Concentration vs. Diversification in Investment Portfolios

For many years, investment managers and academics have argued about the concentration\diversification issue, and although diversification is now widely accepted as the right choice, there are still plenty good examples of concentration successes.

“If it’s your game, diversification doesn’t make sense. It’s crazy to put money into your 20th choice rather than your 1st choice. It’s the ‘LeBron James’ analogy. If you have basketball phenom LeBron James on your team, don’t take him out of the game just to make room for someone else.”

Warren Buffett

Buffet is the perfect example of the concentration strategy working perfectly. If you study in detail Buffet’s methods in the early stages of his career, you will notice that he has concentrated his investments each time he perceived a great opportunity. Often, Buffet would load the bazooka and shoot! This was how he ended up owning Berkshire Hathaway, a decadent textile company, in the 60’s. I even dare to say that some of his early moves could have ended badly. His early investment fund could have been vanished if the agricultural machinery company that he ended up owning (because he wanted to unload the pile of bonds that they owned) had gone out of business (as for a long time it seemed that it would be the case).

Incredibly or not, he was able to turn around that company and ended up richer than before, but during his adventures in the late 50’s he made some risky concentrated bets. After this, Buffet entered a new phase in his career: Inspired by Charlie Munger, he started to notice that quality for a fair price is better than a great price for a mediocre asset. However he kept the concentration tendency. The GEICO business is one of those examples, he saw a growing stock badly priced, since he had the cash-flow from the textiles operations, he went all-in.

The American Express business was similar, he saw a scandal throwing down the stock price of AmEx, he calculated that the company was in the same position than before, and in one year no one would remember the scandal, so here goes the bazooka! The same goes for Coca-Cola, Washington-Post, etc…

I truly appreciate Buffet’s strategies in the late 60’s and thereon, but some of his moves in the early years were really risky. However, I do not think that they were risky because of concentration. I even believe that concentration allowed him to work out better the problems that arose from the low quality of the businesses he entered. He was so concentrated in a handful of companies that he had the time to focus his effort in sorting those problems. Imagine if he had another 40 stocks to pay attention to…

So my take on this is very simple: the small investor should not refrain from doing some diversification, but at the same time he does not need to have more than 10 to 20 stocks, more than this is just attracting troubles. If a small investor has 50% percent in secure bonds, and the other 50% equally distributed in 10 stocks, he will not have more than 5% in each stock, which is pretty conservative and at the same time, it is a good diversification.

Now for the pundits who will say that Buffet now owns more than 80 businesses, I will say that he does so because he also has more money to invest than in any point in the past. He made most of the opportunities that he had, and I bet he would like to own more Coca-Cola, or Wells Fargo stock, but unfortunately he isn’t the only investor in the market and obviously at some point he couldn’t buy more significant portions of those stocks and had to search alternatives to his LeBron James. On the other hand, Warren does not buy significant portions in many new investments at the same time, usually he buys one or two businesses and focus in accompanying them, observing their performance and intervening if he thinks that things are starting to go astray (which is not very often).

In the end, I believe that investors should not exceed the 20 securities limit. Obviously, if you are an investment manager at some fund, your fund will own more than 200 securities, but what I am saying is that each manager should be focused in accompanying 10 to 20 different securities, in order to be able to deal with all the information and to react promptly.

Article Portfolio Performance: An Unbiased View

For a long time I’ve been thinking about the matter of accountability. As an investment writer, I believe my work is only worthwhile when I add value to my readers and followers. The main problem is that the tools available for performance evaluation are clearly flawed. Tipranks, for instance, has been classifying some neutral articles as long ones or even missing some articles, among other inconsistencies. Even, Seeking Alpha (SA) is missing some articles and mistakenly classifying some other articles. Actually, the best tool I’ve found is stockviews.com. Whenever I write a long article, I go there and just give a buy or sell indication on the stock and link my SA article to that buy or sell indication (the site automatically calculates the price of the order, so I can’t interfere with that).

However, I started my stockviews account just 3 months ago, which means that my portfolio is not yet correctly synchronized with my articles. Therefore, I decided to write an article destined exclusively to sum up the performance of my long articles.

Table 1 – Article Performance by company since 1st long article was published vs the S&P500 (Reference date: 18-09-2014)

table 1
I believe this is the most unbiased view that I can offer over my article performance since I started writing for SA. As you can see, my overall performance is 15.8% above the S&P500. The portfolio is being highly penalized by a bad timing on my 1st Peugeot article, but even so I think Peugeot will deliver and, in the long term, the portfolio will improve significantly. At the same time, this portfolio is really young. All of the stock picks have less than a year. If we add the fact that these companies are well regarded companies with strong brands, I think we have a huge potential in our portfolio. More than a value or growth portfolio, I think this is a quality portfolio. Let us now look at each stock:

Santander Bank (SAN)

Santander is the company that I have covered more extensively during the last few years. I have written about this stock way before starting writing for SA. My opinion is that Santander will consistently release value throughout the next few years. Therefore, I clearly rate it as a long term hold. You can read more: here, here and here.

