I’ve often said that you can’t judge a portfolio until you see how it does in both a roaring bull and a raging bear.
Did the market gods have to give me my wish?
My long-term portfolio, the Jubak Picks 50, has done just fine in bull markets. Based on my book The Jubak Picks and started on December 30, 2008, the portfolio http://jubakpicks.com/jubak-picks-50/ gained 57.8% in the bull year of 2009. (You’ll remember that the stock market bottomed in March 2009.) And it did okay in 2010, too, gaining 20.1% that year. In those each of those two years the portfolio beat the Standard & Poor’s 500 Stock Index hands down: The S&P 500 gained 26.5% in 2009 and 15.01% in 2010.
Then came the bear market test of 2011. The portfolio lost 18.59% last year. That’s against a 2.11% gain for the S&P 500.
For the three years, the Jubak Picks 50 was up 54.3%. That’s against a gain of 48.5% for the S&P 500.
That’s an extra 5.8% for the Jubak Picks 50 over the S&P 500. (Yes, the actual advantage would be lower since the Jubak Picks 50 incurs trading costs that an S&P 500 index wouldn’t. But I’m only doing 10 trades a year so, in these days of $10 trades (or less), we’re not talking about a lot of commissions costs.)
Is this a good or a bad result?
To answer that you have to go back to the purpose of this portfolio. The idea was to see if a buy and hold-ish strategy would pay even in these days of extreme stock market volatility. The premise of my book was that by picking trends with long life spans—10 years or more—a buy or hold investor could beat the market even if the individual picks used to buy into those trends were sometimes clunkers. Because markets and companies do change, I’d tweak the portfolio once a year. But not with a very big tweak. I’d sell no more than 10% of the portfolio (5 stocks) and buy no more than 10% (5 stocks) of the portfolio.
And that’s it. No mid-year corrections (unless a company disappeared through an acquisition or, shudder, a bankruptcy.) No panicked buying or selling. No short-term market timing.
When I started this portfolio, buy and hold wasn’t dead, but it sure wasn’t looking very healthy either. Buy and hold was never supposed to be buy and forget, but a great bull market run like the one that stretched from 1982 to 2000 made it seem like all an investor had to do was buy and then remember to add up the profits from time to time.
The bear markets that began in 2000 and 2007 and 2011 have demonstrated exactly how dangerous buy and forget could be. In the first bear, from March 2000 through October 2002 the Standard & Poor’s 500 fell 47%. In the second bear, the one that began in October 2007 and that bottomed in March 2009, the S&P 500 lost 56%. The most recent excursion into the investing wasteland took the S&P 500 down 19.4% (a trifle short, so far, of the 20% loss that officially defines a bear) from the April 29 high to the October 3 low.
The experience of the first two bear markets left many investors reluctant to buy stocks at all—and the losses and volatility of 2011 certainly haven’t done anything to convince them otherwise. The three events have left most of those willing to buy stocks as skittish as whitetail deer in hunting season: Never able to relax and always ready to bolt for escape.
But the original advantages of long-term investing aren’t extinct in my opinion. Long-term investors can still take advantage of temporary panics and mis-pricings to build positions at low costs. They can still put time to work for them by buying the stocks of companies with a high return on invested capital and letting those companies compound those returns over the years. They can still catch long-term trends that can power a company’s stock for years without being sidelined by worries about catching the best price.
All that buy and hold needs is a transformation from buy and forget to buy and review. Even a review as infrequently as annually will do the trick, I believe.
And that’s the belief that the Jubak Picks 50 was designed to test.
The method is simple. At the beginning of the new year I pick 5 stocks to drop from the portfolio because these companies haven’t run their business in the way that I want from a long-term portfolio holding or because they no longer can take advantage of the original long-term trend or because the trend has evaporated. (That hasn’t happened yet with any of the 10 trends I described in my book in 2008 although the environmental trend I described then is sure looking tattered at the moment. The book is out of print by the way but you can still easily order a used copy through Amazon.com.) I replace those five companies with the shares of five companies that I do think have what it takes to profit from one of these trends for the next five years.
In these buys and sells I’m not trying to reinvent the wheel. I’m using the rules developed by long- term investors over the years—and that have worked so well over the years.
The buying rules involve looking for companies with
- a lasting competitive edge. Morningstar.com calls this edge a “wide moat.” Peter Lynch famously advised looking for businesses that even an idiot could run because one day an idiot will. Other long-term investors such as Warren Buffett look for companies that have built up the value of a brand name that assures their continued dominance in a market.
