Invest By Model

Questions from a Subscriber

Ken T asks:

I'm interested to hear you take on CSCO. I think this is a case of over reaction to their guidance. In any case, the sentiment seems to be turning down to account for the end of QE2 in June. Volatility has certainly shot up as well. I'd be interested to hear your thoughts on both these topics.

Ken, thanks for the questions.  Before I address them, I want to remind subscribers that I am hoping to be able to post more current information in a secure environment (i.e. not open to the public, like this blog), but we aren't there yet.  I would add, though, that my new subscription blog service, My Own Analyst, addresses questions like these on a regular basis, in addition to offering actionable ideas both on names in the models on a short-term basis, stocks on my watchlist and even companies outside of my narrow focus.  If anyone is interested, I have a brochure now available at http://ab.esiteasp.com/MOA.nxg

On CSCO, I clearly have been early.  The rationale for buying it was valuation and sentiment driven, and they remain at play.  The stock is frustrating me, but I believe that it should reward us eventually, as INTC and JNJ have done recently.  With that said, it's not clear that a bottom is definitely in, but I expect that the lows, which were tested successfully on the open yesterday, are likely in.  Curiously, most of the EPS estimates actually are rising slightly.  While the guidance was light next quarter, they overachieved this quarter.  Next quarter marks the end of their year.

On QE2, I think it's a non-event.  Let's focus on the real issue, which is short-interest rates.  They should be higher!  I find it funny that rates rose after QE2 was announced, and they are falling now that everyone and his brother are citing concerns over the ending.  The bigger issue is to figure out how the eventual rise in short-rates (in early 2012 is my best guess, but maybe sooner if Q2 GDP numbers are stronger than expected and Q3 data continues to  be strong) will impact longer-term rates.  As I have been suggesting all year and really since last summer, let's watch longer-term corporate bonds and high-yield.  Stocks are still very inexpensive to these alternatives and are likely not at risk unless those start to really break down. 

Questions from Subscribers

I am moving or rather copying a feature that I had tried to implement on a separate blog (My Own Analyst) last year over here, "Ask Alan".  The goal of My Own Analyst is to ultimately provide retail investors a different delivery vehicle for receiving my investment research, with a stronger appeal for those who are really looking more for just ideas and not help with portfolio management.

As many of you realize, Invest By Model is a subscription service that allows you access to basic research (on new buys) as well as a fully defined model portfolio for the very reasonable price of $20 a month.  Of course, I spend a great deal of time on this blog on a weekly basis sharing my big-picture thinking and detailing my rationale for not only new buys (which are included in the service) but also for sells, trims and adds (cryptically, usually!).

I am not a registered investment advisor, so the only way I can provide "advice" legally to individuals is through a public format.  I get some questions quite often, such as how to transition, for instance.  I also get requests for updates on the stocks we own, which I understand and appreciate.  I often do share this information, but it can be challenging on a number of fronts.  First, the time element, as most of my time is devoted to serving institutional clients.  Second, with my open blogs, the more I share, the more likely it is that potential subscribers will choose to just read my commentary and not actually pay for the service.  Ultimately, I hope to close the blogs, which will allow me to protect Invest by Model.  If you are one who is interested in more real-time updates and are willing to pay for it, please share your thoughts with me.  I am quite willing to work to deliver what you want in a way that works for all of us.

OK, with that out of the way, and keeping in mind that I got a similar question to #2 from a free-trialer, I wanted to pass along these questions and to respond:

Hi Alan,

I wanted to ask you two questions regarding the TOP 20 portofolio:

1) If I am a fairly recent subscriber and have been adding positions based on your recommendations since I joined. I have been a bit more hesitant to purchase some existing positions since several of them have run up double digit since the portofolio acquired them. I am curious if you have a strategy for new subscribers of how to build the TOP 20 portofolio.

2) I noticed you suggested to add to the 'loser' in your portofolio and when I read the company review I noticed that one if its risks is Jet fuel prices. Since oil prices have been up lately and the company did not hedge fuel it looks to be the reason for the decline of the stock. Are you concerned about it?

Thanks,

IK

 

Igor, thanks for your questions.

I am constantly rebalancing the portfolio and adjusting position sizes to reflect risk and reward.  While the current price might not be as good as before, the fact that we still hold the name reflects my confidence in the future potential.  At present, every single one of our stocks in Top 20 has a projected return in excess of 30%, with the average and weighted average at 46% and 49% respectively.  I wish I were smart enough to always know the exact future so that I could tell new subscribers to wait for Price X on Stock Y, but I am not.  Nobody is.

Transitioning, as I often explain to new subscribers, is a very difficult challenge, no matter what.  If one is moving from a portfolio of stocks, I think it makes it much easier.  Just sell the old and buy the new and be done with it!  Life is too short too fret over such minutiae.  Unfortunately, it's not usually the case that a new subscriber is transitioning from an invested position.  Instead, it's usually a move from cash.  There are several ways to approach it.  The worst is probably just to jump in and copy without thinking about it first.  If the overall market is extended, you might be making a poor timing decision.  If you don't think this is the case, then I recommend fully transitioning.  If, on the other hand, you have concerns about the market, then you should be incremental.  I have two approaches I use to use myself when I was managing money for others.  One is to try to invest a certain amount in the ones that look the best.  The other is to buy a pro rata amount of everything and then come back  in a few days/weeks/months and continue the transition.

Method 1 seems smart, but it doesn't always work out.  If you look at Top 20 right now, you will see of the 20 names, 8 are above average (greater than 5% weight).  Maybe you could read into my confidence and just buy those names right now and wait on the balance.  That would get you 48% invested actually.  Two of those names are up "double-digit" (and note that we are actually cutting one to 5% on Monday), and the balance are down.  Now, had you done that a week ago, you would have missed a rally of 15% in a name that was below average and that I have been patiently (too patiently) waiting on to increase the size.  Method 1 has some appeal, but realize that just because I think that these are my best stocks, they are only 1/2 of the WHOLE portfolio in value.  I don't know anyone who can predict in advance with complete certainty the ranking of future performance of his or her holdings.  Not me!

Method 2 is the method I actually prefer.  You are making a decision, in this case, to trust my judgment, but you aren't confident that the timing is right.  Who am I to tell you or anyone about what the near-term prospects are for the market?  It's a volatile animal, and don't ever believe otherwise.  If you were to pursue Method 2, I suggest that you commit in advance to how you will scale in.  Give yourself a definitive time-frame, or you may never get invested.  Seriously. 

As far as ALGT, it's a known fact that jet fuel prices are their largest cost and highly uncontrollable.  Over time, one should expect that air fares will correlate to jet fuel prices, and ALGT operates under this assumption.  If not, airlines will go out of business (theoretically, right!).  I don't have a strong view about energy prices, though my gut feel is that they are likely to be well behaved actually.  Commodity price hikes have been less demand-driven and more about hoarding and speculation in my view.  ALGT is a lot more than an airline - they view themselves increasingly as "Expedia with wings", and I expect that this view will ultimately become accepted.  Unfortunately, it's not only the fuel, but several other issues that have hit them and hurt their near-term profitability.  Cheap it is (I use PE as well as EV/EBITDA), but that's not enough.  I believe that the very strong unit demand (in-market, new markets) that is driven by compelling value to their leisure clients in smaller cities will ultimately drive higher profitability and a better valuation.  I reduced my target substantially after the diminished outlook and am looking for 60 (15PE) a year from now (based on 2012 projected EPS of $4, which is well below the consensus).