Tag Archives: ideas

Proposed Allocation

Two weeks ago I wrote an article on Seeking Alpha discussing the ETFs that will comprise the core of our future portfolio . My goal, in all aspects of my life, is to always be learning and growing. Part of that process is to challenge myself and my ideas. My wife and I have run a bifurcated portfolio , comprised almost exclusively of individual stocks, for the past several years. While I thoroughly enjoy researching and valuing companies currently, I can see that the day is coming when I’ll want to be a much more passive investor. I anticipate achieving semi-retirement a couple years out, and at that time I’d like to transition to a portfolio which is maybe 30% individual stocks… with the rest being index ETFs and cash. Recently, I have begun to think it’s arrogant to think that our portfolio of (mostly) individual stocks can provide the diversification we require… while ‘not’ also requiring a great deal of time to manage. I also received a few comments and emails last week asking me why I wasn’t just proposing a portfolio of strictly ETF and index funds. I want to retain 20% to 30% of the portfolio in individual funds, because there are some truly amazing companies available to the investing public. I expect these companies to compound our capital for decades to come! So why not just invest in these amazing individual companies?! Two reasons: 1) I may be wrong, and it’s pure arrogance to think otherwise; and 2) I don’t believe there are enough of these truly amazing companies, that I could build a diversified portfolio out of them… even if I had the time to manage it. Simply put, I am looking to strike the right risk/reward balance. With that background expressed, below is my desired portfolio allocation. Please note that this includes my wife’s and my capital, as well as the trust fund we set up for our children. 25% Individual Stocks 20% Cash (or cash equivalents)* 15% Vanguard Total Stock Market ETF (NYSEARCA: VTI ) 15% Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) 15% Vanguard FTSE All-World ex-U.S. ETF (NYSEARCA: VEU ) 10% Vanguard REIT ETF (NYSEARCA: VNQ ) *Reduced by 10% when bonds re-enter our portfolio Individual Stocks First, let’s talk about what these categories mean. Within Individual Stocks, I mean both the amazing companies I want to hold for the long term (like Union Pacific (NYSE: UNP ), Visa (NYSE: V ), Coca-Cola (NYSE: KO ), etc.) and the “Deep Value” opportunities that present themselves from time to time. While these “Deep Value” opportunities usually manifest themselves as small and under-reported companies, they can also take the form of commodities or alternatives. Agricultural commodities are looking interesting to me today and gold will likely be appealing in a few months. My intention with this group is that the vast majority of this group be long term holdings… and the remainder be allocated toward alternatives and deep-value trades. Bonds You may have noticed, correctly may I add, that our portfolio will not have a bond allocation for the foreseeable future. Given our young age, mid-thirties, and the ultra-low interest rates… we have chosen to shift any bond allocation to other areas of our portfolio. If rates were to suddenly jump a tremendous amount, it’s possible bonds could join our portfolio… but it’s not likely for the foreseeable future. U.S. Stocks The next question I am likely to receive surrounds how we could only allocate 15% to U.S. Stocks (in the form of Vanguard’s Total Stock Market ETF ( VTI )). I will be quick to point out that the ‘vast’ majority of the individual stocks we invest in, are in fact US stocks. Therefore, it’s reasonable to assume that nearly 40% (25% individual stocks and 15% VTI) will be invested in U.S. stocks. Given that I am paid in U.S. dollars and the property we own is in the U.S., I don’t feel like we are short-changing our homeland. Around 40% of the world’s global equity capitalization is sold on U.S.-based markets. Therefore, I feel my U.S. stock allocation is right where I want it to be, especially when you back cash out of the equation. Emerging Markets I frequently receive email questions concerning why I think Emerging Markets are so well-represented in our portfolio. The simple fact is that the majority of global growth will come from countries which are now called “emerging”. Around most of the developed world, populations are barely growing… if they are growing at all. However, the populations of “emerging” markets are growing much more rapidly. There is some elevated risk that those local governments won’t enforce the rule of law, or more likely that those governments will nationalize your investment, but I think that is a risk in developed countries as well… just a little bit smaller risk. Foreign Stocks There are a ton of companies in this world, with plenty of market capitalization to go with them. To gain exposure to these markets, we will utilize Vanguard’s FTSE All World ex-U.S. ETF ( VEU ). It is important to note that nearly one-fifth (18%) of this ETF is comprised of companies from emerging market economies, so there is this overlap. The rest of the ETF is comprised of companies from developed counties (like Germany, the U.K., Japan, etc.). Real Estate Cash-flowing real estate can be a great investment. Unfortunately, our investable capital is not enough to purchase a diversified real estate portfolio in our part of Florida. We can, however, invest in real estate through Vanguard’s REIT ETF ( VNQ ), with the added benefit of instant diversification and much-improved liquidity. If I had the time and inclination to be a full-time landlord, I would prefer to go that route… but it seems unlikely on any large scale. So, with the funds listed above, we intend to transition to a simpler… and less time consuming… investment approach. Last week, I sent an email out to our subscribers discussing which current investments I was looking to rotate out of in the coming months. I also identified a few of the investments I shouldn’t have made, as I think it’s important to learn from our mistakes. If you would like to receive emails like these in the future, sign up for our email list by completing the box on the right side of our homepage. I hope this holy week is fully of good times and great memories for you all. Take care. What do you think of our allocations, and how do they compare to your own? Disclosure: Long VWO, KO, UNP, V. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional. The information above can be found at Vanguard.com.

