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miclane05 (96.20)

July 2013 Update



July 12, 2013 – Comments (1) | RELATED TICKERS: AAPL , RAX

July 2013 - When to Sell:

This update is a few weeks early, and there are several other changes that I'm making at the same time.  The last several updates have been spaced approximately 7 1/2 months apart, which was an arbitrary timeframe that began because it fit into my own personal schedule. I think a bi-annual timeframe makes a lot more sense, and having an update at the end of December allows people to consider the tax consequences of their actions and chose whether late December or early January make more sense for their adjustments. That makes this the midway point in the year, so now seems like a better time to update things rather than wait until the end of July and then February for updates.

So far, this has been a very good year for investors, although the last few weeks have been quite volatile and there's no shortage of analysts and pundits predicting a big pullback in the near future.  There are, of course, reasons to doubt some of the market bears and view the current market conditions are somewhat normal.  See  (recognizing popular bear market sentiment while suggesting their fears overlook important factors).  Whether the next 3 or 6 months are good or bad also misses the point that, as investors, the odds are in our favor over the long term, so net buyers of stocks shouldn't become overly concerned with predictions about short term trends.  See, e.g.,; and  (why a long-term horizon is to the advantage of individual investors).

At its core, investing is really just a matter of making two decisions. First, should I make this investment? And second, should I sell this investment? A disproportionate amount of time is spent on the former, while the later is, in my opinion, a substantially more difficult and complicated decision. For one, although Warren Buffett might suggest that the holding period for any stock is forever, most investors have a finite amount of money to invest, and those funds might be needed for a future expense years down the road. If you bought stock to help pay for a child's college tuition, "forever" is not a very practical time-frame. With limited money to invest, if your money is tied up in an asset you don't expect to appreciate much over the next couple of years, holding onto that investment in lieu of something that will appreciate more also has an opportunity cost, even if it doesn't require you to spend additional money. Finally, the allocation of your investments can fluctuate rather dramatically, leaving you with a portfolio that does not reflect your desired risk or diversification. If you're playing along at home, you bought Melco Crown Ent. ("MPEL") for $4.55 in April 2009 when I first recommended it, and have held it this entire time. With its current 500% gain, its allocation in your portfolio is probably a bit high and you might be concerned about how much money you have tied to a gambling establishment in Macau and whether Chinese regulators will wipe out your holdings before tomorrow's opening bell. So, after almost 4 years of tracking these picks and beating the S&P500 at every interval, I realize that a focus on the second decision of these investments is needed.

First, lets look at our list of picks and their performances since the last update. (Please note that these figures were compiled over the past 2-3 days, so they might be slightly off at the time of posting).

MercadoLibre (MELI):                31.6%
Berkshire Hathaway (BRK.B):    26.6%
Melco Crown Ent. (MPEL):        23.7%
Intel (INTC):                          15.7%    
Atwood Oceanics (ATW):         14.9%
McDonalds (MCD):                  14.4%
Aflac (ALF):                            12.3%
Phillip Morris Int. (PM):              1.9%
Nat. Oilwell Varco (NOV):           1.8%
Nucor Steel (NUE):                     (2.1)%
Rackspace Hosting (RAX):          (45.3)%

Average non-dividend adjusted return is 8.7%, which is behind the S&P 500's gain of 11%.

And here are our total returns since adding each selection:

Melco Crown Ent. (MPEL):     495%
Phillip Morris Int. (PM):           72%
Nat. Oilwell Varco (NOV):       69.9%
Aflac (ALF):                          59.8%
MercadoLibre (MELI):              48%
Berkshire Hathaway (BRK.B):   46.7%
Atwood Oceanics (ATW):        44.6%
McDonalds (MCD):                37.6%
Rackspace Hosting (RAX):     23.8%
Intel (INTC):                          15.2%
Nucor Steel (NUE):                1%

Average return since adding selection is 83% and the mean age of each selection is 31 months. For reference, the S&P 500 is up 47% over the past 31 months. Returns are not dividend adjusted, so actual returns are better than listed (see Jan. 2013 Update for Details).

While an 8.7% gain in 7 months is nice, this is the first update period that we have not beaten our benchmark, which is upsetting.  In hindsight, last update I wrote that I considered replacing AFL and ATW with Tesla (TSLA) and Whole Food Market (WFM). Considering that the first two returned 12.3% and 14.9%, respectively, while TSLA is up 359% and WFM is up 16.7% perhaps I shouldn't have hesitated so much. Which brings us to the theme of the update, when to sell. While creating a new list of 11 picks to best perform between each update is not the goal, and would turn this long term portfolio into short term speculation, much like a real-life portfolio has a limited amount of money to invest, our picks are limited in number to represent our best ideas. Although removing a pick from our list is always warranted if the business fundamentally changes or our thesis proves incorrect, I also think that its appropriate to replace some selections when the risk/reward balance has shifted and there are more attractive ideas that are not on our list. This is not an endorsement for high turnover, but I think we can identify two selections that should be removed for this update.

