Wednesday, July 20, 2016

Recent Sell – The Big Reset Edition

I have broken the one rule that dividend growth investors never dream about doing and Im sure this will not be a popular post with the community. I sold part of my portfolio and took some of my money off the market! I have been antsy over the past few months and decided that for the sake of my sanity, I needed to move part of my portfolio to cash. This was the easier part of the decision. Which stocks to sell? That was much harder to decide. This post details my recent sales in the portfolio and provides my reasoning.

As most investors are aware, buying is the easy part. Its the sale: when to take the profits? or when to cut your losses and re-evaluate your investment thesis? — that is the hard part. Dividend growth investing, while I still really like the overall concept, can cloud this judgement a bit. Being “paid to wait” (dividend payments on a regular basis) is a double edged sword. There are countless articles out there which detail why this is the best thing since sliced bread, so I will not rehash the idea. But the flip side of this argument is that investors become too complacent risking a lot of their capital for very little reward.

Reason # 1 – Insanity in the Market

Image Source: Hedgeye
Image Source: Hedgeye

This market is crazy. There is no other way to put it. There are plenty more high-profile institutional investors, with far more resources than retail investors, who have been sounding the alarms. But like I have learned during the previous cycle (in the lead up to financial crisis of 2008/2009), I dont buy their arguments simply because they say so. I decided to listen and read through their reasoning (for e.g., see Jeff Gunlach’s latest presentation, and Stan Druckenmiller’s latest presentation) and looked at the data. The data doesn’t lie. And as far as my limited understanding goes, I can see why this market cannot continue its run higher, without some bloodletting.

We have had this current bull market raging for the past 8 years. A bull market does not simply die because its old, but it does look very tired. The drugs (QE) are wearing off. Everyone (the Fed, the companies, the consumers) are deep in debt over their eyeballs, having borrowed from the future and overleveraged to the limits (and beyond). If you’ve been paying attention to my monthly Outlook series, you may have noticed that I have been repeating myself over and over since the start of the year that everything stinks and nothing looks like a worthwhile investment (except precious metals). There have been signs from all over the bond, commodity, transportation, manufacturing markets to name a few, that all is not well with the world. We have been in a earnings slump — what the media likes to call, an earnings recession. This is one of the most obvious signs that companies are not doing as well as the market is pricing their stocks.

One of the biggest contributing factors for this bull market have been the share repurchase programs, fueled by cheap access to money via the debt markets. I have made it clear on my blog in the past (again, not a popular opinion with investors these days) that I hate the extent that it has grown to, even though there is a case to be made for some controlled buybacks for some companies. Research has shown that companies are just like individuals/retail investors (is it really that surprising?) and suffer from the same fallacies — they buy when the stock is expensive and there is euphoria in the market and terminate the buybacks when the market crashes and hard times are come around. The buyback continues its crazed euphoria as companies over-leverage and are approaching a point where borrowing more could result in rating downgrades; and thanks to an ‘earnings recession’, the company coffers have been running low for a while.

The following chart from FactSet shows that buyback still continues to be way above average as of Q1 2016. Notice that energy sector buybacks have collapsed well below the sector aggregate illustrating my point that companies, just like individuals buy when market is up and terminate buybacks when the stock price is cheap. So, one has to ask: do you buy stock in a company when the company is buying its own stock (instead of investing for its future) and its insiders are selling?

The tide is also changing from largest institutional and sovereign funds. The collapsed oil market has forced the hands of sovereign funds from Norway to Saudi Arabia to China to start liquidating their assets in stocks.  The move has been slow because there arent much alternatives for good investment out there, but once something new is identified, that selloff may accelerate. These are funds that control a big portion of the respective nation’s wealth and increased activity will have drastic effects on the overall market.
These are just a couple of examples that I am highlighting — there are plenty such movements that make me realize that this market is insane. At the end of this cycle, one of these may not be the reason for the collapse. It could be some other black swan event. But I do know that I want more cash ready to invest for the long term than I had before I started my selloff.

