Investment Activity Review - May 2013

Here are the trades I made for the month of May. There have been two additions to our portfolios.

Bought DirectTV (DTV)
This company popped up in one of our screens and satisfies one of our core values, specifically companies that create tangible, consistent wealth and are selling at a discount. Over the past three years, DTV’s spread of Return on Invested Capital and Cost of Capital has ranged and grown from 13 to 40 percent. The stock is trading in the low $60 range and using Discounted Cash flow analysis, the stock prices in the low $70 range. The stock is cheap relative to other cable TV firms. The company has a huge asset in the NFL Sunday Ticket package which is very popular and forms the core of their service offering. With its subscription based model, the company can generate very predictable cash flows. There are threats out there, specifically technological ones and they are investing to diversify their distribution points to tablets and mobile devices.

Bought iShares Japan ETF (EWJ)
This type of investment goes counter to a few tenants I hold dear, one being to avoid momentum plays and hysteria. The Japanese stock market has been on a tear in 2013 and ever since the new Japanese Prime Minister essentially declared war on deflation and the economic malaise that has gripped the country over the past two decades. The Government and Central Bank have signalled that they will showering the economy with liquidity and stimulus measures like nothing ever seen. The stock market has reacted positively with the core indexes up nearly 70 percent in the past 3 months. This type of performance would normally tell me that the big money has been made and it is likely to end soon. My take is that we are in the early innings of a long term experiment that could see Japanese stocks climb even higher and if I can get in for a 20-25% gain, why not. So far it hasn’t worked out well as government hand wringing has triggered large sell-offs. Many are questioning if the Mr. Abe’s policies will truly get the country on a stronger footing mainly because demographics could hold things back. I'm down 10% since I bought in and as of this writing I am still holding it within a stop-loss of 20%, so I may get some itchy fingers if things continue to be murky in Japan. Why did I go against my tenants? Well one big reason is that history over the past few years has shown that loose monetary policy has been good for stocks and up until now, Japanese stocks have been laggards. The US is a case example with their markets almost doubling in the past 3 years thanks to Quantitative Easing policies by the Federal Reserve. Japan is doing exactly what the US did so the results should transmit the same, no? We’ll find out and if they do not, then it reinforces my theory that basic economic principles do not apply to the US.

CML Healthcare (CLC)
One of my long term investing themes is healthcare. I will not get into the dynamics of the industry because they are well documented in terms of demographics in many other places. What scares me about the sector is regulatory aspect in terms of drug approvals, and patent rules that limit companies from retaining their durable competitive advantage. Investing in a pharma company is like buying a lottery ticket as the odds are so difficult to get a drug approved. The risk is also people dying from your drug or equipment and all the legal hassles that come with it. In theory I like healthcare stocks, the reality is somewhat different as I have been burnt on a few investments. One company that has done well for me in the past has been CML Healthcare. When you need to get any kind of medical test, chances are you may be getting it done in a CML clinic. The beauty of their business is that medical tests are very routine, predictable, has a low-risk for future liability, and the government pays the bills via long-term contracts. It is a very boring but stable business that generates meaningful cash flows. They pay a dividend yield of about 6 percent which is nice. Late last year, they cut the dividend and the stock market did not like it, but it was necessary to shed the last remnants of the income trust model they operated under. The company generates positive Economic Profit and is trading at a meaningful discount. The company a few years ago made strong push into the US and was buying MRI clinics, but found the strategy was not working and so CML is in the process of selling those clinics. They have a new management team that has committed to returning to their core business. The stock has been in trending down despite profits rising. There are many high growth health care businesses out there, but for me boring works well in this circumstance. It is a type of stock I could own for 5 to 10 years as long as they keep getting the government contracts.

Year to date, I have made a total of 16 trades consisting of 8 buys and 8 sells. Despite the continued rise in the stock market and my apprehension that it will continue to go up, I am continuing to build positions in companies that I feel are still mispriced and generating terrific financial performance.

UPDATE: June 14, 2013
Overnight, the Nikkei index took another flop, dropping more than 6 percent. Naturally as I woke up this morning, I didn’t expect good things out of my EWJ position. As I braced for the bloodbath in the ETF, a funny thing happened. The stock opened up. I thought it would be a temporary thing, but the stock continued to trade up in the morning. This totally didn’t make sense. The market overall in North America had a strong opening and so it appeared the ETF was riding on those coat tails, but shouldn'’t it be traded on the value of the index it is tracking instead of an externality? Apparently not. At the end of the day, the stock was up 2.3% eventhough the underlying index was down over 6 percent. My greatest contention with ETF’s has been realized. As a result, at mid morning, I sold the position in ETF. I still like the Japan story, but the ETF and its clearly horrible tracking error was the last straw for me. Now I am in search for individual companies that can offer a similar type of exposure to the Japanese market. The experience has taught me to be very leerly of ETF’s, especially foreign products where there is greater potential for local bias to influence the value of the ETF instead of the underlying index it is supposed to be tracking.