Investment Portfolio Decisions
We post summaries of portfolio transactions here for the purposes of transparency and education of our investors.
Opinions expressed are those of LOM and our advisors. Views and security holdings are subject to change at any time based on market and other conditions. This section of our website is for informational purposes only and should not be construed as investment advice with respect to the information or securities presented.
Please call us at 295-6999 for more details.
August 2011
Increase Emerging Markets; In-Line with Strategic Target
The Investment Committee has decided to add to the strategy’s position in Emerging Markets, moving the allocation in line with our strategic target. Emerging Markets have been among the worst performing asset classes year-to-date as central banks’ anti-inflation policies slowed GDP growth in several developing economies. While GDP growth has slowed, the component countries within the emerging market index are still expected to grow at an impressive 7-8% annualized rate over the next several years. Given the recent underperformance that has accompanied decreased investor expectations, the risk/reward ratio for investing in these economies has improved, warranting an increased weighting within LOM's Global Equity Fund.
The Investment Committee has decided to add to the strategy’s position in Emerging Markets, moving the allocation in line with our strategic target. Emerging Markets have been among the worst performing asset classes year-to-date as central banks’ anti-inflation policies slowed GDP growth in several developing economies. While GDP growth has slowed, the component countries within the emerging market index are still expected to grow at an impressive 7-8% annualized rate over the next several years. Given the recent underperformance that has accompanied decreased investor expectations, the risk/reward ratio for investing in these economies has improved, warranting an increased weighting within LOM's Global Equity Fund.
Reduce Developed International; Below Strategic Target
The Investment Committee has decided to trim the strategy’s position in International Developed Markets, specifically the WisdomTree DEFA Fund (DWM). During the year, EAFE has held up very well given the sovereign debt turmoil and slowing GDP growth in many developed markets, with the DWM outperforming all domestic equity classes as well as Emerging Markets. The recent short-selling ban in Europe has provided what could prove to be a temporary and artificial floor on many financial stocks in the Euro zone. In addition, we believe the sovereign debt crisis and related austerity measures will continue to create headline risk and have a real negative effect on Europe’s GDP growth profile.
The Investment Committee has decided to trim the strategy’s position in International Developed Markets, specifically the WisdomTree DEFA Fund (DWM). During the year, EAFE has held up very well given the sovereign debt turmoil and slowing GDP growth in many developed markets, with the DWM outperforming all domestic equity classes as well as Emerging Markets. The recent short-selling ban in Europe has provided what could prove to be a temporary and artificial floor on many financial stocks in the Euro zone. In addition, we believe the sovereign debt crisis and related austerity measures will continue to create headline risk and have a real negative effect on Europe’s GDP growth profile.
Purchases / Additions
BlackRock (BLK) August, 2011
The Investment Committee has decided to initiate a position in BlackRock, Inc. in the LOM Equity Fund. BlackRock is the world’s largest investment management company, managing $3.6 trillion for individual and institutional investors across more than 100 countries. Of Blackrock’s totals assets, 44% are managed on behalf of clients domiciled outside the United States. The company’s broad product profile is diversified across Equity (48%), Fixed Income (32%), Money-Market (8%), Multi-Asset (5%), Alternative (3%), and Advisory (4%) investments, with passive equity and fixed income index products accounting for almost 54% of total assets. BlackRock’s conservative investment style emphasizes quality, liquidity, and superior client service through all market cycles.
The Investment Committee has decided to initiate a position in BlackRock, Inc. in the LOM Equity Fund. BlackRock is the world’s largest investment management company, managing $3.6 trillion for individual and institutional investors across more than 100 countries. Of Blackrock’s totals assets, 44% are managed on behalf of clients domiciled outside the United States. The company’s broad product profile is diversified across Equity (48%), Fixed Income (32%), Money-Market (8%), Multi-Asset (5%), Alternative (3%), and Advisory (4%) investments, with passive equity and fixed income index products accounting for almost 54% of total assets. BlackRock’s conservative investment style emphasizes quality, liquidity, and superior client service through all market cycles.
Through its iShares subsidiary, BlackRock is positioned to benefit from the continued growth of ETFs. Over the past decade, demand for ETF’s has grown rapidly as investors turned to them as a low-cost alternative to mutual funds. As of December 31, 2010, there was more than $1 trillion invested in ETFs, reflecting a 32% annual growth rate over the past decade. Despite their torrid growth, ETFs still represent less than 10% of investment assets handled by financial advisors and brokers leaving significant room for further growth.
