Image Source: fauxto_digit
We made a few tactical tweaks to the Dividend Growth Newsletter portfolio during 2017. Let’s walk through them, and how we’re out to win the war, not win every battle.
< Note: The introduction is the same as that of the tactical analysis of the Best Ideas Newsletter portfolio. If you have already read through the introduction, please proceed to the section, Dividend Growth Newsletter Portfolio below. >
By Brian Nelson, CFA
I’m not going to reference The Art of War written by Chinese military strategist Sun Tzu some time in the 5th century, nor am I going to use any quotes from the military treatise (I think it’s too well-traveled of a topic), but I do believe the approach to portfolio management is much like that of a general on a path to win the war. Now, don’t get me confused: I’m not saying that portfolio management is actually like being in war. Not. A. Chance. I’m saying that the planning, the thinking, the goal in forming an overall strategy and executing tactical tweaks to win is similar. Obviously, nothing comes close to the brave men and women on the field of battle and what they sacrifice, but I like the comparison, so I am going with it.
Though not always completely accurate, one way of thinking about the difference between strategy and tactics is that, in most cases, strategy can be considered long term, while tactics can be considered short term. Strategy = long-term goals. Tactics = short-term tweaks. If you recall in one of the greatest movies perhaps of all time, Saving Private Ryan, Captain John Miller, played by Tom Hanks, hits one of the most powerful tones in the movie when he says: “Our objective is to win the war.” On a search and rescue mission for Corporal Francis Ryan, Miller and his squad encountered an enemy machine gun emplacement. Instead of going around it, Miller understands what must be done. The overall, long term strategic goals of the United States of America are to win the war, and the emplacement must be neutralized. Miller understood.
The difference between strategy and tactics can also be readily explained through other examples in history. One of the most notorious instances of overemphasizing short-term tactics versus long-term objectives occurred after the Battle of Gettysburg in 1863. Union Army General George Meade, who field-marshalled the victory for the Blue during that three-day battle in July, telegraphed Lincoln shortly after: driven ”from our soil every vestige of the presence of the invader.” Lincoln was furious by the message: “Drive the invaders from our soil! My God! Is that all? … You will follow up and attack General [Robert E.] Lee as soon as possible before he can cross the river. If you fail, this dispatch will clear you from all responsibility and if you succeed you may destroy it.” Meade had only been focused on the tactical victory at Gettysburg, not the strategic goals of the United States of America to eradicate the Confederacy. Meade lost his job.
Focusing on tactical victories has always been a very short-sighted view when it comes to striving to achieve overall long-term strategic objectives, not only in war but also in portfolio management. Frank Reilly and Keith Brown wrote in their book, Investment Analysis and Portfolio Management, that “…about 90% of the maximum benefit of diversification was derived from portfolios of 12 to 18 stocks.” In the context of portfolio management, and generally speaking, in our view, a portfolio of ~20 companies may be sufficient to achieve meaningful diversification, provided that such stocks are also diversified across sectors. This is partly why the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio generally emphasize ~20 ideas, and why we don’t cram or force more ideas within the newsletter portfolios. We’re not getting much more diversification benefit beyond those 20 or so widely-diversified stocks, so we don’t need more. If we add more, we’d just be adding the next best idea, when we could be adding to a better idea already in the portfolio.
We may make tactical tweaks, but the overall strategy is set with the ideas already in the newsletter portfolios. The strategy matters. The tactical tweaks are important, but of lesser importance. But keep all of this in perspective, too. An equity portfolio, of course, is only one part of a well-diversified financial plan, which may also include cash for emergency needs, an owned property (a house or rental for income), and bonds, among other assets. The newsletter portfolios such as the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio, and the ideas within them may be but a small part of the big financial picture, and the tactical tweaks within the newsletter portfolios may only be a much smaller part of that same picture. In some ways, the tactical tweaks made in the newsletter portfolios shouldn’t bear much weight on one’s overall financial picture at all. If they do, a person may not be thinking about their overall strategy; instead a person may be focusing more on short-term tactical endeavors, which are only a small part of winning the war.
Dividend Growth Newsletter Portfolio
Source: Dividend Growth Newsletter portfolio transaction log
We covered how well the ideas that were in the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio performed during 2017 in a big-picture, strategic sense (see here and here, respectively), but how have some of the tactical tweaks as it relates to the newsletter notifications in 2017 on the margin performed? We’re splitting hairs because we are taking these ideas out of the portfolio context (a big no-no), but let’s see how some of the tactical moves of 2017 panned out. As with the tactical evaluation of the Best Ideas Newsletter portfolio, the first tactical trade of 2017 wasn’t a good one in CVS Health (CVS). The company has been rocked by Amazon’s (AMZN) foray in the grocery space and the pharma business, and frankly, we were blindsided by it. Diversification is so important.