Closing picks:
Rackspace Hosting (RAX): What a difference 6 months can make.  Without RAX weighing down our picks this update, our stocks returned 12.81% and would have beaten our benchmark again.  Back in January I wrote "I remain optimistic while recognizing that the move to the cloud is a disruptive technology, and trying to pick winners or losers is difficult. RAX has to fight against GOOG, AMZN and CRM for market share, which is no small task. At the same time, RAX has made its business with its fanatical focus on customer service and if that continues, it should fare well against its rivals. Unfortunately, this also makes RAX our most vulnerable pick and customers could quickly turn on them if service issues arise, so we'll keep watching for warning signs."  While revenue and earning per share continue to grow each quarter, the competition is taking its toll and RAX looks somewhat like an army that keeps winning battles but never gaining any reinforcements to prolong the war. Its momentum has been slowing each quarter and if AMZN and GOOG keep cutting prices and shrinking margins, I'm not sure RAX will be able to last. There are talks of buyouts, first from IBM and now from Dell or HP, but buying a stock in the hopes of a favorable acquisition seems more like a gamble than a sound investment strategy. At this point, our pick is still up almost 24% since we first bought it in October, 2011, and we did so recognizing that we were trying to swing for the fences a bit. Considering the risks, especially from AMZN, I simply cannot justify keeping it on the list in the hopes that things get better.

Melco Crown Ent. (MPEL): While I expected the start of the year to be slow for MPEL, it continued its great run these past 7 months. Up roughly 500% since we added it to our list, risks of an economic slowdown in china have grown, concerns over regulations remain, and while Studio City and the planned casino opening in the Philippines could provide additional growth, right now, MPEL appears overpriced. Competition from WYNN in the next couple of years adds another concern here and, after such a healthy run but with this many questions regarding future growth, I've decided to remove it from the list and put our gains to use elsewhere.

New Additions:
Apple (AAPL): Yes, I've been bearish on AAPL for awhile and have called it out before for having unattainably-high expectations baked into the price. At the end of 2011, I wrote about how Microsoft (MSFT) was a good value and then stated "Not to digress too far, but too many people are bullish on Apple, without considering that its size will weigh on future growth, its industry and its own performance have been historically cyclical, and competition driven commoditization will lower avg. sales prices and squeeze revenue. I'm sure tomorrow's iphone 5 will send the stock shooting higher and everyone will cheer and say that another year of 80% growth, or even 40% growth, lies ahead. I will not be one of them."  AAPL closed at $400 when I wrote that and although it continued to soar higher, nearly two years later it is right back to hovering just over the $400 mark. During that same period, MSFT returned 35% on top of its almost 3% dividend.  So what has changed? AAPL did grow its revenues and earning per share over 20%, and it instituted a dividend yielding almost 3%. Once valued at 30 times earnings and praised by everyone, its now trading at 10 times earnings and everyone claims that AAPL's day is over. This is exactly when adding a strong, innovative company that is sitting on a mountain of cash makes sense, so its joining our list.

Middleby Corp (MIDD) - This addition really isn't a new pick, because it was on our list and was never actually taken off, but it somehow got forgotten as I transitioned from writing these updates simply to myself to then sharing them with friends and posting them in a blog (  Back in April, 2010, I wrote "go through its history and try and find a quarter in which it did not beat earnings estimate. This making of industrial restaurant equipment (i.e. ovens, etc) has demonstrated impressive growth over several years, and is currently discounted with the recession's slowdown of restaurants. When business picks up, this small cap play will continue its charge."  Back then, it traded at $58, so its has enjoyed a solid ride to its current price of $182 over the past 3 years. Since we never officially dropped this pick but have now dropped two stocks from our list and have a goal of 11 picks at all times, this is a good time to reconcile the past oversight.  That said, we're not adding some dead weight to our portfolio simply because it should have been here in the past. Its not the bargain that it was when we first added it to the list, but its PEG ration remains attractive due to its solid growth. Beating wall street estimates for the past 7 quarters, MIDD is also looking towards emerging markets and is focused on increasing its margins. See also (another blog's take on MIDD's healthy future).

Notes on some remaining selections:
Berkshire Hathaway (BRK.B): Not much to say besides that Buffett's great recession deals have paid off handsomely and the company remains a great holding to anchor any portfolio.

National Oilwell Varco (NOV): The energy sector makes up a decent chunk of the entire S&P, although the developed world's demand for oil has been declining for over a decade, with the 2008 recession drastically speeding up that trend. Its also somewhat apparent that technology in the developed world will increase the rate at which better fuel efficiency and cost-effective fuel alternatives decrease demand for oil in the future. Of course, demand in the emerging markets is increasing, and whether that will fully balance out the decreased demand in the developed world is anyone's guess.  When it comes to NOV, however, it is important to realize that while NOV's profits do increase as the price per barrel of oil increases, NOV also has natural gas exposure, so its far better positioned than pure oil plays that are gambling on demand in emerging markets fully compensating for the developed world declines. After providing us with some solid gains a few years back, NOV has been stuck in the mud lately, despite its earning per share rising above their pre-recession highs, it recently doubling its dividend, and substantial new orders in 2013.  Berkshire also recently increased its stake in NOV at today's prices, and it appears both better priced and  less-risky than alternatives within its sector.  See (analysis by someone else who agrees there is minimal downside and significant upside at current prices). Although it was one of our worst performers so far this year, I'm keeping it on our list and hoping our patience pays off.

