock is extremely undervalued at the moment. Price to Sales ratio is 0.1. Very low compared with the 7.2 of Macys (M). I’ll keep this holding in my portfolio, but I know that the recovery will take at least 1 year more. Yearly revenues from the company are finally increasing, after deep declines in 2012-2013. I expect this stock to have a very good 2015.

JCP Revenue (TTM) Chart

JCP Revenue (TTM) data by YCharts

The other company that took a big hit in October was Ecopetrol. For the reasons mentioned above in this article, the whole energy sector is suffering lately. I think this sector crisis is at the bottom and I also expect Ecopetrol to do very well in 2015, especially if the economy sees an improvement.

Acquisitions in October 2014
I added Adidas (ADDYY) to my portfolio, the stock has been down -45% this year, but this is a great company, with a global presence and very well diversified. The stock has been dragged down by the European Stock market, which is not having a great year. I expect this stock to recover very quickly. Price to sales is 0.7, nothing when compared with the 2.9 of Nike (NKE). Adidas has not been this cheap in many years.

I also added Copa (CPA), a very interesting airline company operating in Latin America that was “unfairly” hit because of worldwide Ebola concerns. Many airlines have been down because of this, offering great entry point opportunities. This is a stock that I won’t hold for long. As soon as the stock is up 20% I plan to get rid of it.

Liquidations in October 2014
The only position I liquidated in October was Wells Fargo (WF). Great company that I had to sacrifice in order to take advantage of better opportunities on the stock market.

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The legacy of Larry Ellison at Oracle

by admin on October 9, 2014

Larry Elllison of Oracle Larry Ellison of Oracle

Larry Ellison will be remembered for founding one of the most successful companies of our times. Only time will tell if he will also be remembered as king of the acquisition. Ellison, of course, was a specialist in product engineering, but he was also an excellent salesperson to corporate clients and extremely good in analyzing whether potential acquisitions made sense. In a tech world full of acquisition disasters (the aQuantive acquisition by Microsoft sounds familiar?), Larry Ellison shone brightly by completing many successful acquisitions and integrations.

Larry’s acquisition strategy was to buy software companies that were selling complementary products, and then incorporating the acquired functionality into Oracle’s main product line. This allowed him to offer its clients and prospective clients products with very rich feature sets. Since for a long time Oracle was exclusively a software company, this strategy helped Larry lock his clients into Oracle’s true profit center—the business of selling software updates. Once Oracle’s software has been put in place, it cannot be switched out easily—it becomes an integral part of a company’s business processes and the switching costs to the client are enormous.

The $10 billion 2005 acquisition of PeopleSoft was transformative for Oracle. Prior to that, Oracle had been known only as a database company (i.e., the electronic “containers” that hold data). PeopleSoft was a producer of application software (i.e., the programs employees use to capture or enter data that will be stored in a database). After the PeopleSoft acquisition and subsequent purchases of application software providers Siebel (2006), Hyperion (2007), and BEA (2008), Oracle became a major player in the field of enterprise application software. Oracle’s 2010 acquisition of computer/server maker, Sun Microsystems extended its product footprint into hardware. While some in the investment world derided the acquisition, I believe it has had an extremely beneficial effect on the Oracle’s profitability.

Oracle worked for roughly the first twenty years of its existence on increasing the functionality and user acceptance of its database products. It began its foray into developing application software internally in the late 1990s. However, considering that the firm ended up buying PeopleSoft a few years’ later, we can presume that management decided that it was easier and quicker to develop a presence in application software by buying existing competitors rather than building it from scratch. Existing competitors have well-established client bases to whom Oracle’s primary database products could also be sold.