Graph 1 – SAN stock performance since 1st long article vs the S&P 500

SAN 

Bank of America (BAC)

Bank of America is a clear bet on the American economy. This bank has a huge customer base and a very strong brand that is already revealing its strength through a visible improvement in profits. The fact that there still is some uncertainty about ongoing lawsuits regarding mortgage loans has been a major drag in the stock market performance. However, it is my view that the perception about these problems will fade away and the stock price will improve significantly. You can read more about BAC here.

Graph 2 – BAC stock performance since 1st long article vs the S&P 500

BAC

Best Buy (BBY)

The rationale behind my investment in Best Buy is very simple: not all traditional consumer technology retailers will fail and Best Buy is one of the best positioned companies to respond to online retailers. The strategy presented by the current management is very convincing and it has already exhibited positive indications. You can read more here.

Graph 3 – BBY stock performance since 1st long article vs the S&P 500

BBY

Intuitive Surgical (ISRG)

I am neutral about this stock because the company has performed well in recent times (S&P500 + 5%), but I am not convinced about the company’s outlook. I wrote a neutral article about ISRG in January. At the time, I defined the company as being in a bad momentum but having a good underlying business. During this time, I have not acquired additional knowledge that might help me in going long or short. You can read more here.

 

Peugeot (UG)

A previous note: the graph provided by Google Finance does not include the rights value of Peugeot’s capital increase.  If we account for the possibility of using the rights to buy additional shares at 7.5€, then, the average buy price would be around 12.22€. This means that the actual stock performance is around -7.38% and -16.3% against the S&P 500

This said, I believe entirely in the new management team and I think the stock has been too much penalized. The recent results presented by the company indicate that there are already some positive aspects in the ongoing turnaround. You can explore my opinions about Peugeot here and here.

Graph 4 – UG stock performance since 1st long article vs the S&P 500

UG

Corning Inc. (GLW)

I have always regarded Corning as a good company and I think it still is. However, the company is trading at reasonable multiples (23x earnings) and there are other investment options at very attractive levels (Coach and Adidas). I may return to this company in a future opportunity. The company has underperformed the S&P by 10% since I wrote an article about the company in April. You can read more here.

Coach (COH)

In my opinion, Coach is a clear buy. The company has underperformed the S&P 500 by more than 50% during the last 12 months. Coach is a very well regarded brand and the company has a good track record for business performance. The company is suffering from a glitch in profits and sales, but I think in the end the company has what it needs to thrive again. You can read more about this company here and here.

 Graph 5 – COH stock performance since 1st long article vs the S&P 500

COH

Adidas (ADDYY)

Like Coach, Adidas has a very strong brand and has also achieved very good results in the past. Coincidently, Adidas is also going through a sales and profit glitch. Again, I think this company has what it takes to perform a successful turnaround. You can read more here.

Graph 6 – ADDYY stock performance since 1st long article vs the S&P 50

 ADDYY

Conclusion

I believe this article clarifies my stances on the articles that I have written about several companies. On the other hand, it allows for a correct appreciation about the performance of the work I have been providing. As I said, the portfolio has been performing well and I believe it will continue in the future.

Earnings Digested 2Q14: Best Buy

I have written about Best Buy before: Best Buy: Why This Is One Of The Best Value Plays Around
I f you’ve read the article, you will come to the conclusion that I am bullish on the stock for buy and hold purposes. Therefore, I’ve been monitoring the company’s results, so let us see how the company fared in the 2nd quarter.
Sales dropped 4% to $8.9 million, while profits also shrank to $146 million. However, the diluted earnings per share for the 1st half of the year were $1.73, up from $0.54 a year ago.
Best Buy’s CEO argued that the market environment is not helping the company with soft demand for electronic products. On the other hand, the fact that the company is on track to deliver the $1 Billion in savings, is a promising sign that a recovery in demand for tech products will significantly add to the bottom line.
In my opinion, the 2Q14 results, sustain my view that the company is on track to normalize its earnings. We shouldn’t expect explosive growth, but an improvement in profits is likely.

Table 1 – Normalized earnings estimated

1

Best Buy is one of my favorite companies in 2014. I first wrote about this company in May. At the time the company was trading around $26, it has climbed around 20% since that time, beating the S&P500 by 14.5%

Graph 1 – Best Buy vs S&P500

2

Conclusion: The company is on track with its recovery. Although, the results are not brilliant, the competitive environment is also far from good. On the other hand, the stock had a huge depreciation and an improvement in the company’s markets will, most likely, bring better results and further stock appreciation.