Reason # 2 – Dividend Investing

As dividend (growth) investing becomes more popular — thanks to the coverage from mainstream media, I have noticed a big change in attitude from the overall population. The bond market doesnt yield much, and so everyone turned towards the dividend paying stocks reaching for yield. This has led to stratospheric levels of valuations. Stocks trading at 20-30 times forward earnings is not unheard of. We can try and justify all we want – that its a safe investment, its a solid company, its a recession-proof sector, but that kind of valuation just doesnt make any sense in my opinion.  Look at Procter & Gamble (PG) as an example. It currently trades at P/E of 28 and Forward P/E of 21! That is absurd and I wouldnt want to touch it with a 10-ft pole.
More importantly, I see a lax’d approach amongst dividend growth investors. Most investors I come across are on a buying binge holding 100% in equities, because why not? “What could possibly go wrong”, I hear. Market and stock fundamentals be damned. This has caused me to re-evaluate and look at investments in a new light and get out of some of my positions that I feel do not make sense.

Its the same with the media. Dividend investing is shoved down everyone’s throat making it seem like its easy money. Remember that everyone appears to be a genius in a bull market. Once things go mainstream, like a hipster, you gotta move onto new pastures 😉

Reason # 3 – Simplicity

Over the course of this cycle, I have fallen into the trap of buying companies left, right and center as long as they looked attractive. I kept buying more companies with the thought that I was able to diversify my portfolio. Before this selloff, I had grown my number of holdings to 32 companies (plus 6 funds — which already give me good diversification). But the high number of holdings come at an expense — I have to stay on top of things and monitor the companies to make sure there arent some major issues creeping up. This takes too much of my time. Research has shown that you do not need more than 12 companies to achieve what diversification tries to achieve — i.e., protect from downside movement due to Unique Risk. I have written about this in the past here.

I do not see the point of holding stocks in 50 or 100 different companies. The portfolio loses any sort of focus holding that much and investors are better off with index funds instead. If my portfolio reaches – say 50 different companies, each investment would make such small portion of the pie, that the amount of gains — whether dividends or capital gains, would be meaningless. Yes, I am well aware that if a company fails, you only lose a smaller portion too.

While holding some index funds, which give me good diversification across the sectors, I want to now focus on a smaller group of companies that I am willing to take a bet on. This means that I make my selection process more stricter. Each company has to pass higher hurdles in order to qualify for my investment dollars. This I think is better use of my time and focus rather than perusing IR pages of 50 different companies and reading bull & bear cases from thousands on analysts on why an investment is good or bad and evaluating the points.

Reason # 4 – Sleep Well At Night

With all things considered above, over the past few weeks I’ve spent a lot of nights staying up and worrying about our portfolios and trying to decide what is best for our nest egg. While not up every night, whenever I did think about it, I was worried enough to disrupt my sleep and decided that I need to move a part of my portfolio to cash. After I finally pulled the trigger over the course of last few weeks, I am happy to say that I sleep well at night now 🙂

Recent Sell

So, before I get into the detail of which companies to sell, I was faced with another challenge. Do I sell all of my holdings? How about half? This was really a hard decision and after some considerations, I settled on a number: 1/3.

Amongst all the classes/sectors of the economy, during this low interest rate environment – I have faith only one type of holding: hard assets. This includes precious metals such as gold/silver (hence the recent purchases) and real estate. Note that my exposure to these is still through the equity markets — I own gold and silver mining and streaming companies and REIT stocks (which are dividend growers themselves).
In addition, I would still like to hold some dividend paying stocks generating income and staying invested in the market. I still like my money working for me.

So, with that in mind, I decided that dividing my portfolio into three would be a good compromise. So, I am targeting 1/3 in cash, 1/3 in hard assets and 1/3 in dividend paying/growing stocks. Note that this only for the time-being, until I feel its time to start moving back into the market.

The Sales

Following are the sales I made in the portfolio and I provide some reasoning behind each sale. I also present my total return on each investment, which includes dividends accumulated during the holding period. I considered various different metrics for each sale. Current valuation, expected revenue and earnings growth, secular trends, credit ratings etc. The decision for each sale was a result of combination of each those metrics.