In an industry where clients are increasingly cost-conscious, BlackRock enjoys economies of scale and is able to keep costs low while still driving margin expansion. The scalability of the business model magnifies the potential for operating leverage to drive outsized returns through strong free cash flows. BlackRock’s scale and comprehensive product offerings also provide protection against changes in investor preference throughout the business cycle. This provides the company with significantly more stable cash flows than competitors, enabling greater visibility and prudent capital planning. BlackRock’s industry-leading dividend payout (3.7% yield) demonstrates management’s confidence in the stability and strength of business model. With a truly international footprint, BlackRock has the scale and reach to participate in global growth with what is often a first-mover advantage in many fast-growing emerging markets. Further, unprecedented global scale affords the company valuable capital market intelligence worldwide.
Based on the strength and stability of the business model, we estimate that BlackRock shares trade at a significant discount to their fair value. In February 2011, the company raised the annual dividend payout almost 40% to $1.1 billion or $5.5 per share. With annual free cash flow set to exceed $3 billion in 2011, we expect this payout to continue rising. While recent volatility and macroeconomic concerns have driven BlackRock shares down with the rest of the market, we see this as an opportunity to own a high-quality company at an extremely attractive price. As the undisputed leader in global asset management, we believe BlackRock will emerge from the current environment stronger and better positioned than before, and long-term investors will be generously rewarded as BlackRock continues returning cash to shareholders through increasing dividends and share buybacks.
CVS Caremark (CVS) August, 2011
CVS Caremark is the largest pharmacy care provider in the United States with integrated offerings across the entire spectrum of pharmacy care. The company operates both the nation’s largest drugstore chain – focused on high-quality service and convenience - and a leading pharmacy benefits manager (PBM). This unique combination provides CVS the opportunity to engage plan members in behaviors that improve their health and to lower overall health care costs for health plans, plan sponsors, and their members. We believe that CVS’s integrated business model offers significant value-added synergies, which provides the company a unique competitive advantage in delivering high quality pharmacy services.
CVS Caremark is the largest pharmacy care provider in the United States with integrated offerings across the entire spectrum of pharmacy care. The company operates both the nation’s largest drugstore chain – focused on high-quality service and convenience - and a leading pharmacy benefits manager (PBM). This unique combination provides CVS the opportunity to engage plan members in behaviors that improve their health and to lower overall health care costs for health plans, plan sponsors, and their members. We believe that CVS’s integrated business model offers significant value-added synergies, which provides the company a unique competitive advantage in delivering high quality pharmacy services.
After CVS’s acquisition of the pharmacy benefit manager Caremark in 2007, the newly combined company struggled to meet their financial targets as CVS’s management team underinvested in the Caremark business and failed to adequately promote the combination to pharmacy benefit clients. We now believe these missteps are behind the company and the current management team, led by CEO Larry Merlow, is up to the task. Caremark has been successful at retaining existing business and has won several high-profile contracts this year, including the Federal Employees Health Benefit Program. We see these recent wins as evidence of CVS’s renewed focus in the lucrative PBM business. CVS is dedicated to capital investment in the PBM business that will allow the company to improve their product offerings and maintain business momentum. As the PBM business improves operationally, we believe investors will refocus on the overall strengths of CVS Caremark, including the company’s best-in-class retail operation. Given these operational strengths and the coming wave of profitable generic drugs, we believe the company can deliver double-digit earnings growth between now at 2015, which should lead to an expansion in the stock’s price-to-earnings multiple. At 13x this year’s estimated earnings and 11.5x next year’s, the company trades at a significant discount to peers such as Walgreen’s, Express Scripts, and Medco. We look forward to improving business fundamentals closing this valuation gap.
Trims / Deletions
Hewlett-Packard (HPQ) August, 2011
The Investment Committee has decided to eliminate the Quality Growth Portfolio’s position in Hewlett-Packard. HP’s PC-centric business is facing secular headwinds and declining average selling prices as substitute technologies and the evolving wireless ecosystem has caused consumers and corporations to delay, and in some cases forego, the purchase of traditional PCs. In addition to the headwinds the business is facing, we also believe the risk exists that Hewlett-Packard pursues a large merger to speed its transition to the software/services mode. Although the valuation is compelling at current levels, we worry that a changing competitive environment has unseated Hewlett-Packard’s once dominant market position. As such, we see risk to the company’s fundamentals in the coming years that do not warrant a position in the portfolio given other more attractive opportunities.