Phillip Morris Int'l. (PM): Though its price got a tad lofty for awhile, its now trading back at a reasonable valuation and is the cream of the crop of an industry that has provided some of the best investments of all time while straddling the precipice of certain destruction decades. Former parent Alria (MO) currently maintains almost an identical valuation despite significantly more pressure to its sales, margins, and litigation risk due to its operation exclusively in the U.S.  PM obviously operates exclusively abroad, and for those who invested at its initial recommendation and reinvested dividends, our initial investment has more than doubled (by comparison, other non-volatile (though more socially acceptable) blue chips like JNJ have returned half as much during that period). Even with its isolation from the U.S., there are foreign risks to the business, especially in the EU and Australia and I'm sure there will come a day when the headwinds overcome PM, but at its current price, I'm keeping it on the list and looking for another dividend raise this October.

MercadoLibre (MELI): Just over a year ago, in May, 2012, I added it to our list at $73/share, and stuck by it in January, 2013's update when it was trading just over $83. At today's $115, we're up almost 60% in a year and I'm happy to continue letting our thesis play out.  Even though Amazon entered the Brazilian marketplace last year, MELI remains the hands down number one e-commerce provider in the region. Its projected p/e is still pricey (though less than AMZN), but e-commerce growth in Latin America has drastically outpaced every other region in the world and, as the preferred provider in the region, MELI is capturing that growth.  With a market cap of 5 Billion (compared to AMZN's 125B), MELI still reminds me of our MPEL pick in 2009, picking the small company that was positioned in the right place at the right time over the big American behemoths invading the space (like WYNN, MGM, etc.)

Nucor (NUE): Like copper, iron, and other materials industries, the steel industry is still waiting for macroeconomic conditions to improve. Soft demand remains and is unlikely to get better in the near term, but Nucor is one of the better positioned companies in the business with a stable dividend. Patience will pay off for those with the time to wait.

Thats all for now. I suppose our discussion of when to sell is lacking in depth, but this update has grown a bit unruly and if I don't finish now, it'll be another month before I can write again and all the numbers will have changed. So we'll head to December with our slightly new list of 11 picks and check back in at the end of the year.  As always, all comments are welcome. 

* Disclaimer: I currently maintain real-life holdings in several of the companies discussed in this update, including AAPL, MELI, RAX, NOV, PM, BRK.B, INTC, and AMZN. Your interest in these companies could, on the most miniscule level, benefit me personally. This article is intended for educational and discussion purposes only and is not investment advice.

1 Comments – Post Your Own

#1) On July 12, 2013 at 9:05 PM, gamemily (< 20) wrote:

Design of artificial intelligence must read
[1 paradox]Why 0.999... is not equal to 1?
Written in 2012
The current mathematic theory tells us, 1>0.9, 1>0.99, 1>0.999, ..., but at last it says 1=0.999..., a negation of itself (Proof 0.999... =1: 1/9=0.111..., 1/9x9=1, 0.111...x9=0.999..., so 1=0.999...). So it is totally a paradox, name it as 【1 paradox】. You see this is a mathematic problem at first, actually it is a philosophic problem. Then we can resolve it. Because math is a incomplete theory, only philosophy could be a complete one. The answer is that 0.999... is not equal to 1. Because of these reasons:
1. The infinite world and finite world.
We live in one world but made up of two parts: the infinite part and the finite part. But we develop our mathematic system based on the finite part, because we never entered into the infinite part. Your attention, God is in it.
0.999... is a number in the infinite world, but 1 is a number in the finite world. For example, 1 represents an apple. But then 0.999...? We don't know. That is to say, we can't use a number in the infinite world to plus a number in the finite world. For example, an apple plus an apple, we say it is 1+1=2, we get two apples, but if it is an apple plus a banana, we only can say we get two fruits. The key problem is we don't know what is 0.999..., we can get nothing. So we can't  say 9+0.999...=9.999... or 10, etc.
We can use "infinite world" and "finite world" to resolve some of zeno's paradox, too.
2. lim0.999...=1, not 0.999...=1.
3.The indeterminate principle.
Because of the indeterminate principle, 1/9 is not equal to 0.111....
For example, cut an apple into nine equal parts, then every part of it is 1/9. But if you use different measure tools to measure the volume of every part, it is indeterminate. That is to say, you may find the volume could not exactly be 0.111..., but it would be 0.123, 0.1142, or 0.11425, etc. 
Now we end a biggest mathematical crisis. But most important is this standpoint tells us, our world is only a sample from a sample space. When you realized this, and that the current probability theory is wrong, when you find the Meta-sample-space, you would be able to create a real AI-system. It will indicate that there must be one God-system in the system, which is the controller. Look our world, there must be one God, as for us, only some robots. Maybe we are in a God's game, WHO KNOWS?
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