Apple Inc (AAPL)

Yes, Apple. There is a lot of like about the company and I like the story on a long term basis. The company continues to invest in new technologies — and is currently investing more than ever their next set of products (Apple Car?). But for now, I have decided to exit this position. Apple is a cash flow machine but it faces the Curse of the Dow. Ever since it got included into the DJIA, the company has stagnated as its stock price is destined by the movements over the overall index — large institutions buy and sell an insane amount of the DJIA components due to re-balancing measures and simply money moving in and out of index funds. The company has become a value trap of sorts over the course of last year or two. Apple is also one of the biggest share repurchasers in the market and can raise money from debt markets at a great rate. But this financial engineering is also part of the problem. Apple has to resort to such measures because most of its cash is parked overseas and the broken US tax system forces the company’s hand to take these measures. This is one company I will definitely reconsider buying in the next cycle.
Total Return: -11.6%

Amgen Inc (AMGN)

Amgen is one of the largest biotech companies in the world. Its largest money-maker, Enbrel, came off its patent in 2012 and since then, the market has been flooded with biosimilars. Although the US FDA granted Amgen a second patent which gives it exclusivity for another 16 years, it hasnt stopped the biosimilars. The company has been trying hard to add roadblocks to competition on moving into its turf, but its pretty obvious that sooner or later they are going to lose the war, even if they win a few battles. All is not lost, since Amgen has some great lineup for other drugs with its focus on oncology, nephrology and cardiovascular. Amgen is also launching its own biosimilars. More recently there has been talk of Medicare spending slowdown that could see an effect on the sales of these drugs. During my holding period, the stock has traded sideways over the last couple of years and I decided to take a step back and reconsider this investment.
Total Return: 2.8%

Agrium Inc (AGU)

The commodities are in a slump. While most other fertilizer companies have collapsed and had to resort to dividend cuts, Agrium has done extremely well. This is mainly due to the fact that they have a large retail segment, which has avoided the storms the wholesale businesses face. Right after I purchased it a couple of years ago, it was disclosed that ValueAct, a hedge fund, had taken a large stake in the company, which caused the stock price to take off. Although it had cooled down a bit since hitting its peak, I was still able to sell at a decent gain. I had to ask myself a question whether I strongly believe in this company, whether it had a huge moat, and whether I want to focus my attention so closely to the fertilizer industry. The answer was no. Considering all those options, I decided that I will take my profit and exit this position.
Total Return: 30.6%

AT&T (T)

Telecom companies are turning into utilities these days and the high yield is very attractive for investors looking for yield. The reason to sell AT&T was mainly due to the debt load and management issues. Lately there has been no growth in the company even though its had decent cash flow. But the company’s move to acquire DirecTV was heralded by the market as a great move even though the company added an extra 50% to its debt load. In addition, after being unshackled from the DJIA when Apple replaced it, the stock has taken off. The current debt load looks ok, and is still better than its main rival Verizon Communications (VZ). Current debt service ratios suggest that the company can easily service its debt. The concern I have is that management seems to be addicted and not following on its word. During the acquisition of DirecTV, the CEO stated that the debt load has gotten high and will focus on reducing it going forward. However, like a drug addict, they are high on the debt-funded buying sprees putting on more debt on the balance sheet and considering more purchases – the latest bid for Yahoo’s Internet Business, which can add another $4B-$8B in debt. The debt load has already risen since the statements from the CEO last year. If a management cannot control its urges to spend and stay true to its word, I have no patience for its stock in my portfolio.
Total Return: 26.7%

Cineplex Inc (CGX.TO)

Movie-goers month-after-month continued lining my pocket with money with this stock. Over the course of the years, I have enjoyed the monthly dividends from this company and also some decent capital appreciation. A small-ish company at $3B market cap, the company has high valuation with P/E and Forward P/E of 22. Overall, the company has been a decent cash flow entity, but lately has struggled growing its revenue (although earnings have increased nicely). Cineplex’s biggest money maker has been the “concession” stands (the food and beverage business) and the new media advertising business is doing pretty well too. Overall, I am tepid about this investment and decided to take my profit.
Total Return: 86.2%

