Between 1965-2008, the book value of Berkshire Hathaway shares grew at compounded annual gain of 20.3%.  In comparison, the S&P 500 (including dividends) had a compounded annual gain of 8.9%.

Regarding the current economic environment, Warren Buffet notes:

But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.

In good years and bad, Charlie and I simply focus on four goals:

(1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash;

(2) widening the “moats” around our operating businesses that give them durable competitive advantages;

(3) acquiring and developing new and varied streams of earnings;

(4) expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results.

An individual investor can follow Buffet’s lead by ensuring that his or her portfolio contains companies with strong balance sheets, proven management, solid earnings, strong market share, and a wide moat.  Historically, companies of this type have sold for a substantial premium (i.e., a higher P/E than their peers).  However, the market decline has reduced that premium.  This is a good time to exchange low or medium quality companies for high quality one.

]]> http://stockherd.com/moosepond/2009/03/taking-a-long-term-view/feed/ 0 http://stockherd.com/moosepond/2008/11/replacing-low-par-stocks/ http://stockherd.com/moosepond/2008/11/replacing-low-par-stocks/#comments Sat, 01 Nov 2008 21:00:23 +0000 Admin http://stockherd.com/moosepond/?p=312 Using data from our portfolio dashboard on Manifest Infesting, here are some proposed changes to the portfolio.

First, sort the portfolio by projected average return (PAR) to show which stocks have the highest and lowest PAR. You do this by clicking on the PAR column heading or look at this PDF file.  (Place your mouse over the embedded yellow note in the PDF file.)

The six stocks on the bottom (highlighted in yellow in the PDF file) have the lowest projected average return. Looking at these stocks, that is not surprising. Two are bank stocks (WFC and SNV). The current housing market adversely impacts LOW.  Similarly, a decrease in consumer spending impacts BBBY and WMT.

We should consider replacing all of these except JNJ. (JNJ is a high quality blue chip stock despite the mediocre PAR.  It is a keeper.)

Now we can add to our positions in stocks we already own with stocks that have a higher projected average return than those we are replacing.

Look at again at our portfolio dashboard. Now sort by the value this time, so our largest positions are on top and our smallest positions are on the bottom. Look for stocks for which we don’t yet have a 5% position and which have a projected average return of more than 20%. We can would increase our position in those shares to about 5% or $2,000 total.

This PDF file shows the idea. The candidates for replacement are shown with struck through text. These are the five stocks with the lowest projected average return or PAR. The candidates for additional shares are highlighted in yellow.

There are several additional stocks we may want to consider, including ADBE, AAPL, PCP, and PTR. More to follow on this.

The Wise Investor Program hosted by Randy Beeman of the Wise Investor Group (affiliated with Ferris Baker Watts) airs on WMAL (630 AM) each Sunday in the D.C. area. This program, started by Ric Malone, has been broadcast for 17 years. It follows a value oriented approach to building a portfolio. You can download the program from the WMAL website the day after the regular broadcast.

Your Money with Chuck Jaffe is another excellent investment program. He broadcasts and records a daily one-hour radio program. He interviews a wide range of interesting guests who discuss stocks, mutual funds, and personal financial planning. MarkeyWatch posts an edited 30-minute version of the radio show. From both technical and content perspectives, this is high quality broadcast. You can also use Apple iTunes to download the MarketWatch version. The full one-hour program can be found on Chuck Jaffe’s website, http://www.yourmoneyradio.net.

If you download the free Apple iTunes software, you will discover hundreds of interesting podcasts on a wide range of topics (besides investing). Install iTunes on your PC and get an MP3 player. Your walking, exercising, and driving around town will take on a new dimension.

While the iTunes program was designed for the iPod, you still can use it to download and organize podcasts for use with any MP3 players. (Both Mac and PC versions of iTunes are available.) It won’t automatically sync with a non-iPod player but the work around is easy, just manually drop and drag the files to your MP3 player. It you have an iPod, it is seemless.

One of the activities in portfolio management is to look for “outliers” in a portfolio. That is part of the continuous process of improving a portfolio. Comparing the projected average return, P/E ratio, projected sales growth, projected revenue growth, and quality metrics for each stock in a portfolio, can help spot outliers. To borrow an airborne term, at least one stock will be standing in the door, ready to jump. Outliers make good candidates for sale when a better opportunity comes along.