The Investment Committee has decided to eliminate the Quality Growth Portfolio’s position in Hewlett-Packard. HP’s PC-centric business is facing secular headwinds and declining average selling prices as substitute technologies and the evolving wireless ecosystem has caused consumers and corporations to delay, and in some cases forego, the purchase of traditional PCs. In addition to the headwinds the business is facing, we also believe the risk exists that Hewlett-Packard pursues a large merger to speed its transition to the software/services mode. Although the valuation is compelling at current levels, we worry that a changing competitive environment has unseated Hewlett-Packard’s once dominant market position. As such, we see risk to the company’s fundamentals in the coming years that do not warrant a position in the portfolio given other more attractive opportunities.
Accenture (ACV) August, 2011
The Investment Committee has decided to reduce the portfolio’s position in Accenture. Since adding to the stock in July, 2010 it has risen 50%, significantly outpacing the market. Although the company’s fundament outlook remains strong, the Investment Committee believes the stock is fairly valued at current levels. We believe it is prudent portfolio management to realize gains in the position to pursue other opportunities, while maintaining a position in the stock. We remain bullish on ACN shares and believe there is still room for long-term fundamental improvement and earnings growth at the company.
The Investment Committee has decided to reduce the portfolio’s position in Accenture. Since adding to the stock in July, 2010 it has risen 50%, significantly outpacing the market. Although the company’s fundament outlook remains strong, the Investment Committee believes the stock is fairly valued at current levels. We believe it is prudent portfolio management to realize gains in the position to pursue other opportunities, while maintaining a position in the stock. We remain bullish on ACN shares and believe there is still room for long-term fundamental improvement and earnings growth at the company.
Whirlpool (WHR) August, 2011
The Investment Committee has decided to eliminate the portfolio’s position in Whirlpool. We purchased the stock in order to capitalize on what we believed would be two powerful economic themes in 2011: pent up consumer demand in developed markets and the rise of the middle class in emerging markets. We also anticipated that better-than-expected U.S. GDP growth and an improving jobs market would be positive catalysts for stock. Our thesis has not developed as anticipated and demand for household appliances remains anemic. In addition to the lack of consumer demand, Whirlpool’s management has also had to grapple with significant increases in raw material costs and stiff pricing completion, which has further exacerbated a decline in margins in an environment of weak demand. While management believes they will be able to pass through pricing increases during the second half of the year, we are skeptical that the macro environment will allow for such actions. With the time horizon for realizing our original thesis lengthened and an increasingly competitive environment, we believe more attractive investment opportunities exist elsewhere.
The Investment Committee has decided to eliminate the portfolio’s position in Whirlpool. We purchased the stock in order to capitalize on what we believed would be two powerful economic themes in 2011: pent up consumer demand in developed markets and the rise of the middle class in emerging markets. We also anticipated that better-than-expected U.S. GDP growth and an improving jobs market would be positive catalysts for stock. Our thesis has not developed as anticipated and demand for household appliances remains anemic. In addition to the lack of consumer demand, Whirlpool’s management has also had to grapple with significant increases in raw material costs and stiff pricing completion, which has further exacerbated a decline in margins in an environment of weak demand. While management believes they will be able to pass through pricing increases during the second half of the year, we are skeptical that the macro environment will allow for such actions. With the time horizon for realizing our original thesis lengthened and an increasingly competitive environment, we believe more attractive investment opportunities exist elsewhere.
March 14, 2011
LOM Fixed Income Strategy Update
The LOM Fixed Income Fund sold its position of XL this morning based on the unquantifiable liabilities of the Japanese earthquake and subsequent tsunami. We feel this and the $70 to $85 million hit XL announced last week (attributed to the New Zealand earthquake) will create a spread widening and a perceived risk that could create a further deterioration of the credit (i.e. “a self fulfilling prophecy”).
The LOM Fixed Income Fund sold its position of XL this morning based on the unquantifiable liabilities of the Japanese earthquake and subsequent tsunami. We feel this and the $70 to $85 million hit XL announced last week (attributed to the New Zealand earthquake) will create a spread widening and a perceived risk that could create a further deterioration of the credit (i.e. “a self fulfilling prophecy”).
While we still like XL due to its large reserve base and diversified insurance/reinsurance portfolio and believe this will be nothing more than a hit to the 2011 bottom line, we feel that two big disasters in the first three months of the year entails more risk than we are comfortable holding.
