I find the business of professional investing to be very similar to the business of professional sports. In investing, the customers of a mutual fund want and deserve a competitive return on their investment for the price that they pay. ETF/Index fund guys are cheap and are willing to settle for mediocre, while others are willing to pay up for performance that hopefully exceeds mediocre but usually lags. The owner of the fund hires a manager (sometimes the same guy or gal), and that person is responsible for finding the investments.
In professional sports, the fans of a team want and deserve a good return on their investment for the price that they pay too. The owner hires a manager who is responsible for building a team that includes a coach and players. The manager has to work within a budget and has to produce results. If a player isn't cutting it, then he gets cut. When I was growing up (let's call it the 70s and early 80s), fans knew their teams well. Walter Payton was a Bear last year, this year and next year. Earl Campbell was an Oiler. I could go on, but I will quickly get out of my league! In any case, we all know that today players come and go like the wind.
Most investors should feel the same way about their funds as they do about their hometown team, as turnover is typically very high in their mutual funds. I am guilty of this as well. It would be nice if everyone could find their companies in which they invest, act like long-term owners and then reap the long-term capital gains over time. Unfortunately, it's not the way it works any longer. Transaction costs (commissions especially, but also the bid-offer spread) have plunged compared to decades ago, and, absent those barriers, humans will be humans. Doing something seems to be a better use of time at the time than doing nothing, but it often hurts us. As an example, I did something good early in 2009, buying Intuitive Surgical (ISRG) below 100. But a few months later, I did something again, and it wasn't good. It seemed good at the time booking that 50% gain, but had I held on, it had another 100% to go from there. I don't recall what I did with those proceeds, but I know it didn't do that well!
I am a little philosophical today over this because I do wonder if I end up better off by trying to improve my returns by constantly changing up the players. The answer for us collectively is clearly no on average by definition, as for every winner in a short-term trade, there is a loser. Still, I would like to believe that for the nimble, we can "earn through churn". I bring this up because I churned a LOT in 2009. A client of mine has an annual stock-picking contest where its employees contribute a list of names and number of shares at the beginning of the year (with no cash or shorts). I was included in the 2009 contest. Of the 5 participants, the very worst static portfolio returned 34%. The very best returned 59% (more on that later). It frustrated the heck out of the principal of the firm, as their client portfolios didn't do quite as well as the worst picker. There are lots of reasons why, but clearly market timing hurt (raising cash on the way down and not getting it redeployed on the way up quickly enough).
The +59% static portfolio winner was mine. I contributed my Top 20 Model Portfolio as of 12/31/08. Fortunately, all of my trading during the year in that model actually added to the return, as we closed the year at just under 69%. That was a lot of work, though, for not really that much more gain. Had I not been so fearful that the rug was going to get pulled out, I might have had the courage to stick with things like ISRG, NetApp (NTAP) or even America's Car-Mart (CRMT) a bit longer.
In any event, I probably want to always believe that turnover is justified, as otherwise my life would be a lot more boring. So, consider that admission as I make the case for why the current investment environment demands a high turnover strategy.
In 2010, the market will be up... and down. It could crash, but probably won't. It could soar, but probably won't. I am very humble in terms of having conviction about this, and, from what I read, this is probably not too uncommon. The economy has to deal with the training wheels coming off - artificially low rates could rise, unfunded government spending and tax-crediting must abate. God help us if China's growth proves to be an illusion. Companies will find it harder and harder to improve operating costs as they did last year unless revenue growth comes back (and it likely won't).
2009 was all about things not being as bad as they could have been and PE ratios reinflating as easy money (for investors and banks, anyway) was abundant. 2010 will most likely be about the supply of stocks, whether it's more former LBOs coming back to the market, insiders unloading or companies that are getting life-lines due to low borrowing costs raising equity as they extend their debt or move it from the banks to the capital markets. So, I guess my expectations are that the run-up of the last 9 months continues for a while, but then runs into a wall. The portfolio I share below won't perform that well if the economic recovery proves to be quite strong. No need to worry, though, as I will crank up the churn!
