Portfolio Workshop

Here are the slides from the portfolio management class held by the D.C. Chapter of BetterInvesting. The slides are available in PowerPoint and Adobe PDF formats. Also, here are links to the Portfolio Record Keeper reports and the Excel spreadsheet discussed at the workshop.

Annual Report for 2005

Happy New Year to all! We started Moose Pond Investors a little over five years ago. It is hard to believe that five years have gone by. We now have 18 partners made up of family and friends.

Given the amount of effort that went into research and analysis this year, the results for 2005 were a little disappointing. However our 5-year total return is well ahead the S&P 500 (large stock index) and almost even with the Russell 2000 (small stock index).

Here is our Annual Report for 2005.

Performance for 2005

Given the amount of effort that went into research and analysis this
year, the results for 2005 were a little disappointing.  On a
cash flow basis, we finished with a very small gain.  While
that is better than losing money, we did not beat either the
S&P 500 or the Russell 2000.  They were up 4.9% and
4.6% respectively.  On a positive note, we have soundly beaten
the S&P 500 over the past five years and we are almost even
with the Russell 2000.

The table and chart below show the annual return for Moose Pond
Investors over the past five years.  The “Stocks
Only” column only shows the return of the stocks we
held.  The next column, “Stocks &
Cash,” includes cash awaiting investment and monthly
brokerage fees.  As a result, the return is slightly
lower.  As our portfolio holdings grow larger, cash on the
sidelines and fees will have less of an impact on overall portfolio
return. 

 

The annual returns for Moose Pond Investors are calculated using
internal rate of return (IRR).  This method is more precise
because it
looks at actual cash flows.  It better accounts for partner
investments
and market fluctuations throughout the year.  We could have
calculated
annual return using the change in unit value from year to
year. 
However, we opted for the more accurate IRR method. 

The two
indices that we have been using for comparison, the S&P 500 and
Russell 2000, show the total return for each year including
dividends. 
These return calculations do not take into account the actual cash
flows for Moose Pond Investors. 

Amgen Inc. (AMGN)

SSG and PERT A (12-26-2005) | Google “Stocks: AMGN” | Company Website

Amgen remains a HOLD. Morningstar provides the following summary of Amgen:

Amgen stands out in an industry dominated by companies trying to creep out of the red. With 37% operating margins last year (excluding acquisition-related charges) and historical margins periodically surpassing 40%, Amgen has proved its ability to translate sales into profits. Even though it invested $2 billion in research and development last year, Amgen still generates plenty of cash, with free cash flow solidly above 20% of sales. With these numbers, Amgen is rewarding investors by both funding future growth and repurchasing shares.

Growth. The Value Line 3-5 year growth projection for revenue growth is 18.5% and EPS is 10%. M* only forecasts 15% revenue growth. The attached stock selection guide uses revenue growth of 17%. Using the preferred procedure, this results in EPS growth of 15.5% and a projected 5-year EPS of $5.88.

Quality. AMGN is high quality company with Value Line rating Financial Strength A++ and Earning Predictability 95. Section 2 of the SSG shows average return on equity (ROE) of 16.8% and average pretax margin of 41.6%. The RQR quality rating is 78.2.

Valuation. Applying the above and a conservative future average PE of 23, the projected average return is 10.8% making Amgen a HOLD. M* rates AMNG four stars meaning the stock is under valued.

Investing Philosophy

We invest in quality companies that grow their earnings based on a sound business model.  We buy these stocks when they are priced to provide superior long term returns. 
While many investors and mutual funds invest in either “growth” or “value” stocks, we
look for companies that have both attributes.  Growth, quality, and value are interrelated.

A company should have a sound business model that has demonstrated consistent growth in revenue and earnings over the past 3 to 5 years.  The company also should have the potential to sustain growth in revenue and earnings into the foreseeable future.  

The quality of a company, which usually reflects strong management, manifests itself in several ways, including:  (1) consistent historical growth in revenue and earnings, (2) steady or increasing pre-tax profit margins, (3) steady or increasing return on equity that is greater than the industry median and is generally greater than 15%, and (4) a strong balance sheet.  

Value Line ratings of  B++ or better for Financial Strength and 85 or better for Earnings Predictability correlate well with quality and good management.  We also compare each company’s prospects for future growth and net profit margins with other companies in the same industry.  The Manifest Investing quality rating combines these four factors into a single 100 point rating.

Superior long term returns can be assessed in two ways – (1) by calculating intrinsic value for a company using discounted cash flow or (2) estimating the projected average return using a stock selection guide or similar calculation.  Using the stock selection guide, we look for a projected average return (PAR) greater than 15%.  We also look for quality stocks that sell below their intrinsic value.  Morningstar uses a discounted cash flow analysis to determine the fair market (or intrinsic) value of a stock.  Stocks rated 4 and 5 stars sell below their intrinsic value.  It is generally easier – although not as precise – to compare stocks using their projected average return from the stock selection guide.  

We prefer companies that, if purchased, offer the possibility of price earnings (PE) ratio expansion.  We generally avoid companies with high PEs, particularly when the PEs have been contracting in recent years.  High growth stocks with high PEs are particularly vulnerable to large downward price adjustments if the growth outlook for the company slows down.

Portfolio management is as important, perhaps more important, as selecting good stocks.  Several general principles guide our portfolio management:  

• Try to stay fully invested and to keep our cash position
  below 5%.  
• Don’t try to time the market.  
• Maintain about 20 stocks in our portfolio +/- 5.  We reinvest all of our dividends in the companies paying the dividends or in the portfolio.  
• Replace a holding if the company’s fundamentals deteriorate or if the company becomes overvalued.  
• Replace an individual stock if the replacement company will improve the overall projected average return or the quality of the portfolio.  
• Consider diversification when making purchases and try to stay invested in at least five different sectors but there are no strict rules about sector weighting or company size.

The Coiled Spring Effect

Market forces are not always rational. Sometimes, a company continues to grow its earnings but its stock price gets stuck in a rut, trading within the same price range for several years. Earnings continue to grow but the price stays about the same. This phenomenon can be observed in the graph in Section 1 of the stock selection guide and also in the table in Section 3 (falling high and low PEs). Sooner or later, the market will “discover” the stock and the price will quickly adjust upward and then follow earnings more closely. Patient investors are rewarded. This is the coiled spring effect.

Three quality stocks that fall into this category are Wal-Mart Stores (WMT), Microsoft (MSFT) and the Coca-Cola Company (KO). They are discussed below. Moose Pond currently holds Wal-Mart.