Valuation Dashboard: Energy And Materials – Update

Summary 4 key fundamental factors are reported across industries in Energy and Basic Materials. They give valuation status of an industry relative to its historical average. They give a reference for picking stocks in each industry. This is part of a monthly series of articles giving a valuation dashboard in sectors and industries. The idea is to follow up a certain number of fundamental factors for every sector, to compare them to historical averages. This article covers Energy and Basic Materials. The choice of the fundamental ratios used in this study has been justified here and here . You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. You can refine your research reading articles by industry experts here . A link to a list of stocks to consider is provided in the conclusion. Methodology Four industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Price to free cash flow (P/FCF), Return on Equity (ROE). They are compared with their own historical averages “Avg”. The difference is measured in percentage for valuation ratios and in absolute for ROE, and named “D-xxx” if xxx is the factor’s name. For example, D-P/E = (AvgP/E – P/E)/AvgP/E. It can be interpreted as a percentage in under-pricing relative to a historical baseline: the higher, the better. It points to over-pricing when negative. ROE is already a percentage. A relative variation makes little sense. That’s why we take the simple difference: D-ROE = ROE – AvgROE. The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and limiting the influence of the largest companies. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors. Industry valuation table on 12/21/2015 The next table reports the 4 industry factors. For each factor, the next “Avg” column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next “D-xxx” column is the difference between the historical average and the current value, in percentage. So there are 3 columns relative to P/E, and also 3 for each ratio. P/E Avg D- P/E P/S Avg D- P/S P/FCF Avg D- P/FCF ROE Avg D-ROE Energy Equipment&Services 20 24.2 17.36% 0.72 1.73 58.38% 8.65 35.34 75.52% -10.91 7.34 -18.25 Oil/Gas/Fuel 14.93 18.53 19.43% 1.65 3.35 50.75% 15.48 29.03 46.68% -15.55 4.47 -20.02 Chemicals 18.3 18.48 0.97% 1.31 1.21 -8.26% 35.82 25.37 -41.19% 8.71 6.74 1.97 Construction Materials 51.27 21.44 -139.13% 1.36 1.16 -17.24% 58.56 40.5 -44.59% 9.34 5.77 3.57 Packaging 21.58 17.96 -20.16% 0.91 0.61 -49.18% 23.15 20.09 -15.23% 18.23 8.34 9.89 Metals&Mining 19 19.83 4.19% 1.2 2.65 54.72% 13.94 25.53 45.40% -19.39 -8.6 -10.79 Paper&Wood 30.98 21.27 -45.65% 0.92 0.72 -27.78% 21.8 22.81 4.43% 8.35 4.99 3.36 The following charts give an idea of the current valuation status of Energy and Materials industries relative to their historical average. In all cases, the higher the better. Price/Earnings : Price/Sales : Price/Free Cash Flow : Quality (ROE) Relative Momentum The next chart compares the price action of the SPDR Select Sector ETF in Materials (NYSEARCA: XLB ) and energy (NYSEARCA: XLE ) with SPY (chart from freestockcharts.com). (click to enlarge) Conclusion In one month, XLE has fallen by 11.3% and XLB by 6.3%, both underperforming SPY by a wide margin. The reason is obvious looking at WTI oil price: it hit last week a level not seen since the second half of 2003. In this meltdown, the five more resilient S&P 500 stocks in Energy and Materials on a 3-month period are Airgas Inc (NYSE: ARG ), Chevron Corp (NYSE: CVX ), E. I. du Pont de Nemours (NYSE: DD ), Tesoro Corp (NYSE: TSO ), Valero Energy Corp (NYSE: VLO ). The two latter are refiners. Oil price is not a major driver of their profitability, and concerns about a possible end of the crude oil export ban seem to disappear. The improvement in valuation ratios for all industries of these sectors since my last update is just a consequence of lower stock prices. The harder the fall, the better the “improvement”. It is not a signal that things are really improving for oil and gas companies. It is even the opposite: the quality measured by the ROE industry factor went down. As a group, energy and metal/mining are looking like a nest of value traps: the 3 valuation ratios point to underpricing, whereas the quality factor (D-ROE) is deep in the red and worsening. This is not true for all the oil industry: we have seen that refiners are doing quite well and several of them have hit an all-time high in November. Some of them are also in the very best of the S&P 500 in my value and quality-based screens. No industry in these two sectors looks globally very attractive. However, comparing individual fundamental factors to the industry factors provided in the table may help find quality stocks at a reasonable price. The next table shows a list of stocks in the Energy and Basics Materials sectors. They are all cheaper than their respective industry for 3 valuation factors simultaneously: Price/Earnings, Price/Sales, Price/Free Cash Flow. Then they are selected for their higher Return on Equity. This screen updated and rebalanced monthly has an annualized return about 17% and a drawdown about -65% for a 17-year backtest. The corresponding sector ETFs XLE and XLB have an annualized return of respectively 8.32% and 6.79% on the same period. Past performance, real or simulated, is not a guarantee of future return. This list may be considered an entry point for further due diligence, or as a portfolio after adding a few trading rules and market timing. This is not investment advice. Do your own research before buying. ATW Atwood Oceanics Inc. ENERGYEQUIP DOW Dow Chemical Co (The) CHEM EMN Eastman Chemical Co CHEM IOSP Innospec Inc CHEM KS KapStone Paper & Packaging Corp FORESTRY LYB LyondellBasell Industries NV CHEM REX Rex American Resources Corp OILGASFUEL TSO Tesoro Corp OILGASFUEL VLO Valero Energy Corp OILGASFUEL WNR Western Refining Inc OILGASFUEL If you want to stay informed of my updates on this topic and other articles, click the “Follow” tab at the top of this article.

