Ruminations on Portfolio Management

Looking at my portfolio yesterday I realized there should be no way I am down 4% on the year while the S&P is up 7.4%.

Yesterday I was also updating my mom's portfolio and adding to info in it to my spreadsheet so I could check the up and downs versus the S&P. I haven't even looked at this portfolio for two months and didn't know that it was 25% cash until I logged in.

So I bought WU, and two special situations I am currently favoring. Now she is 10% cash and I will go back to patiently waiting for good opportunities.

Good opportunities is basically what I do with her portfolio and my sister's. Some of the good opportunities we have bought are Pfizer at $20, Altria at $49.55, MSO at $11 after Martha Stewart went to jail and selling at $22 a year later, both Tilson mutual funds at inception in April 2005, since then they are both up between 25 and 30%

So I was looking at her portfolio returns - 31% since June 2004 compared with 21.2% from the S&P - and couldn't figure out why she was up 28% more than me even though her biggest position is AVEMX and I spend about 2,000% more time 'managing' my portfolio by researching ideas trading in and out of Going Private Transactions and other Special Situations, until it hit me.

Her portfolio has soundly beat the S&P because I don't 'manage' it. It's such a pain to convince her to allow me to log-in to her account to look at what she owns and jump through the hoops to be able to buy companies they have to be obvious buys for them to be purchased.

This is where I go wrong in my portfolio; JRCC was not an 'obvious buy' I read articles from smart investors saying the coal market was in an up cycle and JRCC was the most undervalued of all the coal companies. What the articles didn't say is JRCC had crappy management and the coal market was about to fall fast. Since I didn't know enough about the company or the coal market to convince my mom to buy it I didn't even bother explaining it I just bought it in the accounts I manage where I don't need permission to buy things.

This has happened over and over with my portfolio, more so with the money I manage for my Grandpa. His portfolio is truly excruciatingly painful for me to look at every day and I dread the phone calls where I have to explain what's wrong with it.

I did get lucky with a few stocks in his portfolio, DTV is up 57% since I bought it, LKI is up 15% and was up 25% when I trimmed it by half, OSTK is up 10% so far and I have made about 20% on the portfolio with different special situations since I started managing it.

Even with all of this the portfolio is down 14% since inception compared with a 16% gain by the S&P, this is 30 percentage points of difference - unacceptable.

Before this year I barely did any research for stocks I bought in this portfolio, it was barely any of my Grandpa's net worth so there was no reason for me to worry about it falling.

But it was down about 10% going into this year and my grandparents were getting antsy so I promised to start treating this portfolio as I did the others.

This translates to better, positive, returns. Or so I thought.

After buying ACUS late last year because of a series of posts on the Motley Fool Message Boards and next to no additional research on my part ACUS is down 42%. I also played with fire, or should we say coal, in this portfolio to the tune of a current 35% loss in ICO and a 50% loss on the selling of JRCC.

So here's my solution to all this, and hopefully this will put the returns of my portfolio 33% higher then the S&P over the next few years: I will keep the current 50% of my mom's portfolio in mutual funds, but with the other 50% I will duplicate my portfolio - this means before I buy anything in any portfolio my mom needs to understand the reasoning and be OK with the buy.

Book Update

I have been too busy to read anywhere but school so I am currently a few chapters from the end of Moneyball and should have a review of it and another previously read book up soon.

Western Union

Western Union was started in 1851 as The New York and Mississippi Valley Printing Telegraph Company this marked the start of 150 years of innovation. Five years later it would change its name to Western Union because of the Union of telegraph companies in the Western United States. In 1866 a genius inventor who used Western Union to finance some of his early inventions created the stock ticker, his name was Thomas Edison.

In 1871 they initiated what is to this day their core business: wiring money. In 1884 they became an inaugural member of the DOW.

In the 20th century they held the name of a number of firsts including: first charge card, first fax machine, the singing telegram, first domestic telecommunications satellite in space and the first company with five satellites in space.

