Today, I will recap the quarter and share my outlook. This review will replace my usual weekly message that I would ordinarily send out after the close on Friday. Let's go straight to the numbers:
Top 20
Top 20 had its second consecutive strong month after starting the year a little behind the S&P 500 as Small-Caps encountered some profit-taking early on. It wasn't an easy month or quarter, but we managed to beat the S&P 500 by 1.52% for the month and 3.65% for the quarter. This quarter, we will hit our three-year anniversary. Since May 2008, the model is up 104%, while the S&P 500, with dividends, is up about 3%.
The 20 names we hold were all in the portfolio at the beginning of the month, and we have turned over 5 names so far in the year. As an illustration of how difficult the month was, 1/2 of our names actually declined during the month, with one by 17%. On the other hand, 4 of our names rallied by more than 10% during March. Looking at the stocks we hold currently on a YTD basis, 3 names are down more than 10% (and we have held all of them), while 9 names are up more than 10%. If I include the sales, several of those were also up double-digit when we sold them. One of the things that pleases me the most is how well some of our purchases in December performed during the quarter (BEN, PLPC and TECD). You may recall that I described my actions as being very proactive at the time, preferring to find some new names rather than resting on my laurels.
The current portfolio is 98.4% invested, which is pretty maxed out. As a reminder, I don't time in this model, and it is required to be 90% invested at a minimum. As I look at the 20 stocks, they have a 45% return over the next year if they achieve my targets. Due to our weightings, the portfolio's expected return on the stocks is 47%.
Looking at the market capitalizations, 1/4 of the names (26% of investment) are larger than $10 billion, 1/4 (19% of investment) are between $1 and $10 billion, and 1/2 (54% of investment) are below $1 billion. Our median is $1.2 billion, with our average at $23 billion.
Looking at sectors, we are 30% each in Industrials and Technology, 15% in Consumer Discretionary, 13% in Healthcare, 6% in Financials, 2% in Energy and also 3% in international stocks. Compared to the S&P 500, we are heavy in the first three sectors I mentioned and most underweight Consumer Staples, Financials and Energy.
On other characteristics, we continue to have a substantially better financial strength, with most of our companies being either debt-free or having more cash than debt. Our PE ratio is slightly higher than the S&P 500, but we have substantial variability. Our dividend yield is 1% compared to 1.8%.
Conservative Growth/Balanced
CG/B also had a strong month, especially considering that several of its larger holdings were down. For March, the model returned almost 0.5%, which was 0.4% better than stocks and bonds. For the quarter, the return of 5.19% compared to stocks at 5.92% and bonds at 0.42% (or, at 60/40, a combined 3.72%). Our 1.47% advantage continues a long record of success, with the total return of 56% more than triple the 17% return of the benchmark since we launched in July 2008.
For the month, we had declines in 7 of the 15 stocks. Trading and having favorable position sizing helped us to achieve the small gain. For the quarter, we were helped by our overweight in stocks and our underweight in bonds. We had a single name decline more than 10%, but we had 4 rally by more than 10% (not including our sales, which push that number to 6 or 7).
The current portfolio is invested as aggressively as possible at 75% stocks, 22% bonds and 3% cash. In addition to trying to beat the blended 60% stock and 40% bond benchmark, it is my responsibility to preserve capital as best I can. I am able to do so by moving to as much as 45% cash at times that stocks and bonds are both falling (stocks have a minimum of 45%, bonds 10%). We can also protect capital by investing in securities with less risk than the market (due to stability of earnings, conservative balance sheet, low valuation, high dividend yield, etc.). Our current equity holdings have a 34% average expected price return over the next year to my targets, with a weighted average of about 36%. Our current dividend yield on the equities is about 2.3%, which is above the 1.8% on the S&P 500. Our bond exposure is mixed, with the majority replicating our benchmark (the Barclays Aggregate Bond Index) but a large amount invested in just the mortgage portion. Given my outlook for stable to slightly higher interest rates, the mortgages give us a bit more yield but slightly less interest-rate exposure. I estimate our overall yield on the portfolio to be about 2.4%.
Looking at market caps, the portfolio has less exposure to Small-Caps than the Top 20. 57% of the portfolio is invested in companies with market caps in excess of $10 billion, 22% between $1 billion and $10 billion and 21% less than $1 billion. The average is $48 billion, with a median of $17.6 billion.
Looking at sectors, the portfolio is much closer to the weightings of the S&P 500 than the Top 20. Healthcare is our largest exposure at 27% (of equities). Tech at 16% is just in line with the index, while Consumer Staples at 15% are somewhat overweight. Financials at 13.6% are roughly in line, as are Consumer Discretionary at 13%. Other sectors include Industrials at 9% and Energy at 7%.
On other metrics, our PE is roughly in line with the market, but we have much better balance sheets. I am not a big fan of "beta", which is a measure of sensitivity to market moves, but our average is 0.9, indicating slightly less exposure. All of these metrics support my contention that the portfolio is indeed "conservative".
Outlook
My longer-term view remains bullish, supported by likely stable interest rates, moderately higher economic growth and some expansion in PE ratios. I have shared a view that the S&P 500 should appreciate about 20% this year while interest rates rise moderately, and the first quarter was certainly in line. I am not sure that we can expect the path to be so linear, and, in fact, it wasn't, as we had a substantial shakeout following the Japanese catastrophes that left the market briefly down YTD.
Looking at this quarter, the positive trends seem likely to persist. I am somewhat concerned about the potential for the market to worry about the likely changes ahead in Fed policy - we can't expect zero interest rates permanently. While it could lead to volatility in the short-term, valuations are so low and the recovery still so entrenched now that we should actually welcome modest interest rate hikes as long as they are going from below normal to normal. Clearly, there is a risk that monetary policy becomes too tight, but this is likely a 2013 event. While short-rates could rise substantially, I don't expect longer maturities to get hit too hard. Big picture, I am finding tremendous value in Large-Caps, several of which seem to have ok fundamentals but very cheap valuations due to being out of favor. While I don't think small companies will necessarily continue to outperform large companies in aggregate, I want to maintain high exposure to Small-Caps due to my view that M&A activity is likely to remain robust.
Articles
While today is April Fool's Day, I am not kidding when I say how much I appreciate your continued support. We are doing things very differently than most people, and it seems to be working. Invest By Model is all about great stocks combined into a portfolio built for long-term performance, delivered at a fantastic price that allows the subscriber to retain 100% control. Thanks for being a part in Q1!
I look forward to the quarter ahead, which will include my participation as a speaker at the Money Show in Las Vegas on May 11th. I will be staying there the 10th and the 11th and encourage you to attend (it's free). Here is a link to my presentation. I also am in discussions to begin a series of live educational webinars with TradeKing - I will certainly let everyone know when that commences.
Best Regards,
Alan Brochstein
www.InvestByModel.com