- a return on invested capital that’s higher than that at competitors. This is insurance since it means that a company will have lots of profits to reinvest (at a higher than average rate of return) in staying one step or more ahead of competitors
- a history of research and development (or acquisition and development) that demonstrates that this is a company that doesn’t fall asleep at the switch, that knows how to press its advantage over competitors, and that can manage the change that sweeps through all parts of the global economy with increasing power these days.
- a conservative management style that can balance risk—since companies don’t survive for the long term unless they take risk—with safety. Things can still go wrong at companies like these but conservative management avoids bet-the-company gambles. an ability to recognize long-term global economic trends and to ride them even at the cost of disrupting the company’s existing business.
And the simple selling rules include
- Sell when the reason you bought the company in the first place no longer applies. Sell when the long-term trend that the company is riding turns in a direction the company didn’t expect or dissipates entirely. No use investing in even the world’s best buggy whip company when cars are replacing horses. Sell when a stock looks so over-valued that it has taken up a lot of the room to run in the larger trend.
At the same time as I pick five stocks to add and five to drop, I name five more already in the portfolio than I think are especially appropriate now—that is in 2012—for any portfolio, buy-and-hold, buy-and-review, whatever.
The result is ten stocks for the next ten years. (To see the Entire list of my 50 picks for the long-term see http://jubakpicks.com/jubak-picks-50/. For more on the broad themes that have guided these picks see my 2008 book The Jubak Picks. You’ll see an ad and an easy way to order on my blog The Jubak Picks http://jubakpicks.com/ )
I’d add one other rule to these, one that wasn’t so important to stress when stocks were headed up and up. The other part of selling high has always been buying low. After a year like 2011 in my annual revision I’m looking to add long-term picks that play long-term trends but that are currently trading at very beaten down prices.
So what companies get the ax as we start 2011?
That’s not as easy a question to answer as it might seem after a big down year in the portfolio. Just as in a bull market some pretty shaky companies look like winners; in a bear market some very good companies look like losers. Let me stress that I’m not looking to jettison a stock from this list just because it lost big money in 2011. That’s a sure way to buy high and sell low. What I want to do is get rid of those companies that on a fundamental level look like they’ve lost their ability to profit from the long-term trends that I’ve identified.
Central European Distribution (CEDC). The company’s strategy to build market share in the distribution of vodka and other liquors in Poland, Russia, and the rest of Eastern Europe by acquisitions went haywire in 2011-2011. The company wound up acquiring brands for the sake of acquiring brands and the result was a stable of labels that all too often competed with itself. Unfortunately for the company’s ability to recover from this mis-step, its early success has validated the attractiveness of this market to the extent that bigger liquor producers and distributors are moving in. I think Central European Distribution can sell out to a bigger competitor but I don’t think it can recover to take advantage of rising incomes and rising consumption in Eastern Europe. The pick lost 80.9% in 2011.
Deltic Timber (DEL). Deltic Timber was one of the portfolio’s better performing stocks in 2011—up 7.7% for the year—so why am I taking it out of the portfolio now? Because I think the trend that makes Deltic valuable—the conversion of timber producing land into real estate—will be more profitable in the years ahead if you own more land than Deltic’s 439,000 acres and you own it in what are likely to be—once the housing market returns—higher demand areas than Arkansas and Louisiana. (Remember this is a long-term portfolio so I’m willing to look ahead five years or so.) I’ve therefore added a timber to real estate play to the portfolio to replace Deltic. This pick gained 7.7% for 2011.
Encana (ECA). The company’s December 2009 split into two companies was supposed to highlight the value of the U.S. and Canadian natural gas assets that Encana kept. (The new company Cenovus (CVE) got the Canadian oil sands and refining assets.) Instead it has wound up emphasizing Encana’s exposure to a glut in North American natural gas that could keep prices depressed for years. Encana still has a huge number of acres under lease but there are North American energy companies with a more attractive mix of assets. The pick lost 33.6% in 2011.
First Solar (FSLR). This thin-film solar energy company saw the competitive ground shift against it in 2011—and the shift doesn’t seem about to reverse in quick order. First Solar’s strategy has been built upon the superiority of its technology: Thin films aren’t yet as efficient at turning sunlight into electricity as crystalline silicon technology is, but they are a whole lot cheaper. Make them cheap enough and improve efficiency as well and at some point the technology leaves crystalline silicon solar cells in the dust. But this year the key competitive advantage in the solar sector shifted to financing. If you had access to cheap money, you could provide cheap financing to utilities to build projects that used your solar product. If you had access to cheap money, you could continue to build production capacity, even if the industry was awash in capacity that no one needed, and then cut prices to gobble up market share even if you lost money on what you produced and sold. That gives the big edge to Chinese solar manufacturers (Yingli Green Energy (YGE) and Trina Solar (TSL), for example,) and manufacturers in other countries with parents with deep pockets (such as Sunpower (SPWR)). This pick lost 74.1% in 2011.
