Saturday, June 18, 2011

Top Investment Picks

I have been doing quite a bit of reading and as of recently decided to make a few changes to my investments.  Nothing really crazy but I did add to a couple of existing postions including Wells Fargo (WFC) and some more Bank of America Warrants (BAC.WS.A).  I do read a lot and it seem the negativity on these two banks, Bank of America in particular, has been growing recently.  As Buffett has said, be greedy when others are fearful. 
I have a number of stocks on my watchlist and I get email updates when they reach certain price points or a 52 week low.  Bank of America, Microsoft, Cisco, and others have recently been coming up for new 52 week lows.  It seem a number of people believe we are headed for a double dip, and while that may happen I don't believe it will last long. 

I follow a couple economic blogs and receive updates from a couple other sources which have provided some interesting perspective on the recent economic data.  A really good blog is the Califia Beach Pundita and can be found here http://scottgrannis.blogspot.com/.  It appears the Japan earthquake has rattled the economy somewhat recently, particularly in the auto sector.  The housing sector in the USA, which is currently only contributing a dismal 2% of US GDP is poised to rebound later this year.  One economic blog I read recently believe we will like go from over supply to under supply in the housing market in the next few years.  The area of the economy was majorly oversupplied during the past decade and now massively underperforming as the excess inventory is being mopped up.  Eventually we will be caught sleeping and we will all be caught by surprise. 

So what makes a good investment today.  I would recommend a number of companies in the Dow 30...  BAC, MSFT, CSCO, WMT, JPM, & even KFT is underperforming.  WFC isn't included in the above list as it isn't in the DOW 30, but is definitely a value stock.  Berkshire Hathaway (BRK.B) isn't a Dow component either but it offers outstanding value and outstanding safety at it's current price. 

Let's take a look at JPM, for instance.  The company closed yesterday at just over $40 and the bank had earnings of $4/shr last year.  That gives a trailing earnings yield of 10% and looking forward the bank should earn $5 per share this year... growth of 25% and a forward P/E of 8 times.  Now, I would never personally invest in JPM as I have listened to a few conference calls and management seems to be quite arrogant.  I respect Jamie Dimon but his attitude leaves something to be desired.  Who knows, someday he may need some help at JPM and because of those burned bridges the help will not be there.  I place a lot of emphasis on management, and I look not only for honesty and sound management... They have to be good people. 

As for the new technology investments I have made (not huge positions), MSFT and CSCO, I do think they offer decent potential over the next few years.  Technology stocks are very difficult to value because the future is quite uncertain, but one thing is certain we will be using more technology in the future.  I have stayed away from consumer technology companies as constant innovation and popularity are they key drivers of maintained market share.  I like another group of technology companies that are what I would call the infrastucture companies.  Companies like Microsoft (MSFT), Cisco (CSCO), and AT&T (T).  I believe Microsoft has some pretty strong competitive advantages simple due to their size and widespread usage of their products.  Obviously their gross and net profit margins would agree. 

One final thing I find ironic is that little over ten years ago technology was all the rage and now everyone thinks these companies are so called "value tech".  I would agree that they are value tech, which give a good margin of safety if a fall in revenue and earnings occur.  Secondly, and also ironically, the cheaper Microsoft stays the better for it is for current shareholders.  The company has been buying back approximately 4% of the shares per year and the lower the prices the lower the cost to buy back shares.  Microsoft isn't the only company buying back significant amounts of shares these days, Johnson & Johnson (JNJ) bought back $435 million in the first three months of 2011.   

Recent Reading

I have been reading a good number of books lately.  I have read House of Card the story of the collapse of Bear Stearns, Hank Paulsens book On The Brink, and Peter Bernstein's Against the Gods a good book about the history of probability and risk management.  I have also read Joel Greenblatt's new book The Big Secret for the Small Investor.  The latest quarterly reports in Canada have been quite interesting as we have adopted International Financial Reporting Standards (IFRS).  I particularly like how oil and gas firms have to report assets on the balance sheet.  The notes to the financial statements have also been quite insightful. 

Of all of the books above, I would like to recommend Hank Paulsen book, On The Brink.  It's a very long but and interesting account of the financial crisis from the inside (government's perspective).  Interesting to read about the decision why Lehman was allowed to fail and AIG wasn't.  AIG is perhaps the best example of what derivatives will do to a company.  What I did find particularly interesting is how much Hank took his ques from the market and credit default swaps, and his failure to see how mark to market accounting was killing any company that owned mortgage back securities.  Now I like mark to market accounting but when there is no market for something it doesn't make the assets worthless, especially if the assets are still income producing. 

The other key takeaway is that derivatives are the biggest risk to any investor as you just don't know what any one company has gotten itself into.  Take AIG for instance, they had written a bunch of derivative contracts insuring every financial company in the world.  They thought they were being brilliant and would never have to pay on the contracts.  Then 2008 came around.  How does the average investor know what kinds of risks are involved?

Derivatives are also the reason why companies are labelled "Too Big To Fail"... They aren't too big to fail but they are far too interconnected to fail.  One failure will bring them all down together.  I find it so interesting that every company, I repeat EVERY company, think they can manage risk with derivatives.  It's like the risk magically disappears because it is passed around.  To me, it's more like a risk hot potato and nobody knows who's going to be left holding the hot potato or what potatoe is ready to explode. 

Conclusion

A number of companies offer decent value today, partucularly amount the large US high quality.  May of them should provide anywhere between 10-20% returns (or better) over the next 4-5 years.  Stocks I personally really like are big banks like WFC, BAC, GS, JPM, BK & USB.  In techonology, I like MSFT & CSCO.  For large and safer firms I like BRK.B, WMT, GE & KFT

In Canada I like Fairfax Financial (FFH), Home Capital Group (HCG), and Manulife (MFC) is just about cheap enough to start nibbling again.  In the energy space I like Peyto Energy (PEY) if you want to speculate, and I repeat speculate, on natural gas prices.  Natural gas prices have perked up a little lately and Peyto is earning very good return on capital at current prices.  In full disclosure, I have owned Peyto for a very long time and have been recently selling some shares.  I think Peyto is fairly valued and companies like WFC, BAC, BRK.B, MSFT, and CSCO too attractive at mid to high single digit P/E ratios.  BRK.B, MSFT and CSCO have huge stockpiles of cash which also make them safe in case of market downturn.  CSCO is nearly to the lows reached during the height of the 2008 crisis, amazing. 

If you want to take the shotgun approach, I would recommend buying BRK.B.  Berkshire owns a number of the companies I have recommended above so in buying BRK.B you are buying a nice diversified group of outstanding business that will do very well over the next 4-5 years.  BRK.B also gives you some nice exposure to the eventual recovery of the housing market.  At $75/shr it is a great buy. 


Best Regards,
Kevin Graham

Disclosure - Long WFC, BAC.ws.a, BAC, BRK.B, MSFT, CSCO, MFC, PEY, GS, KFT, GE & JNJ
(Personally or for accounts I manage)

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