Tag Archives: utilities

How Many Stocks Should You Own? Remember Warren Buffett’s Advice

Summary Diversification is trumpeted as a key point of proper portfolio design. Warren Buffett disagrees with diversification, with a single caveat. The return spread among stocks suggest that every new holding you add is more likely to be a loser than a winner. If you asked SeekingAlpha readers why investors should own more than one stock, the overwhelming response would easily be diversification. The idea is simple: the more holdings you have, the less exposure you have to unsystematic risk (risk associated with a particular company or industry). Now, if you asked a follow-up question, “How many stock holdings you should have?”, you would end up with a hotly debated topic. On page 129 of my copy of The Intelligent Investor , legendary money manager Benjamin Graham advocates holding 10 to 30 positions. Modern portfolio theory supported this advice, and many continue to follow its preachings religiously. According to this theory, if you own 20 well-diversified companies, each held in equal amounts, you’ve eliminated 70% of risk (as measured by standard deviation) and reduced volatility. Can’t argue with the math (or can you?), and diversification has been harped on by many as the foundation of any properly constructed portfolio. It is likely that anyone that has had a financial advisor or even discussed finances with a family friend has heard this advice before. Always spread your capital across multiple sectors and markets is in that person’s best interest. Makes sense right? Who doesn’t want less volatility and risk? Warren Buffett apparently. “Diversification is protection against ignorance. It makes very little sense for those who know what they’re doing.” – The Oracle of Omaha Himself So, Do You Know What You’re Doing? Of course, modern portfolio theory and its offshoots were theorized between the ’50s and ’70s. Volatility is up since then, and stocks have become increasingly uncorrelated with the underlying market. To more clearly illustrate this point, stocks increasingly don’t follow a normal distribution pattern: * Source: Investopedia The results of the above image have been repeated over and over in recent market studies. The key takeaway for an individual investor is that the odds of a stock you own outperforming the stock market is actually worse than 50/50 , contrary to what many investors might think off hand. The reason for this is because overall market returns have been boosted by just a handful of “superstar” stocks, like Apple (NASDAQ: AAPL ) or Microsoft (NASDAQ: MSFT ). If you don’t own something like the next Apple or Microsoft in your portfolio (roughly 1 in 16 odds), then well, you’re likely doomed to underperform. So if you have a portfolio of 16 stocks, what are the odds you have that one in sixteen superstar company included based on random chance? Just 38%. Let us say you get lucky and manage to stumble upon a superstar. Now the question is whether you will continue to hold it as it multiplies. Enter the disposition effect . Retail investors have a tendency to sell winners (realizing gains too early) and hold onto losers, following the thought process that today’s losers are tomorrow’s winners. How many investors held on to Apple from $7.00/share in the early 2000’s all the way up to more than $700.00/share (split-adjusted) today? The answer is likely very few. Retail investors took the profit from the double or triple (if they even held that long) and likely didn’t reinvest back in because they had sold in the past. None of this changes the fact that the more companies you own, the more you will inevitably track the index of the positions you hold. In order to generate alpha (abnormal return adjusted for risk), it is a fact that the more stocks you own, the less likely you will be able to generate that alpha. The more holdings you have, the more likely you will have just tracked the index that your holdings are a part of, but in an inefficient way. For all your trouble, you are out both your free time and likely higher trading costs. The question then is why bother with all the headaches of investing in numerous individual companies you buy individually, if you could simply just buy the index and take it easy? If you take a look at major hedge fund and money manager holdings, it is clear that concentrated holdings are used to drive alpha. Visiting the Oracle of Omaha’s portfolio, the man clearly practices what he says. The top five holdings of Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B )[Wells Fargo (NYSE: WFC ), Kraft Heinz (NASDAQ: KHC ), Coca Cola (NYSE: KO ), IBM (NYSE: IBM ), and American Express (NYSE: AXP )] constituted 67% of his portfolio as of September 30, 2015. 43 scattered holdings constituted the remaining 33%. As for diversifying across sectors versus buying what you know and understand, 37% of Buffett’s holdings fall in the Consumer Staples sector and 35% in Financials. The man clearly doesn’t buy utilities just because portfolio theory tells him he should in order to reduce his risk. Conclusion Thousands of people will read this article. Are you smarter than two thirds of them? If you don’t believe that, buy ETFs, sit back, and be content with market returns. If you think you’re smarter than two thirds of readers of this article (I suspect 95% of you believe that), then the takeaway is slightly different. Diversification, for the sake of diversification, is stupid. Buy what you know, can understand, and believe in the long-term potential of. Don’t understand bank stocks? Reading their SEC filings even gives me headaches, and I work at one. If you don’t understand the company, chances are you aren’t going to pick a winner other than by dumb luck. You shouldn’t lose sleep at night for not having exposure to an industry you can’t adequately review, and it is likely your portfolio returns will thank you for it. As far as how many positions to have, hold as few positions as you are comfortable with when it comes to risk and volatility in order to increase alpha on your high conviction positions. For most investors, that sweet spot still likely falls within modern portfolio theory guidance, around 15 to 25.