The dashboard for our portfolio shows the projected average return for each stocks. Factset Research Data (FDS) is the outlier, with the lowest projected average return (6%) of all our stocks except ChevronTexaco. Looking at the portfolio summary, FDS has a current current P/E of 34 making it the highest P/E stock in the portfolio.

FDS has been one of our winners, +12.3% YTD. However, its run-up in price has reduced its projected average return (PAR) to about 6%. (See updated stock selection guide.) Value Line rates its financial strength B++ and earnings predictability 100. Morningstar rates it “three stars” meaning it is fairly priced.

So the dilemma is do we “let the winner run” or “take profits.” It is probably a hold at this point. If the PAR falls any lower, however, it will be candidate for replacement.

Vanguard money market funds are a good place to park money that you may need in the next 1-3 years. At your tax bracket, I would not worry about finding a tax-free fund. Tax free money market funds don’t become advantageous until you reach the 28% tax bracket or higher. You can ask Vanguard for a check book for your money market account and redeem shares by check. However, the check has to be $250 or more.

Here are three suggestions. The fund are listed with the safest funds first. The spread between the Treasury-based fund and the prime rate fund is very small. It comes out to about a $25 per year difference on $10,000. So you might want to stay with safety (either Treasury or Federal). That way if the world goes nuts, your funds will be secure.

Vanguard Treasury Money Market Fund (VMPXX). It is currently yielding 4.84%.

Description: The Fund invests solely in high-quality, short-term money market securities whose interest and principal payments are backed by the full faith and credit of the U.S. government. At least 80% of the Fund’s assets will always be invested in U.S. Treasury securities; the remainder of the assets may be invested in securities issued by U.S. governmental agencies. The Fund maintains a dollar-weighted average maturity of 90 days or less.

Vanguard Federal Money Market Fund (VMFXX). It is currently yielding 5.06%.

Description: The Fund invests primarily in high-quality, short-term money market instruments. At least 80% of the Fund’s assets are invested in securities issued by the U.S. government and its agencies and instrumentalities. Although these securities are high-quality, most of the securities held by the Fund are neither guaranteed by the U.S. Treasury nor supported by the full faith and credit of the U.S. government. To be considered high-quality, a security generally must be rated in one of the two highest credit-quality categories for short-term securities by at least two nationally recognized rating services (or by one, if only one rating service has rated the security). The Fund maintains a dollar-weighted average maturity of 90 days or less.

Vanguard Prime Money Market Fund (VMMXX). It is currently yielding 5.09%.

Description: The Fund invests primarily in high-quality, short-term money market instruments, including certificates of deposit, banker’s acceptances, commercial paper, and other money market securities. To be considered high-quality, a security generally must be rated in one of the two highest credit-quality categories for short-term securities by at least two nationally recognized rating services (or by one, if only one rating service has rated the security). If unrated, the security must be determined by Vanguard to be of quality equivalent to securities in the two highest credit-quality categories. The Fund invests more than 25% of its assets in securities issued by companies in the financial services industry. The Fund maintains a dollar-weighted average maturity of 90 days or less.

The expense ratio is 0.29%. Other mutual fund families have similar offerings. For example, see Fidelity’s offerings. Since Vanguard is the only large mutual fund family that is owned by its share holders, I tend to prefer it. Vanguard also offers some of the best index funds and exchange traded funds (ETFs) available.

The Wise Investor Show has been broadcast in the Washington, DC, area for 17 years. The program advocates a conservative, value-oriented approach to investing. The program is always informative and educational. The weekly program can be downloaded from the WMAL.com website. Currently, the program is only archived one week at a time, with the Sunday program becoming available on Monday. The program lasts about 2 hours.

Paul Douglas Boyer, who happens to live near here in Vienna, Virginia, has a blog and a podcast that discusses fun investment topics and reviews the Mad Money recommendations of guru Jim Cramer. His weekly podcast last about 30 minutes and is entertaining and well produced. The program advocates an asset allocation strategy. Both podcasts and model portfolios can be found on the Mad Money Machine.com website.

Jim Cramer is interesting, educational, and, at times, controversial. He has a daily radio program that lasts about 30 minutes. Podcasts for the radio program can be found on the TheStreet.com website. He advocates a trading approach with a small percentage of a portfolio. While his near term trading philosophy differs significantly from an NAIC-approach, he often offers interesting and insightful perspectives. His book Real Money: Sane Investing in an Insane World is well worth reading.