Kinross Gold (KGC). Kinross got so deeply involved in adding new gold reserves that the company lost its focus on costs. Gold production indeed climbed in 2011, rising 13% year over year in the fourth quarter, for example. But cash costs soared to $634 a gold equivalent ounce in the fourth quarter of 2011 from $517 in the fourth quarter of 2010. Some of these came from higher fuel, labor and royalty costs, but the increase that will be hardest to do anything about came as Kinross saw increased production from its higher-cost West African mines. Add in a huge backlog of projects under development and I don’t see management having the bandwidth to effectively tackle rising costs. This pick lost 39.3% in 2011.
And now for the fun part. Putting together my 2012 list of 10 stocks for 10 years.
One part of this list is new—well, actually it’s a year old since I added it with last year’s revision to the portfolio. These are the five long-term picks already on the list that I think will do best in 2012. (This list didn’t do very well in 2011 with picks Bunge (BG) down 11.2%, Cemex (CX) down 47.7%, Deltic Timber (DEL) up 7.7%, Johnson Controls (JCI) down 16.4%, and Rayonier (RYN) up 31.8%. If you want to be mean, you could snidely say that with the exception of Cemex those best picks did beat the loss for the portfolio as a whole, but you wouldn’t be that mean, right?)
Cemex (CX). I’m keeping the Mexican cement giant on the list in the belief that the company will manage to pay down/renegotiate its huge debt load again and continue its end of the year recovery as the U.S. construction sector picks up some speed. (Not much. Just some.) The shares, down 47.7% in 2011, were up 55% from November 25 through the end of 2011.
Freeport McMoRan Copper & Gold (FCX). Copper is the commodity most sensitive to the growth rate of the global economy. I expect demand to pick up in the second half with evidence that the slowdown has bottomed in China and Brazil. Because of the strike at its Grasberg mine, the company will face relatively easy comparisons in the second half of the year. This pick was down 36.2% in 2011.
General Cable (BGC). The global economic slowdown pushed back a lot of spending on upgrading the electricity grid. There’s only so long that kind of spending can be put off and General Cable has pushed hard to gain share in the part of the global economy that will recovery first and up spending on infrastructure, emerging markets. This pick was down 28.7% in 2011.
Gol (GOL). Brazil’s stock market is recovering faster than China and in 2012 investors will focus more on the increase in air travel from the soccer World Cup and the summer Olympics.
Potash of Saskatchewan (POT). The temporary slump in demand for potash and other fertilizers will end once distributors see that the world isn’t coming to an end and as farmers order for the spring season. The pick was down 19.5% in 2011.
And, finally, here are my five adds for this year’s list.
Home Inns and Hotels Management (HMIN). This operator of low and moderate cost hotels and motels will profit from the increase in domestic travel in China as incomes rise—and from the end of the bear market in China’s stocks.
Lynas (LYSDY). The rare earth producer will get its processing plant running in Malaysia just in time for the recovery in global demand for rare earths in the technology and alternative energy sectors.
Pioneer Natural Resources (PXD). Pioneer’s acreage in the Barnett and Eagle Ford shales are rich in natural gas liquids, which has helped the company dodge the worst effects of low natural gas prices. Unlike many of its peers, Pioneer has been able to raise money in the financial markets–$490 million in November—to finance development of its assets rather than having to sell off stakes to bigger, cash-rich energy companies.
Weyerhaeuser (WY). The company converted to a real estate investment trust in 2010 (3.04% dividend) after selling off its paper and corrugated packaging businesses. Real estate sales on the company’s 6.15 million acres of timberland provided 13% of sales in 2010.
Yamana Gold (AUY) . In the third quarter Yamana reported a 22% year over year increase in revenue and cash costs of just $468 per gold equivalent ounce. Yamana isn’t putting a huge amount of capital at risk to increase production since it has been able to increase reserves by developing existing mines rather than exploring for and then developing new deposits.
Look for the usual sporadic updates on the stocks in this portfolio over the next year. (And I promise to have the all the stocks added to or deleted from the portfolio within a week this year.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Freeport McMoRan Copper & Gold, Gol, Home Inns and Hotels Management, Johnson Controls, Lynas, Pioneer Natural Resources, Potash of Saskatchewan, and Yingli Green Energy as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/. I’ll have the fund’s portfolio as of the end of December posted in a few days.
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