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.

Is Consolidated Edison A Good Income Investment With Its Underperforming Total Return?

Summary Consolidated Edison’s dividend is high at 4.1% and has been increased each year over the last 41 years making Consolidated Edison a dividend aristocrat. Consolidated Edison’s total return underperforms over the last 35.8 month test period but its cash flow is good to make the dividend safe that will most likely be increased in. Consolidated Edison’s revenue growth is not great at 2% going forward but is very stable and the company business is defensive. This article is about Consolidated Edison Inc. (NYSE: ED ) and why it’s an income company that’s being looked at in The Good Business Portfolio. Consolidated Edison is a holding company with its business being an electric and gas utility in the North East United States. The Good Business Portfolio Guidelines, total return, earnings and company business will be looked at. Good Business Portfolio Guidelines. Consolidated Edison passes 7 of 10 Good Business Portfolio Guidelines. These guidelines are only used to filter companies to be considered in the portfolio. There are many good business companies that don’t break many of these guidelines but will still not be considered for the portfolio at this time. For a complete set of the guidelines, please see my article ” The Good Business Portfolio: All 24 Positions .” These guidelines provide me with a balanced portfolio of income, defensive and growing companies that keeps me ahead of the Dow average. Consolidated Edison is a large-cap company with a capitalization of $17.829 billion. The Company operates through its subsidiaries, which include Consolidated Edison Company of New York, Inc. (CECONY), Orange and Rockland Utilities, Inc. (O&R) and the Competitive Energy Businesses. Consolidated Edison has a dividend yield of 4.1% that has been increased each year for 41 years. The dividend grows slowly but is extremely safe. Consolidated Edison therefore is a income story. The average payout ratio is 67% over the past five years which leaves plenty of cash remaining for investment after paying its high dividend Consolidated Edison’s cash flow is good at $1.2 Billion which leaves it with plenty of cash allowing it to pay its high dividend and have cash left over for company equipment modernization. I also require the CAGR going forward to be able to cover my yearly expenses. My dividends provide 3.1% of the portfolio as income and I need 1.9% capital gain in addition for a yearly distribution of 5%. Consolidated Edison has a three-year CAGR of 2% not meeting my overall requirement. Looking back five years $10,000 invested five years ago would now be worth over $15,379 today (from S&P IQ). This makes Consolidated Edison a good investment for the income investor with its steady slow growing 4.1% dividend that has been raised for over the last 41 years each year but does not meet the 5% CAGR growth I require. Consolidated Edison’s S&P Capital IQ has a two-star rating or sell with a price target of $59.0. This makes Consolidated Edison slightly over priced at present but a good choice for the income investor that does not need much capital gains growth and wants a safe income stream. Total Return and Yearly Dividend The Good Business Portfolio Guidelines are just a screen to start with and not absolute rules. When I look at a company, the total return is a key parameter to see if it fits the objective of the Good Business Portfolio. Consolidated Edison did worst than the Dow baseline in my 35.8 month test compared to the Dow average but does have a positive total return of 24.54% over the test period of 35.8 months.. I chose the 35.8 month test period (starting January 1, 2013) because it includes the great year of 2013, the moderate year of 2014 and the losing year of 2015 YTD. I have had comments about why I do not compare the total return to the S&P 500 average. I use the Dow average because the Good Business Portfolio has six Dow