It is easy to become a fan of podcasts. You can find podcasts on many different subjects, not just investing. They allow time shifting. With an inexpensive MP3 player, you can listen to a podcast in the car, while walking, or while exercising. Apple offers a free program called iTunes. It includes a link to a podcast directory maintained by Apple. It can be configured to manage your podcasts by automatically downloading new programs and deleting old ones.

In general terms, stocks that have consistent increases in earnings and revenue, at a rate faster than the growth of the economy, are characterized as growth stocks. In contrast, stocks with a low price-to-book (P/B) ratio and low price-to earings (P/E) ratio are characterized as value stocks. Mutual funds are frequently characterized as either growth, value, or blend (a combination of growth and value). Mutual funds are further characterized as large, medium, or small capitalization. Market capitalization is simply the number of shares issues time the market price of share of stock.

All of this is a leading up to the observation that large capitalization stocks have not done as well as value stocks. Similarly, growth stocks have not done as well as value stocks, in the last 12 months or so. The Callen Periodic Table of Investing Returns shows how different sectors (large, medium, and small capitalization, and growth, value, and blend) have different returns from year to year.

So what do we do at this point? Stay the course. We have an excellent portfolio, even though it is weighted more heavily in larger growth stocks. As we buy more stocks, we should look for opportunities in smaller stocks, especially smaller growth stocks that are cheaply priced.

You can see how growth, value, and market capitalization interact, using this spreadsheet. The spreadsheet calculates return for a portfolio over the last 15 years based on the asset classes in the portfolio. The S&P 500 is a good surrogate for large capitalization stocks. Similarly, the Russell 2000 is a good proxy for small capitalization stocks.

To compare investment returns, enter a number, e.g., “100″ in the blue column for the asset class you want to examine and “0″ for all others. You can also look at the return of various combination of asset classes. You might find this spreadsheet helpful if you are trying to decide how to allocate long term savings.

After a great deal of research, I see considerable merit in having a substantial amount of core savings allocated among index funds that represent these asset classes. I am paying much closer attention to asset classes. (Moose pond Investors is really a large/medium cap, growth asset class.) Asset allocation might be the subject of a future posting if there is any interest. But for now, the returns of the various asset classes will help explain why the Moose Pond returns have not been stellar this year.

• Value Funds (all caps): Fairholme Fund –> FAIRX and Muhlenkamp Fund –> MUHLX
• Mid Cap Value Funds: Third Avenue Value Fund –> TAVFX and FAM Value Fund –> FAMVX
• Small Cap Value Funds Third Avenue Small Cap Value Fund –> TASCX. The program also discussed the Royce small cap funds but their best open-end fund is currently closed to new investors. The Royce closed-end funds discussed below are probably better alternatives.
• International Funds: Dodge & Cox International Fund –> DODFX and Harbor International Fund –> HAINX.

The program also mentioned www.fundalarm.com a free, non-commerical web site that helps to idenitfy when to sell a mutal fund.

Closed End Funds

• Source Capital –> SOR is a value oriented fund that has outperformed the Russell 2500, S&P 500, and the NASDAQ for the past 1, 3, 5, 10, and 15 years
• Royce & Associates, a manager of portfolios of small- and micro-cap companies, has three closed end funds with excellent track records:  Royce Focus Trust (FUND), Royce Micro-Cap Trust (RMT), and Royce Value Trust (RVT)

Some Open-End Mutual Funds (that don’t suck)

• Neuberger Berman International Fund –> NBISK invests primarily in common stocks of foreign companies of all sizes in developed and emerging industrialized markets and has consistently outperformed the EAFE.
• Brandywine Blue –> BLUEX focuses on mid to large cap growth stocks and limits the portfolio to about 30 holdings
• Forward Hoover Small Cap Equity –> FFSCX has outperformed the Russell 2000 but it has a high expense ratio and has not performred as well as the Royce funds
• Third Avenue Value –> TAVFX is a mid-cap blend with a very good track record

For example, a diversified portfolio might include:

• 50% Large cap (35% Investment Club Units, 15% Source Capital)
• 30% Small- or mid-cap (15% Royce Value, 15% Royce Focus)
• 20% International (20% Neuberger Berman)

More information about educational classes conducted by the D.C Regional Chapter of BetterInvesting can be found on the chapter website.