But all this innovation was taxing to the balance sheet and Western Union underwent bankruptcy in 1994. After reorganization it was bought by First Data and in 2006 it was spun-off from First Data.

Today Western Union is a refreshed company with over 270,000 agent locations in over 200 countries and territories. Its name is synonymous with money wiring and it has twice the market share of its closest competitor.

I will analyze this company using Warren BuffettÂ’s tenets as told in The Warren Buffett Way, Second Edition.

Business

Is the Business Simple and Understandable?

Western Union operates in two businesses: Transferring money from person to person worldwide and transferring money from consumer to business worldwide.

Does the Company Have a Consistent Operating History?

While it has been around for 150 years the company underwent bankruptcy only ten years ago and has been part of FDC since then. The revenue and earnings shown over the past five years are consistent.

Does the Business Have Favorable Long-Term Prospects?

While Immigration reform in the United States could cut back on profits Western Union has more than twice the market share of its closest competitor and the means to stay a going concern for a long time. One problem could be the $3.5 billion of debt sitting on its balance sheet – this, however, can be easily resolved with the $1 billion in Cash Flow the company makes every year.

Management

Is Management Rational?

It is too early to tell for sure but judging by the ROE management seems rational at this point.

Is Management Candid With its Shareholders

So far the company has only one important filing, which because of its nature as a prospectus, is extremely informative. ItÂ’s Investor Relations site is also impressive, better then many I have seen.

Does Management Resist the Institutional Imperative?

Again it is too early to tell, but the corporate governance information on the WU Investor relations site is exceptional.

Financial Tenets

What is the Return on Equity?

Western Union has earnings of $927 million and ShareholderÂ’s Equity of $3.353 billion. This is a ROE of 28%. This is an excellent ROE showing a good business and in touch management, but it is high with a lot of debt, something Buffett frowns on. It is encouraging that ShareholderÂ’s Equity has grown almost $2 billion in the past two years.

What Are the CompanyÂ’s OwnerÂ’s Earnings?

Net income $927, the company mentions $19 million being D&A for the first six months as a standing alone company in 2006 will use $38 million, and CapEx is said to be between $200 and 225 million I will use 225 million to be conservative. This is ownerÂ’s earnings of $740 million. I will not use this number because of the uncertainty with the latter two expenses.

What Are the Profit Margins

The annual profit margins are 23.25%. This is very good, and will be high as one-time costs associated with the spin-off are paid.

Has the Company Created at least One Dollar in Market Value for every Dollar in Retained Earnings?

The company has not been public for more then a year, I would like at least five years of info for this tenet.

Value

What is the Value of the Company?

Operating Cash Flow for 2005 was $1 billion, I will use $775 million in my valuation. The analyst recommendation for the next five years is 12.5% I will 10% earnings growth over the next ten years, 3% terminal and an 11% discount. This yields a DCF value of $21.56.

Can the Company be Purchased at a Significant Discount to its Intrinsic Value?

Currently the discount is 10%, while not significant it is a discount.

Conclusion

My valuation is probably too conservative as Morningstar values them at $32/share using revenue growth and increasing margins. Also I believe Western Union will grow faster than 10%, If I up the growth to 12% the value goes to $25/share. Regardless I believe quality is more important then price and have purchased shares of Western Union and intend to hold them for as long as possible.

This article is not a recommendation to buy or sell any securities. Consult an investment professional before making any trades. The author and some members of his family own shares of WU but not of any of the other companies mentioned in this article.

Small-Cap Value?

After selling JRCC and CENF and narrowing down my LKI position I am now 20% in cash, own only 6 stocks - one is a cigar butt and one a special situation - and am in need of a new position.

I have Thursday and Friday off of school and am using these two days to research a few stocks hoping to find a fat pitch I will be able to start a position in.

The first stock I have looked at is Drew Industries (DW), which could possibly be a good Small-Cap Value or GARP play.