February 2011
Purchases / Additions
Apache Corp (APA) February, 2011
The Investment Committee has decided to initiate a position in Apache Corporation in the portfolio. Apache is an independent energy company that explores for, develops, and produces natural gas, crude oil, and natural gas liquids. Apache’s operations are geographically diverse and evenly split between oil and natural gas. No single geographical location represents more than 25% of revenues or 30% of reserves. The company’s North America operations are focused in the Gulf of Mexico, the Gulf Coast, East Texas, the Permian basin, the Anadarko basin, and the Western Sedimentary basin of Canada. Outside of North America, Apache has exploration and production interests in offshore Western Australia, the North Sea, onshore Argentina, and in Egypt.
The Investment Committee has decided to initiate a position in Apache Corporation in the portfolio. Apache is an independent energy company that explores for, develops, and produces natural gas, crude oil, and natural gas liquids. Apache’s operations are geographically diverse and evenly split between oil and natural gas. No single geographical location represents more than 25% of revenues or 30% of reserves. The company’s North America operations are focused in the Gulf of Mexico, the Gulf Coast, East Texas, the Permian basin, the Anadarko basin, and the Western Sedimentary basin of Canada. Outside of North America, Apache has exploration and production interests in offshore Western Australia, the North Sea, onshore Argentina, and in Egypt.
We believe the current geopolitical backdrop is providing an opportunity to initiate a position in this high-quality, well managed company. Unrest in Egypt will almost certainly lead to political changes, but we believe the country will emerge from the current turmoil with a stable government. Apache’s current production agreements with the government, including a 50/50 revenue share, will likely be reviewed by the incoming administration, but significant changes to this agreement are unlikely. The Egyptian State Oil company is ill-equipped to sustain the technological investment needed to maintain current production levels, and it is in Egypt’s best interest to maintain its relationship with Apache.
The company’s stock has traded down since the Egyptian riots began and its valuation has de-coupled from industry peers. Apache now trades at a steep discount to its peers, which we believe is unwarranted, and will ultimately result in Apache stock outperforming as it closes this valuation gap. LOM estimates that Apache’s Egyptian assets, which contribute about 20% of the company’s total revenues and profit, are worth approximately $25 per share. Given these well-defined risk/reward parameters we are very comfortable investing in Apache at this valuation.
Beyond the short-term opportunity provided by the turmoil in Egypt, we believe Apache can provide long-term production growth in excess of the major integrated oil companies through their focused development approach. Apache has a proven history of profitably growing reserves and production volume through both exploration and acquisition. In 2010, the company utilized its strong balance sheet to make several acquisitions, increasing proved reserves by 25%. We believe that once the company is able to apply their development approach to these assets, production levels will increase beyond current expectations, creating long-term value. Given this combination of long-term growth potential and short-term opportunity Apache represents one of the best values within the Energy sector.
Trims / Deletions
ConocoPhillips (COP) February, 2011
The Investment Committee has decided to reduce the portfolio’s position in ConocoPhillips. Since adding to Conoco in November of 2009 the stock has outpaced the S&P 500 and the Energy sector by 16% and 8%, respectively, and we believe it is prudent to realize gains to fund other opportunities. The strength in Conoco’s shares reflect management’s plan to improve its financial position and increase returns on capital through a combination of enhanced capital discipline and portfolio rationalization. To improve their financial position, Conoco has sold close to $10 billion of assets, including a 9% interest in Syncrude Canada, an oil sands venture, and 20% interest in Lukoil, Russia’s large oil company. We remain positive on COP shares, believing there is room for continued fundamental improvement and earnings growth at the company and will continue to maintain a position in the stock.
The Investment Committee has decided to reduce the portfolio’s position in ConocoPhillips. Since adding to Conoco in November of 2009 the stock has outpaced the S&P 500 and the Energy sector by 16% and 8%, respectively, and we believe it is prudent to realize gains to fund other opportunities. The strength in Conoco’s shares reflect management’s plan to improve its financial position and increase returns on capital through a combination of enhanced capital discipline and portfolio rationalization. To improve their financial position, Conoco has sold close to $10 billion of assets, including a 9% interest in Syncrude Canada, an oil sands venture, and 20% interest in Lukoil, Russia’s large oil company. We remain positive on COP shares, believing there is room for continued fundamental improvement and earnings growth at the company and will continue to maintain a position in the stock.