Peugeot: The Making Of A Turnaround

Peugeot (PSA) is going through a tough transition. The company is facing an European declining market and its heavy dependence on this market has been a drag on the company profits. This way, the company decided to revamp its current management team and brought the Portuguese Carlos Tavares (ex-COO at Renault) to turnaround the company. 

The first results appeared on the Q2 earnings presentation, where the company posted some interesting improvements. I have recently wrote an article about PSA, you can read it here.

Ford: Where is the upside?

In my most recent article for Seeking Alpha, I discuss the Lean production system approach adopted by Ford, the future income tax rate and the current valuation levels:

Summary

  • Ford has partially executed a successful turnaround based on lean production principles.

  • The operating business has improved a lot and the current shareholder has an increased margin of safety.

  • However, the current valuations do not indicate much upside in the most likely scenario.

You can read the whole article in Seeking alpha.

Why is Santander poised for growth?

Currently, Santander (NYSE:SAN) has been perceived as another Southern European bank. However, Santander is the biggest Euro zone bank, in terms of market capitalization, with presence in several high profile markets like: UK, USA, Brazil, Mexico, Germany, among others.

Graph 1 – Santander Profit Distribution (Source: Santander strategy presentation)

Looking to the Graph 1, we can see that the company’s profits are not dependent on a single geography. This, probably, helps to explain why this Spanish bank did not have any quarterly loss since 2007 (Source:Santander strategy presentation). On the other hand, the stable earnings base has helped the bank achieving a total capital ratio around 12.1%, which is well above the 8% minimum required.

Strong liquidity position helps business

With a stable and diversified earnings source and a strong capital position, Santander has been mostly focused in streamlining its current operations while making some acquisitions, taking the opportunity to close interesting deals. One of those deals, the acquisition of a 470 million stake in Bank of Shanghai (Source: Financial Times), perhaps signals an incursion into the Asian banking market. While other banks in trouble have been mostly selling good assets in order to boost capital ratios, Santander has been able to take an opportunistic approach to the current environment.

The opportunistic banking deals have been in Santander’s DNA for a long time. In 1993, Santander bought a significant position in the US bank First Union (Source: High Beam). In 1997, Santander sold the position at a hefty profit, just in time to buy the Brazilian Bank Banespa in the beginning of the millennium (source: New York Times). Needless to say, Brazil represented 20% of Santander’s profits in the 2013 exercise.

Since 2008, Santander has been on a spree of acquisitions. The bank took advantage of the opportunity created by the financial crisis, to buy the totality of the Sovereign Bank (Source: Bloomberg). From 2010 to 2012, Santander bought two Polish banks, which together are worth around 10% of the market share in deposits (Source: Bloomberg). As we can see in Graph 1, the US and Poland, already represent 15% of the Santander’s profits.

Building an asset base during fire sales must be good for business

Most banks were caught off guard during the 2008 crisis. The impact of the crisis was amplified by strict regulations in terms of capital levels. This meant that many banks had to sell some of their best assets in order to be able to have asset sales gains that generated positive impact on capital levels. The problem with this approach is that it resolves the capital problem in short term, but reduces the asset base quality, which means lower profitability in the long run.

Santander, on the other hand, wasn’t caught off guard. The bank always relied mostly on traditional banking and wasn’t relying too much on leverage. This way, when the storm came, Santander had the flexibility to adapt to new capital levels demands while keeping a liquidity slack to take advantage from circumstances. I am guessing that in the following years, the bank’s asset base will be more profitable than in the past.

Angles to cover

No investment is ever perfect, there are always some risks that are hard to quantify. In the case of Santander, there’s the huge influence that the Botín family still maintains in the bank. On the other hand, Emilio Botín, 79 years old, has been held as the main responsible for the huge growth that the bank achieved during the last 3 decades. Clearly, the succession plans will be a major concern, for the bank, in the following years.

Conclusion

Santander has been able to meet capital levels while maintaining the liquidity to address interesting opportunities. I believe that the deals that the bank made recently will contribute positively for a stronger balance sheet than it had before the sovereign debt crisis. I think this will be evident once the Spanish operations normalize.

12 Rules that make great CEOs

1. Experts are clueless;
2. Clients can’t tell you what they want;
3. True innovation is on the next curb;
4. Biggest challenges beget the best work;
5. Design counts;
6. Use big graphics and big fonts;
7. Changing your mind is a sign of intelligence;
8. Value not equal to price;
9. “A” players hire “A+” players;
10. Real CEO’s demo;
11. Real entrepreneur ship;
12. Marketing = unique value.