In aggregate, the next tactical trades weren’t too bad, but we did make an unforced error. We added the Alerian MLP (AMLP)—ugh, we know better—and Hanesbrands (HBI), both of which have faced some selling pressure, but we also added Boeing (BA), which was one of the best performers in the Dow Jones Industrial Average (DIA) this year. We recently put together a summary of that January 26 trade in the image below, and as of interim trading November 21, the aggregate performance was effectively a wash. Where Boeing might be considered a phenomenal idea, one of the best among all of large cap in 2017, the other two were quite poor, in many respects. Still, a 9% aggregate “gain” to match that of the S&P dividend-growth ETF proxy isn’t bad, so we’re not beating ourselves up much about it.
Image Source: A “Terrible” Negative Alpha-Generating “Trade” and More
On May 8, we removed Coach, now Tapestry (TPR), from the Dividend Growth Newsletter portfolio for a nice “gain,” and we couldn’t be more pleased with how this one turned out. Coach, now Tapestry, has traded off by more than 10% since that time, and we think tactically, the move was solid. We had wanted to rid the portfolio of the idea for some time before the newsletter notification, and optimism surrounding its deal with Kate Spade provided an excellent exit point. You know all about the next move on May 15, to remove General Electric (GE). Aside from maybe removing Teva (TEVA) from the Best Ideas Newsletter in time before its last few leg downs, the General Electric tactical “trade” to remove it in the high-$20s from both newsletter portfolios may have been the best all year, if not the best of all time (June 2015 Kinder Morgan trade included). We keep hitting homeruns that may not always show up in the “performance” column, but they are so very, very important.
We didn’t quite get rewarded for the added put protection in mid-May, but we also can’t be disappointed that the market went up, instead of going down as we feared. We’re generally quite conservative and prudent, and as we said in the piece that walked through a similar tactical analysis in the Best Ideas Newsletter portfolio, sometimes it’s okay to lose a battle (position) to protect the whole army (portfolio). We removed Medtronic (MDT) May 25, and we’re not too upset with having to part with this huge winner. Shares of Medtronic are off a few percentage points since that time, so we’re viewing this tactical trade as a minor win, too. In mid-June, the decision to remove the Alerian MLP ETF was also a very good one, as shares have only fallen since.
On July 19, we added Novartis (NVS) to the Dividend Growth Newsletter portfolio in the mid-$80s, and shares are trading at about those levels at the time of this writing, so tactically, this idea can be viewed as a wash. In late July, we removed half of the position in Boeing, and while shares have continued to advance since then, we can’t possibly be disappointed with prudently taking some off the table. Tactically, we still believe this was the right move. In late July, we also added Gilead Sciences (GILD), which wasn’t a great tactical idea, unfortunately, and the move to remove half of Altria (MO) from the Dividend Growth Newsletter at that time could be considered tactically-neutral at best. The most recent tactical “trade” in the Dividend Growth Newsletter portfolio, to remove 75% of Hasbro (HAS) in the mid-to-upper $90s, can also be viewed as largely neutral, but deal talks with Mattel (MAT) have only complicated Hasbro’s dividend growth profile, so we’re not too upset about cutting down exposure.
Those are they. When you see all the tactical changes in the Dividend Growth Newsletter in aggregate for 2017, it’s clear that we’ve been very busy this year, arguably too busy. Many of the tactical moves could be considered poor in light of the performance subsequent to the decision, but several were excellent/phenomenal. For the most part, however, we think a neutral/good ranking may capture the essence of the tactical moves in the Dividend Growth Newsletter portfolio this year, similar to that of the Best Ideas Newsletter portfolio. Though we’ll stop measuring the performance of the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio effective at the end of 2017 in lieu of a list-and-weighting format, we’re certainly not disappointed by any stretch of the imagination. We hope you’re not either.
Remember: When it comes to investing, as in war, the long-term strategic objective will always trump any short-term win, so please don’t lose sight of the portfolio context, especially when it comes to the concept of diversification. A position that is approaching 8%-10% of the total portfolio is a highly concentrated one, in my view, and very few of our ideas have ever reached those levels in the most recent past. In previous work, we showed how the weightings of ideas within the portfolio are of critical importance to executing on a long-term strategy (and can be more important than the ideas themselves), and in this piece, how the moves we make during each year are short-term tactical tweaks that we hope will augment the overall long-term strategy of each respective newsletter portfolio given current market conditions. Though we evaluated them as such, short-term tweaks should not be viewed in isolation, just like a battle can never ever be more important than the war itself.