Company Description

Drew has two reportable operating segments: the recreational vehicle and leisure products segment and the manufactured housing products segment. The RV Segment accounted for 67 percent of consolidated net sales for 2005, and the MH Segment accounted for 33 percent of consolidated net sales for 2005. Approximately 95 percent of the RV Segment sales were products for travel trailers and fifth-wheel RV’s. Drew’s wholly-owned subsidiaries, Kinro, Inc. and its subsidiaries (collectively,
"Kinro"), and Lippert Components, Inc. and its subsidiaries (collectively, "Lippert"), each have operations in both the RV Segment and the MH Segment.

Kinro manufactures and markets components primarily for RVs and manufactured homes (“MH”), including windows, doors and screens, and thermo-formed bath products. Lippert manufactures and markets components primarily for RV’s and manufactured homes, including steel chassis, steel chassis parts, slide-out
mechanisms and related power units, electric stabilizer jacks, leveling devices, axles and steps. Lippert also manufactures specialty trailers primarily for hauling equipment, boats, personal watercraft and snowmobiles.
Certain products manufactured by Kinro and Lippert are also used in modular homes and office units.

Moat?

The company believes its market share ranges from 25 - 70% in its various products. It also says its market share in RV window and door products exceeds 70% and it exceeds 60% in RV Chassis and Chassis parts.

Even 25% market share is envied by some of the best companies in America, from this limited view it looks like Drew is a small company that has a found a niche to exploit.

Management

Insiders hold 20% of the stock.

Edward Rose is the Chairman of the Board, he has been an officer since 1984. Leigh Abrams is the CEO and has been an officer since 1984.

After listening to the conference call I got the impression that management resists the institutional imperative and is generally annoyed with Wall St. analysts. Though their shortness with the calling analysts could be bad sign I believe it shows they would rather be focused on the business then Wall St.’s opinion.

Valuation

Using the earnings of $39.6 million, 13.5% or 75% of analyst’s estimates of 18% growth during the next 5 years, 7% of about half of that for the next five years, 3% to eternity and an 11% discount rate I get a DCF value of $42.13 per share, the current price is $27.49 this is a margin of safety of about 53%. Using more conservative inputs of 10% then 5% growth the value comes to $34.4 per share, a 25% margin of safety.

According to Quicken Drew needs to grow 8.6% over the next 10 years to justify the current price. Though this isn’t a low number it is lower the analyst expectations.

Drew currently trades for 15x earnings, 16x cash flow and four fifths of sales. Reversion to the mean – industry averages – would provide target prices of $54, $62 and $42 respectively. Drew’s industry includes a lot of different companies, the vast majority do not makes doors and windows for RVs so I do not believe this is a good comparison.

Drew’s P/E is historically high and its P/S and P/CF are lower then usual.

Conclusion

This is a very brief write-up and only an introduction to a possible buying decision. I feel Drew is a good company with exceptional management and is undervalued. I do not know the extent of the under valuation or if Hurricane Katrina has inflated earnings, on the other hand high gas prices may have artificially deflated earnings – because of a lower then usual RV market. I used earnings in my analysis, Drew has CapEx of 33 million, 83% of earnings, which is a very high number and would drastically reduce the DCF value. I will not buy now, but I will continue my research and listen to the company’s next cc, which is scheduled for November 1.

Reading Log #1: Busting Vegas

For English this year I have to read 700 pages each quarter - each quarter is about nine weeks long. Through the first 6 weeks of the current quarter I have already surpassed this number and have read a total of 1,208 pages.

In an effort to keep track of all the books I read, I will post on each book as I finish it.

In this post I'll go over the three longer books I have read so far.

Now I Can Die in Peace - 384 pages - 4 out of 5 stars - ESPN.com's Bill Simmons goes over all of the Red Sox columns he has written looking for clues of how his favorite team could win the World Series. Simmons is my favorite columnist and I jumped at the chance to read an archive of his columns, Jimmy Kimmel calls him the funniest sports writer and the footnotes throughout the book prove this.