In 2009, my strategy was to invest in out-of-favor companies with strong balance sheets and strong competitive positions for the most part. I ended up with my 20 names having a high concentration in Consumer Discretionary despite my view that the economy would absolutely stink in 2009. Here are the names, symbols and economic sectors:
| ALLERGAN INCORPORATED | AGN | HlthCare |
| AMERICAS CAR-MART INC | CRMT | ConsDisc |
| AMERICREDIT CORPORATION | ACF | Finance |
| BIOMED REALTY TRUST INCORPORATED | BMR | Finance |
| CARLISLE COMPANIES INCORPORATED | CSL | Industrl |
| CARPENTER TECHNOLOGY CORP | CRS | Material |
| CATALYST HEALTH SOLUTIONS INC | CHSI | HlthCare |
| CHEVRON CORPORATION | CVX | Energy |
| CISCO SYSTEMS INCORPORATED | CSCO | Tech |
| EZCORP INCORPORATED CL A | EZPW | Finance |
| HORMEL FOODS CORPORATION | HRL | Staples |
| LADISH COMPANY INCORPORATED | LDSH | Industrl |
| MENS WEARHOUSE INCORPORATED | MW | ConsDisc |
| MIDDLEBY CORPORATION | MIDD | Industrl |
| NATIONAL INSTRUMENTS CORP | NATI | Tech |
| NETAPP INC | NTAP | Tech |
| RAVEN INDUSTRIES INCORPORATED | RAVN | Industrl |
| SHOE CARNIVAL INCORPORATED | SCVL | ConsDisc |
| THOR INDUSTRIES INCORPORATED | THO | ConsDisc |
| TIMBERLAND COMPANY | TBL | ConsDisc |
The 2010 picks include 3 that were in the model at the beginning of 2009 as well: EZCORP (EZPW), Hormel Foods (HRL) and Timberland (TBL). After I share the names (but not the weightings, which are available with a free trial at Invest By Model), I will share some details about what the portfolio looks like:
| ACETO CORPORATION | ACET | Industrl |
| ALLEGIANT TRAVEL COMPANY | ALGT | Industrl |
| BARD C R INCORPORATED | BCR | HlthCare |
| BUCKLE INCORPORATED | BKE | ConsDisc |
| CARDIAC SCIENCE CORPORATION | CSCX | HlthCare |
| CERADYNE INCORPORATED | CRDN | Industrl |
| DORMAN PRODUCTS INCORPORATED | DORM | ConsDisc |
| EZCORP INCORPORATED CL A | EZPW | Finance |
| FAMILY DOLLAR STORES INCORPORATED | FDO | ConsDisc |
| FOOT LOCKER INC | FL | ConsDisc |
| HORMEL FOODS CORPORATION | HRL | Staples |
| MARTEK BIOSCIENCES CORPORATION | MATK | HlthCare |
| MET-PRO CORPORATION | MPR | Industrl |
| NATIONAL PRESTO INDUSTRIES | NPK | ConsDisc |
| SOMANETICS CORP COM NEW | SMTS | HlthCare |
| ST JUDE MEDICAL INCORPORATED | STJ | HlthCare |
| SYNOVIS LIFE TECHNOLOGIES INC | SYNO | HlthCare |
| TIMBERLAND COMPANY | TBL | ConsDisc |
| TITAN INTERNATIONAL INCORPORATED | TWI | Industrl |
| VOLCANO CORPORATION | VOLC | HlthCare |
Here are some overall parameters:
- Forward PE: 14X median
- 2009 return: 7% median
- P/TB: 2.5X median
- Net Debt to Cap: 18 of 20 have net cash, with -21% net debt to cap median
- Market Cap: median of 850mm
It should be clear from both the statistics and a cursory review of the names that this is a pretty contrarian and value-oriented portfolio, similar to last year's in structure despite the names being so different. Volcano (VOLC) was a small position, and we eliminated the balance today (January 5th) after a 54% rise from our May purchase. On the other side comes an industrial with a low P/TB, lots of cash and not such great performance in 2009 (-2% after a 37% rise in 2008). Many of the companies I included had a pause of sorts in 2009 after doing a lot better in 2008, and we scooped many of them up late in the year (and a few, unfortunately, earlier). I would include MPR, ALGT, ACET, DORM, FDO, SYNO, MATK, STJ, BCR and EZPW in that group (lagged in 2009 after beating in 2008).
One final observation is that I don't believe in closet indexing. You may notice that I don't have any Energy, Materials or Technology, while I have a ton of Consumer Discretionary, Industrial and especially Healthcare. Some of this is intentional (Energy), but, for the most part, it has to do with a focus on what I think is really cheap. The cheapest tech stocks look expensive to me compared to the cheapest health stocks. If you are using some of these ideas, you might consider that there is a great risk of deviating from the S&P 500 due to the size of these companies but particulary due to the concentration in certain sectors. Hopefully that deviation will be positive!
Disclosure: Of the 20 names recommended for 2010, all but VOLC are in the Top 20 Model Portfolio or other model portfolios (being sold today). All but VOLC and NPK are in a porfolio that I manage (see my holdings)
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