These are some of Oracle’s most successful acquisitions, carefully planned and executed by Larry Ellison:

  1. i-flex in Banking and Financial Services: August 2005 for $900 million
  2. MetaSolv in Communications: October 2006 for $219 million
  3. Siebel Systems in CRM: January 2006 for $5.85 billion
  4. Hyperion Corporation in Enterprise Performance Management: March 2007 for $3.3 billion
  5. Agile Software in Product Lifecycle Management: May 2007 for $495 million
  6. Sun Microsystems in Hardware: January 2010

I expect Oracle’s acquisitions of Endeca, RightNow, InQuira and Taleo in 2011 will further add to its software revenues. In the near future Oracle may be targeting even more interesting acquisitions such as Workday (WDAY) or Salesforce (CRM).

Being successful in acquisitions in any industry it is not an easy task.  During the last shareholder meeting of Berkshire Hathaway, Warren Buffet said that mergers and acquisitions are often so bad, because big companies have people working full time solely to look for these deals, and they are compelled to complete some, even if ultimately they don’t make much business sense. That’s their job and that’s why they are being paid. From the outside at least, it appears that the acquisition culture at Oracle is different, all their acquisitions make good business sense, and they are implemented in a timely manner – ostensibly without market or stakeholder pressure. This is the biggest legacy of Larry Ellison at Oracle, and a culture that Oracle must work hard to preserve. As long as Oracle continues to make smart acquisitions, they will go far.

Summary Portfolio Performance

Since inception (01/19/12), the model is up 46.7%, versus the S&P 500 57.7%. The return of the S&P 500 in September 2014 was -1.55%, as compared with -3.30% for my Dividend Paying Large Caps portfolio. Year-to-date my portfolio is up 7.21% as compared with 6.70% of the S&P 500.

Gainers

In September Bed, Bath and Beyond (BBBY), and Google (GOOG) performed well. They were up 2.4%, and 1.0% respectively. BBBY continues its recovery after the big drop that it faced this year from January to May. The fundamentals of the company are still strong and I’m sure this is one of the stocks that will continue trending up for the remainder of 2014. In one day in September BBBY was up 7.4% and saw eight positive estimate revisions suggesting that more solid trading could be ahead for the company.

Google (GOOG), continues to amaze me, recently a new project was announced that will include the creation of giant TV’s. The project is led by Mary Lou Jepsen, a former Massachusetts Institute of Technology professor best known for co-founding the One Laptop Per Child Project, an ambitious but ultimately unsuccessful project to give cheap laptops to tens of millions of children in poor countries.

Ms. Jepsen has also co-founded three startups around display technology. The most recent, Pixel Qi, specializes in low-power displays that can be read in direct sunlight. She now heads the display division inside Google X, Google’s futuristic products lab. With so many interesting products in the pipeline, Google is a one to hold for a long time.

Losers

In September my holdings in oil companies did poorly. Lukoil (LUKOY) was down -8.3% and Ecopetrol (EC) -9.6%. Those two stocks led to the underperformance of my portfolio vs the S&P 500 this month. As the economy recovers worldwide, I expect crude oil prices to go up and these stocks to recover rapidly. The positive side of the story is that these two companies pay the best dividends in my entire portfolio. LUKOY currently pays 5.73%, and EC 7.5%. Both stocks reached a 52 week lows in September. I don’t have plans to hold to these positions long term, because the dynamic of the petroleum is changing worldwide – especially as technology improves and the US is able to extract more resources from home at a better price. Since 2008 domestic oil production in the US has increased dramatically, reversing what was nearly a three-decade decline. That has some predicting that the U.S. could overtake Saudi Arabia as the world’s largest petroleum producer in coming years.

In 2011 the U.S. produced 5.66 million barrels of crude oil per day, according to the Department of Energy’s Energy Information Administration. By next year the agency projects that production will increase 21 percent to 6.85 million barrels per day. Add in products like natural gas liquids, biofuels, and processing gains at refineries and that number increases. This may put some pressure on international markets and prices likely will stabilize for a while. I expect these stocks to recover some ground in the last quarter of this year.

Acquisitions in September 2014

No positions were added or increased in September.

Liquidations in September 2014

No positions were closed in September.

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