The Lost Colony (Artemis Fowl, Book 5) - 400 pages - 3.5 our of 5 stars - This is the fifth book in a series about a 14 year old genius - now you know why I like it ;-). I do not think it is the best book in the series, but those who have an interest in Teen Fiction books should take a look at the series I highly recommend it.

Busting Vega$: The Mit Whiz Kid Who Brought the Casinos to Their Knees - 304 pages - 4.75 out of 5 stars - Ben Mezrich is currently my favorite author and this kind-of a sequel to Bringing Down the House is better then the original. The book goes through how MIT student Semyon Dukach and his team use advanced Black Jack techniques to bring their expected returns up to as much as 30% per hand - much more then the card counter's 2%. Blackjack is a new fascination of mine and Beat the Dealer is waiting on my book shelf.

I did rank all three of these books pretty high, this is not a scheme to get my amazon commsions up, these are actual opinions, I enjoy reading and am pretty selective with my reading; if a book does not interest me I stop reading it pretty quickly.

The two books I am reading now are Moneyball: The Art of Winning an Unfair Game and The Vulture Investors, Revised and Updated I will post on these upon my finishing of them.

Carnival of Investing

Hi! I'm Mike welcome to the Carnival of Investing. Feel free to look around the blog, and read what it is about.

Also check out The Value Blogs a new site I am developing with Kevin Kelly that feeds the first paragraph of posts from the very best value blogs. To check it out or apply your blog please visit the site.

And now the Carnival:

mbhunter presents Taking the ROI Bull by the Horns posted at MBHunter

The Dividend Guy presents The Time Tested Rules of Investing posted at The Dividend Guy Blog.

Nick presents Great Investing Tip: Put Your Money Into BARRELS posted at Punny Money, saying, "Here's a great bit of investment advice some crazy guy on the street gave me."

Pete presents Variable Annuities: Are they a good investment? posted at My Financial Awareness.

Sean presents How To Lose Your Shirt Online posted at Irregular Payments, saying, "HYIP - investment opportunities you should definitely avoid!"

HeJustLaughs presents Why reinsurance companies like MRH are the place to be. posted at HJL Money Blog, saying, "HeJustLaughs explains why he thinks reinsurance companies like MRH are the place to be."

gte presents No Guts, No Glory posted at Getting To Enough, saying, "This post goes over some of the basics of risk vs. return and offers some practical suggestions."

Nina Smith presents Straight Talk about Viatical Settlements posted at Queercents, saying, "In the LGBT community, the topic of viatical settlements seems antediluvian with many gay men living healthy lives as HIV positive. Then I thought about it and realized that’s a narrow view since we all have some chance of getting or knowing someone with a serious illness."

Bryan C. Fleming presents How to Get Through a Cash Pinch posted at Bryan C. Fleming .com.

MyMoneyForest presents India Investments Looking Good posted at MyMoneyForest.

Steve Faber presents Internet Ad Revenue Growth Slower – Is That Indicative of Something Bigger? posted at DebtBlog.

frugal presents Learning How to Invest posted at 1stmillionat33

Dan Melson presents Manufactured, Modular, and Site-Built Homes: How Lending Practices Drive the Sales Market posted at Searchlight Crusade.

Michael K. Dawson presents The Time & Money Group Accelerates Your Path to Financial Freedom » Blog Archive » A Simple Relationship to Put Money in Your Pocket posted at The Time and Money Group.

Kevin Kneupper presents Think We're Heading For 1970's Style Economic Collapse? What Should You Do? posted at Free the Drones, saying, "A post on fears of a coming U.S. depression - why they're probably wrong, and what you can do for your portfolio if you're still convinced."

Scott presents Your Week Was Not as Bad As… posted at Scott, saying, "The article I'm submitting helps put our investing losses in perspective.