companies in it and is weighted more to the Dow average than the S&P 500. Modeling the Dow average is not an objective of the portfolio but just happened by using the 10 guidelines as a filter for company selection. This total return makes Consolidated Edison appropriate for the income investor with the steady slow growing dividend of 4.1%, but the aggressive investor should look for companies with more growth potential. It is expected that the dividend will be increased from its present $0.65/Qtr. to $0.67/Qtr. in January of 2016. DOW’s 35.8-month total return baseline is 30.71% Company Name 35.8 Month total return Difference from DOW baseline Yearly Dividend percentage Consolidated Edison Inc. 24.54% -6.17% 4.3% Last Quarter’s Earnings For the last quarter Consolidated Edison reported earnings on November 5, 2015 that missed expected at $1.44 compared to last year at $1.48 and expected at $1.48. They reaffirmed yearly earnings of $3.90 – $4.05. This was a fair to weak report. Earnings for the next quarter are expected to be at $0.52 compared to the last year at $0.58. The steady slow growth in Consolidated Edison over long periods of time should provide a company that will continue to have slightly below average total return but provide steady income for the income investor. Business Overview Consolidated Edison, Inc. (Con Edison) is a holding company. The Company operates through its subsidiaries, which include Consolidated Edison Company of New York, Inc. (CECONY), Orange and Rockland Utilities, Inc. (O&R) and the Competitive Energy Businesses. CECONY delivers electricity, natural gas and steam to customers in New York City and Westchester County. Orange and Rockland Utilities Inc. (O&R) delivers electricity and natural gas to customers located in south-eastern New York, northern New Jersey and north-eastern Pennsylvania. O&R’s utility subsidiaries include Rockland Electric Company and Pike County Light & Power Company. Competitive energy businesses provide retail and wholesale electricity supply and energy services. The Competitive Energy Businesses include three subsidiaries: Consolidated Edison Solutions, Inc. (Con Edison Solutions); Consolidated Edison Energy, Inc. (Con Edison Energy), and Consolidated Edison Development, Inc. (Con Edison Development). The good cash flow of Consolidated Edison, Inc. allows the company to expand its business slowly and modernize its equipment as the population of its service area increases over time. Takeaways and Recent Portfolio Changes Consolidated Edison Inc. is an income company choice considering its steady slow growth and its total return underperforming the Dow average. Consolidated Edison is a buy for the income investor that is willing to have underperformance of total return but have a steady increasing income and have safety of a defensive company business. Consolidated Edison is not being added to The Good Business Portfolio right now since there are no open slots in the portfolio and the total return underperforms the DOW average for the 35.8 month test period. Bought Eaton Vance Enhanced Income Equity Fund II (NYSE: EOS ) to bring it up to 6.5% of the portfolio. Great income fund that beats the DOW average. Trimmed Cabela’s (NYSE: CAB ) to 4.6% of the portfolio, want to take a little off the table while its up due to the buyout possibilities. The Good Business Portfolio generally trims a position when it gets above 8% of the portfolio. Home Depot (NYSE: HD ) is 8.3% of portfolio, Walt Disney (NYSE: DIS ) is 7.5% of the portfolio and Boeing (NYSE: BA ) is 8.9% of the Portfolio therefore BA and HD and now in trim position with DIS getting close. I have written individual articles on EOS, CAB and HD, if you have an interest please look for them in my list of previous articles. Of course this is not a recommendation to buy or sell and you should always do your own research and talk to your financial advisor before any purchase or sale. This is how I manage my IRA retirement account and the opinions on the companies are my own.