General Electric (GE)

The behemoth in the industrial space. The company is shedding a lot of financial segments and buying more industrial players in Europe. Overall, a great direction for the company to move into. But with 10 billion outstanding shares, it takes a lot to move the needle — although the company is buying back shares and is on target to reduce the number of shares to 8 billion. Current payout ratio is extremely high (at 143%) and dividends have been stagnant — may raise this year after a failure to raise in 2015. GE usually tends to perform really well late in the economic cycle and that is what its been doing. Time to take some profits, although it might continue its march higher a bit more from here.
Total Return: 23.1%

Main Street Capital (MAIN)

One of the best Business Development Companies (BDC). This company is run better than other BDCs, and the deals setup are slightly safer making it an attractive investment. With Main Street, I was directly exposed to small businesses and any slowdown/recession in the US would have an adverse effect on repayment of loans. In addition, the investments are focused in southern US in and around Texas — which has faced the wrath of the oil industry’s collapse and other industries have/can continue to see a knock-on effect. With the stock yielding 8.2% (7% regular dividends + semiannual special dividends), my original investment in this company was a reach for yield. I have been through one cycle where high dividend stocks crashed and burned (not to say, the exact same will happen with MAIN), but I decided that its a risk I am not willing to take with my money anymore.
Total Return: 18.4%

Power Corp of Canada (POW.TO)

Another great company that has a lot of history. But the stock has stagnated due to the fact that insurance industries can barely make any money in this low interest rate environment. The company has already started raising dividends after a freeze for a few years, but an argument can be made that the move was premature. The fundamentals are great with this company overall and I will reconsider to invest in the future, but at the moment, this company made the cut for elimination.
Total Return: -6.3%

Thomson Reuters (TRI)

Thomson Reuters has faced increasing competition over the years as more established as well as upstarts have been chipping away at its core business. The company has been moving pretty slowly to turn things around and forming new products, services and deals. Overall, the revenue has stagnated, earnings have suffered, dividends have increased very slowly and payout ratio has been all over the place. Its a segment that I dont really have the desire to focus on and decided to take my profits here.
Total Return: 85.5%

Wells Fargo & Co (WFC)

This has been a hard decision to take. Wells Fargo has been a great investment and has a huge exposure to the US housing market. While I dont think we will see a 2008-style crash again, there are some sign of some more housing and consumer loan credit issues. Wells Fargo has also been relaxing a lot of its rules lately, such as reducing the downpayment needed, and also recently lowered the credit score requirements in order to fuel its sales. These are the kind of moves that I am not happy to see in my investment holding. A similar argument can be made with my two other bank holdings – Bank of Nova Scotia (BNS) and Toronto-Dominion Bank (TD) — which are exposed to Canadian housing market, where chances of a crash are higher. I am considering selling those as well, but for the time being decided to hold onto the shares.
Total Return: 30.2%


When to sell a stock is almost always harder to decide than buying. Its been an interesting few weeks/months and a lot of things have been weighing on my mind lately. From my vantage point, this market seems insane and after a lot of considerations, I decided that I want to simplify my life and reduce the number of holdings. The approach I have taken is to move my portfolio for the short-term into thirds: 1/3 in cash, 1/3 in hard assets (gold/silver and real estate) and 1/3 in other dividend growth stocks. After pulling the trigger to make these sales over the past few weeks, I now feel a lot more comfortable with my holdings and am ready for the market to correct. Of course these sales will change my overall forward dividend income and will probably lead me to fail my annual goal, but I can now sleep better because I know my portfolio is ready to move when this market gets some sanity knocked into its head.

After the sales mentioned, my overall portfolio diversification looks as follows. I still havent hit the 1/3 in Gold + Silver + REITs, but will be hoping to make some purchases in the coming days on that front to get to the balance I desire.
image (1)
I know this move will not be a popular opinion with most of the community and I look forward to hear your arguments and counterpoints. Bring the onslaught on 🙂

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