Thanks you fo taking the time and energy to host.

-Scott"

savvy saver presents Compushare (formerly EquiServe) posted at Savvy Saver, saying, "Low-cost alternatives to brokerage houses include direct stock purchaing programs and dividend reinvestment programs."

Donna Fielding presents Spam Investment Scams posted at Taking Control Over Money, saying, "This is an article that reports on a New York Times Article on spam stock selling. A study showed that people buy stocks as a result of spam, and, surprise, much of the spam is a scam to artificially inflate the price of the stock and make the spammers rich. I was surprised that people could part with their money that easily, but, apparently, they do."

Abnormal Returns presents Primum non nocere posted at Abnormal Returns, saying, "Financial writers should above all, first do no harm, when providing investment advice to a mass audience. We note one writer who handles this job in a consistent fashion."

ML presents Book review: Ahead of the curve by Joseph H. Ellis posted at Investing the Middle Way, saying, "This is a review of Ahead of the curve, a book on forecasting market and business cycles."

A Samuel presents Talkback Msn Money Low Cost Airlines Part 2 posted at Nubricks.com: A daily shot of off plan property launches & new development news.

Tom Hanna presents The Week Ahead: Your Financial Roadmap for September 25 to September 29, 2006 posted at Financial Options, saying, "An overview of the economic indicators for the upcoming week including a calendar of economic indicators, Treasury auctions and interesting earnings announcements. Updated through the week as indicator results are released."

John Buehler presents Rebuilding Eden - The 3rd Channel » The Selling of America posted at Rebuilding Eden.

Brandon Peele presents Freakonomics Book Review posted at GT.

FMF presents Update on My Three CEOs posted at Free Money Finance, saying, "Three stocks I've purchased and how they are doing."

Jim presents How Much Income Do You Need In Retirement? posted at My Retirement Blog.

Jim presents PFCollege: Start Thinking About Roth IRAs posted at Blueprint for Financial Prosperity.

Abnormal Returns presents 30 minute portfolios posted at Abnormal Returns, saying, "It has never been easier (or cheaper) for an investor to assemble a globally diversified, low cost, indexed portfolio, but for a number of reasons many investors fail to do so."

Bryan C. Fleming presents Counting Cold Hard Cash posted at Bryan C. Fleming .com.

The Dividend Guy presents The Four Important Dates for a Dividend Investor posted at The Dividend Guy Blog.

Jeremie Beaudry presents So Many Companies. So Little Information. posted at eFIPO Finance and Politics for the Younger Generation, saying, "This article offers a breakdown using a simple quiz to find out where you should invest your money, and find some really good individual results. Every investing tactic is unique and this post provides some answers."

fedor presents Leverage is not even a double-edged sword, it?s a guillotine posted at forexblog.

goldguru presents Silver Wheaton - The Best Silver Play in Town posted at goldguru.

Sagar Satapathy presents Hedge Fund Reader : Hedge Funds: Alternative Investment Strategy posted at Hedge Funds: Alternative Investment Strategy

frugal presents Nay to GoldDrivers.Com Newsletter posted at 1stmillionat33, saying, "A negative vote for golddrivers.com"

Super Saver presents It's Time to Lock in CD Rates posted at My Wealth Builder.

Daniel presents Muni Bonds Pay A 7.12% Equivalent Yield? Yes! posted at My Money Path.

Todd presents What does it really take to make money? posted at Aridni

Harrison presents 6 Ideas to know how much rent your should charge for your rental property posted at Journey To Financial Freedom, saying, "6 Ideas to know how much rent your should charge on your tenants"

Kevin Kneupper presents Dysfunctional Financial Personality #8 - The Compulsive Gambler posted at Free the Drones, saying, "A post on the problems it can cause for your retirement portfolio if you tend to be a gambler / risk taker with your investments."

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New Festival of Stocks

The Festival of Stocks #4 was posted today.

Check it out.

-Mike