We know many of you use our services for a wide variety of different reasons, whether for a primary source of fair value estimates and fair value ranges, to assess the risk of the sustainability of the dividend through our Dividend Cushion ratio, or to apply the Valuentum Buying Index as an overlay to your own processes and beyond. For those that are following changes to our newsletter portfolios, we’re going to make a few today. None of these should be surprising.
First, we’re taking some profits in Altria (MO), removing half of our position in both newsletter portfolios. Specifically, we’ll be removing 158 shares in the Best Ideas Newsletter portfolio and 101 shares in the Dividend Growth Newsletter portfolio at $58 each. We value shares at $55 apiece, and the cat is already out of the bag with respect to its previously “hidden” stake in SABMiller (SBMRY). Though not a consideration of ours to take profits in shares, we were also recently reminded of the significant litigation risk associated with the company. Though the Illinois Supreme Court rejected a $10 billion cigarette verdict, we see no reason in taking on outsize risk on a relatively overpriced security that has started to roll over. We’ll still retain half of the position in both portfolios, however, pending the addition of a new idea.
Second, we’re adding modestly to two of the “riskier” ideas in the Best Ideas Newsletter, Michael Kors (KORS) and Buffalo Wild Wings (BWLD). Both of these companies haven’t fit well with the Valuentum Buying Index methodology as a result of the material declines in their share prices recently, but we believe both are underpriced enough on a discounted cash flow basis to add to their modest “starter” positions. Kors, for one, is only trading at ~10 times current-year earnings and sits on a nice net cash position on the balance sheet, and while Buffalo Wild Wings has hit a snag in underestimating expenses regarding the purchase of several franchised locations, our channel checks remain very positive on the company. We’ll be adding another 0.5% (a half of one percent) to each, a very modest move. That’s 22 shares of Michael Kors at $43.76 each and 6 shares of Buffalo Wild Wings at $150.15 each. Both will now account for ~1%-1.5% of the Best Ideas Newsletter portfolio.
The email transaction alerts should be taken in context of the goals of both newsletter portfolios. The weightings and ideas in the newsletter portfolio are designed to achieve the following goals, though no guarantees can be made:
The Best Ideas portfolio seeks to find firms that have good value and good momentum characteristics and typically holds each idea from a Valuentum Buying Index rating of a 9 or 10 (consider buying) to a rating of a 1 or 2 (consider selling). Just like a value manager may not include every single undervalued company in the market in his/her portfolio, not all highly-rated companies on the Valuentum Buying Index are included in the portfolio. We may tactically add to or trim existing positions in the portfolio on the basis of sector or broader market considerations, but we seek to capture a stock’s entire pricing cycle (from being underpriced with strong momentum to being overpriced with poor momentum). The goal of the Best Ideas portfolio is to generate a positive return each year and to exceed the performance of a broad market benchmark.
The Dividend Growth portfolio seeks to find underpriced dividend growth gems that generate phenomenal levels of cash flow and have pristine, fortress balance sheets, translating into excellent Valuentum Dividend Cushion ratios. Firms in the portfolio may have lengthy dividend growth track records, but we focus most of our efforts on assessing the future safety and dividend growth potential of holdings. The goal of the Dividend Growth portfolio is to generate a mid-to-high single digit annual return over rolling three-to-five year periods. We have yet to have a Dividend Growth portfolio holding cut its dividend, and we credit this to the Valuentum Dividend Cushion methodology.
Some recently asked questions…
Q: I am a Valuentum subscriber who has noted your recent criticism of the MLP model. The thing that I am having a hard time understanding is, in light of your criticism, why Kinder Morgan and Energy Transfer Partners were in your dividend portfolio earlier this year. The problems you note with MLPs have been around for a long time. Did you just discover these problems? They were there before you put KMI and ETP in the portfolio. Please explain the sudden enlightenment.
A: That’s a great question, and thank you for your support.
Part of our effort in portfolio management, as it relates to the newsletter portfolios specifically, go beyond individual business analysis. For example, to retain exposure to the energy space in the midst of a route in crude oil prices, which sent them tumbling from over $100 per barrel to under $50 today, the midstream arena offered a place of sanctuary. We capitalized on this “alpha.”
That said, we’ve always been cautious on the construct of MLPs, the explanation of which has been housed in every one of the reports on our website since we launched coverage of them. In light of the collapse in crude oil prices and the Fed’s intentions to begin tightening, the risks have increased exponentially with respect to the sustainability of the MLP model over the long run. Many still believe that midstream entities are completely immune to changes in commodity prices. Some may even say interest rate hikes don’t matter.
We think the future of today, which starts at a federal funds rate near 0% is distinctly different than one that started in 1980 with a federal funds rate north of 20%. We also believe OPEC’s intentions to continue to produce for market share as opposed to price stability offers a threat to the customers of most midstream players. While we generated significant outperformance in the midstream space by avoiding most upstream players during the collapse in crude oil prices, now that energy resource pricing is substantially lower and the interest-rate environment is becoming increasingly more ominous, the threats to MLPs have substantially increased.
We’re doing our best to highlight the long-term risks, not only operational, but also the financial and valuation dynamics.
Q: I’m trying to get a better understanding of your Valuentum Buying Index rankings. An 8 looks like something that is undervalued but still going down; is that correct? I believe that Michael Kors is a current example. Isn’t buying something like that (falling knife) a bit dangerous? Even if you aren’t wrong about the value aspect of the stock, couldn’t it go a lot lower first, particularly in the wrong market? How do you think about approaching and sizing such a position?
A: This is simply a fantastic question and reveals a great understanding of our process. In short, you are correct, yes.
For companies such as Michael Kors, for example, the risks of it being a “value trap” are higher than they are for companies that are growing comparable store sales at a fast pace. The reason for this is quite simple: our future expectations are more likely to be higher than what might be achieved by the company as a result of earnings deleveraging, which is one of the more difficult things to forecast, in terms of magnitude. Furthermore, with companies that face top-line pressure, the prospect for such companies to “grow into their valuations” or for multiple expansion is substantially reduced.
Though we generally avoid such circumstances in the newsletter portfolios, we may add such companies when a price-to-fair value discount is large enough to suggest downside risk may be limited. We also mitigate losses on such ideas by limiting positions to ~1% upon initiation and adding to them over time, if at all. By no means would we ever take a full position in a company that does not register a 9 or 10 initially on the Valuentum Buying Index. Our process is rigorous, but flexible at times.
Great question; one of the best!