ONEOK: The 2016 Guidance Is Bullish

Summary ONEOK surges 15% after providing its 2016 financial guidance. Dividend is expected to be unchanged from 2015 levels. Free cash flow after dividends is expected to be ~$160 million. Though, ONEOK’s success largely depends on its MLP ONEOK Partners doing well. It is truly amazing just how much volatility there is in the midstream sector right now. Formerly steady stocks like ONEOK, Inc (NYSE: OKE ) have been eviscerated, down 44% since early October, following oil lower. Besides falling oil prices, ONEOK has been hurt by the troubles over at Kinder Morgan (NYSE: KMI ) which forced that company to lower its dividend . However, ONEOK recently surprised the markets by announcing plans to sustain its current dividend for 2016. The same holds true for ONEOK’s MLP ONEOK Partners (NYSE: OKS ). This sent shares of both stocks up 15%. Though, despite this news, the yield on both is still elevated at over 11%, indicating continued investor anxiety. OKE data by YCharts 2016 Outlook is looking strong Looking at ONEOK’s updated guidance, it appears not much will change versus 2015. Cash flow available for dividends is expected to come in at $675 million, or $3.22 per share, up 9% from 2015 estimates. Dividend payments are expected at $515 million, or $2.46 per share, flat from 2015 levels, leaving free cash flow of $160 million, or $0.76 per share. This would also result in a robust 1.3x dividend coverage ratio. Though, there is one major weak spot in ONEOK’s guidance–virtually all cash flow is coming from cash distributions from the LP and GP stakes in ONEOK Partners. If ONEOK Partners were to cut the distribution, ONEOK’s cash flows, and thus the dividend, would drop significantly. However, unlike KMI, ONEOK Partners is not relying on the equity markets to fund the capex budget in 2016. Furthermore, the MLP is projecting to fully cover its distribution in 2016. I’ll have more on ONEOK Partner’s 2016 outlook in a future article. The press release is also unclear as to how ONEOK’s free cash flow will be handled. The company noted that: “Free cash flow after dividends and cash on hand totaling approximately $250 million available to support ONEOK Partners” This implies that ONEOK will be contributing cash directly to its MLP. Earlier this year, ONEOK did help out the MLP by buying 21.5 million common units for $650 million. I would not be surprised if another capital infusion from ONEOK to ONEOK Partners is required next year. Though, I would imagine they would want to use something other than ONEOK Partner’s common equity given the high yield and low unit price. Conclusion While the 2016 outlook is undoubtedly good news for ONEOK, investors need to remember that the dividend is not set in stone. If ONEOK Partners fails to cover the distribution, ONEOK’s dividend will be at risk. Nevertheless, it appears things are not as dire for ONEOK as the stock price and 11% yield implies. I believe the stock will eventually recover to a more reasonable level. Though, short to medium term, the price action will likely be dominated by the general trend in oil as the midstream sector’s fundamentals have been ignored by the market. Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.