Investment Activity Review- June 2013

It’s amazing how half the year has gone by! Here are my trades for June as well as a recap of our portfolio performance for the first half of 2013.

Sold iShares Japan ETF (EWJ) -9%

Last month I opened a position to gain exposure to the Japan equity market. The reason being that Japan has since the start of the year made no secret that they are going all-in on combatting deflation and getting the economy out of its 20 year funk. They have decided to adopt their own brand of quantitative easing and are more than comfortable to devalue the Yen. The Nikkei has been up almost 70 percent year-to-date. Looking at the American experience with printing money and the impact is has had on paper asset prices, the upside should naturally be there given Prime Minister Abe just began his program. I still hold true to that playbook so why did I sell the Japan ETF?

My issue is that I don’t trust the plumbing of the ETF product. In the time I held the ETF there was some bizarre behaviour. On days where the index was down and crashing 5-6 percent, the ETF was actually up and on other days when Nikkei as surging upward, the ETF was down! Isn’t the whole point of ETF’s and especially index funds to mirror the performance of the respective benchmarks? The behaviour of the EWJ totally freaked me out. It’s not like this is an illiquid fund of some small country. The experience highlighted my skepticism of ETF’s and which I have written about in the past.One element is that you really don’t know what is driving the price of the ETF. Is it fundamentals or technical indicators or is it something altogether different? It just did not seem the fund was trading on the market performance. I can understand if time differences permit the opportunities for arbitrage and I do realize you should expect some sudden shifts in prices, but this was ridiculous. So I took the loss mainly so I can sleep better and I’ve decided to seek out specific blue chip type companies to get less volatile, more tangible exposure to the Japanese market. I think I’d rather exploring owning a well-run company like Toyota or Honda than hold a basket of companies, at least half of which are duds. Many Japanese companies trade on US exchanges as American Depositary Receipts (ADR’s), so I will be exploring those.

Bought some Big Blue (IBM)

Last month, my wife and I opened up an RESP account for my son. Given the goal is to meaningfully grow the portfolio to provide money for his schooling, and the fact we have a time horizon of about 15-18 years, I decided to construct the portfolio to include high quality companies with durable brands that we would be comfortable holding for 2,3,4,5 years or longer. The same principles hold as for any of our other portfolios; they should be generating tangible economic profit, have a solid balance sheet, be dominant in their sector and selling for a discount. One company that jumped out was IBM, a best of breed in technology services with a durable business model in that they are embedded deeply in many companies globally. Because of this, they can generate significant and predictable cash flow. The stock has been pricy the last few years, but recently took a 10 percent haircut mainly because other enterprise management companies were reporting weak quarterly earnings. We are not interested in quarters. Our horizon is long-term so we used the pull-back in price to open a position that we would be willing to add in the future.

Bought Tyson Foods (TSN)

We can talk about how Emerging Market stocks are taking a big hit due to economic malaise in the rest of the developed world and the eventual pull back of the uber stimulus. That’s all fine and good, but the real transition that will not stop is the growth of the middle class in these countries. As incomes rise, they will demand better quality food which includes adding more protein to their diets. Tyson has been positioning themselves as one of the world’s largest meat protein companies and boasts one of the most recognized brand names in the food industry. When you go through their portfolio they are everywhere and becoming a leading producer globally, especially in Latin America. Food will be one of the more meaningful themes in the global economy in the years to come.

Drilling down into their numbers, Returns on Invested Capital has been tracking in the 12-16 percent range the last 3 years. Combined with a cost of capital of around 10 percent and the company is consistently creating tangible wealth. The stock is trading at a discount relative to its peers with a PEG at 1.0 vs 2.1 median and forward P/E of 12 vs peer of 19. The company appears to have strong liquidity and a modest but manageable level of debt on its balance sheet. On a discounted cash flow basis, the stock comes in at a value in the mid $30’s, so it appears to be on sale. The sector is getting some attention as a result of the Smithfield Foods takeover several weeks ago.

Pending Sale: CML Healthcare (CLC) +37% Gain

When I bought CML last month, the main thing I liked about it was it gave us exposure to one of the less volatile segments of the health care industry, namely the testing side. It is a classic boring stock that generates stable, consistent, and predictable cash flows. Apparently I was not the only one who thought so as last week it was announced that the CML agreed to be purchased for $10.75/share by a rival LifeLabs. When I analyzed the company, I put a valuation in the $11.00 range using discounted cash flow analysis so the market seemed to be OK with that valuation. Either way, I view the events as a product of luck and not anything profound that I was doing. You can’t predict a takeover. I decided to hold on to the stock to get the last dividend payment before the company turns over in September. I’ll gladly take a 37% return for a one month investment thank you. It will be sad to see the stock go as it has been a great performer for me on numerous occasions.

Half-Year Scorecard

Overall my portfolios are up 1.84% year-to-date, driven mostly by the CML Healthcare sale. Obviously not great compared to how the broader markets have been doing so far but also not great in that it is not near my personal acceptable return range of 6 percent. A lot of it is also driven by the fact I have still remained heavy on the cash side as the price distortions I perceive to be in the market have made me hesitant to pile more money in the market. Currently I am still at near a 60/40 Cash/Equity ratio.

I sold 4 stocks, one at a loss of 9 percent (the Japan ETF) and other 3 (Tiffany, Johnson and Johnson and the PowerShares International Dividend ETF) yielding greater than 10 percent returns. My total realized return, which is tangible return we actually banked and put in my pocket, was 9.5 percent. This is above my 6 percent threshold so that is good to see. Once I sell the CML Healthcare position in September and lock in the 37 percent return, these values will likely rise.

I am carrying several loss positions including Apple, Horizons BetaPro Short S&P500, as well as the Emerging Market ETF’s. My loss positions range from 2 to 16 percent, which is within my comfort level. If anything, I may be looking to add to some of these loss positions. The S&P500 short position continues to test my mettle and often I go back and forth on whether to continue holding it. Right now, I still hold true to the fact that Central Bank money printing is distorting stock prices and at some point they will correct. I still plan to buy great business for long term consideration that I feel has upside potential. Overall, I’m happy with the types of companies we own and I continue to see upside going forward.

I made a total of 20 trades in the first 6 months of the year, which is in line with our historical trend. I continue to try not to trade the market but make conscious efforts to minimize transaction costs. So far transaction fees have taken about 0.15% off my portfolios which is much lower than historical where annually I was tracking at 1-1.25 percent, which is mainly due to our trading commissions falling from $29.99/trade to $9.99/trade