January 2011
Purchases / Additions
Exxon Mobil (XOM) January 2011
The price of oil is near its two-year highs and up 200% from the lows of 2009. We believe that growing demand and a dearth of new supply will continue to put upward pressure on the commodity throughout 2011. Exxon Mobil is likely the least leveraged of the major integrateds to the price of oil, which, along with their acquisition of XTO, is one of the reasons why the stock has lagged peers during the past year (XOM stock is up only 6% during the past twelve months). In the near-term, we believe the stock is poised to make up some of the performance differential of the past year and will be a leader within the sector. Longer-term, we are confident that Exxon Mobil’s capital discipline and management approach will continue to afford them industry leading profitability metrics and returns. Exxon has an incredibly strong balance sheet and the cash flow generating capability to repurchase $20 billion in stock in 2011 (representing 6% of market capitalization). We also anticipate that earnings will increase over 11% in the coming year while the stock trades at just 11x 2011 earnings.
The price of oil is near its two-year highs and up 200% from the lows of 2009. We believe that growing demand and a dearth of new supply will continue to put upward pressure on the commodity throughout 2011. Exxon Mobil is likely the least leveraged of the major integrateds to the price of oil, which, along with their acquisition of XTO, is one of the reasons why the stock has lagged peers during the past year (XOM stock is up only 6% during the past twelve months). In the near-term, we believe the stock is poised to make up some of the performance differential of the past year and will be a leader within the sector. Longer-term, we are confident that Exxon Mobil’s capital discipline and management approach will continue to afford them industry leading profitability metrics and returns. Exxon has an incredibly strong balance sheet and the cash flow generating capability to repurchase $20 billion in stock in 2011 (representing 6% of market capitalization). We also anticipate that earnings will increase over 11% in the coming year while the stock trades at just 11x 2011 earnings.
Johnson Controls (JCI) January 2011
The Investment Committee has decided to add to the Quality Growth portfolio’s position in Johnson Controls, a diversified global leader in the building and automotive industries. The company’s future earnings power looks strong as conditions continue to improve in their Automotive and Building Efficiency segments. Since initially purchasing the stock our economic outlook has improved, the company raised its earnings guidance, and the dividend was increased by 23%. These developments have strengthened our conviction in the position which we believe warrants a heavier weighting in the portfolio. While the stock price has increased since we added JCI to the portfolio, we believe the market value is still very attractive relative to the company’s excellent long-term prospects.
The Investment Committee has decided to add to the Quality Growth portfolio’s position in Johnson Controls, a diversified global leader in the building and automotive industries. The company’s future earnings power looks strong as conditions continue to improve in their Automotive and Building Efficiency segments. Since initially purchasing the stock our economic outlook has improved, the company raised its earnings guidance, and the dividend was increased by 23%. These developments have strengthened our conviction in the position which we believe warrants a heavier weighting in the portfolio. While the stock price has increased since we added JCI to the portfolio, we believe the market value is still very attractive relative to the company’s excellent long-term prospects.
Novartis (NVS) January 2011
Novartis recently announced a deal to purchase the remaining minority stake in Alcon - the world’s largest eye care company - that it did not already own. We view this deal as positive for the company and a catalyst to share price performance. The price paid for Alcon was reasonable and we expect little-to-no near-term negative earnings impact. Longer-term we believe Novartis will be able to extract cost synergies that will provide upside to 2012 and 2013 earnings estimates. In conjunction with closing the deal, Novartis also reinstated their buyback program with the aim of repurchasing $10 billion in stock by the end of 2012. With the purchase of Alcon favorably concluded, we believe that investors will refocus on Novartis’s growth prospects and solid drug pipeline. Novartis maintains the strongest pipeline relative to its patent exposure of any major pharmaceutical company. Notable drugs in development include Gilenia (multiple sclerosis), Ilaris (gout), Afinitor (kidney cancer), Lucentis (diabetic macular edema), Tasigna (leukemia), and a meningitis B vaccine. The company’s only meaningful upcoming patent expiration is for Diavon in 2012. Trading at only 10x 2011 estimated earnings, we believe NVS will reward shareholders in the coming year and believe the stock warrants a larger position in the Quality Growth portfolio.
Novartis recently announced a deal to purchase the remaining minority stake in Alcon - the world’s largest eye care company - that it did not already own. We view this deal as positive for the company and a catalyst to share price performance. The price paid for Alcon was reasonable and we expect little-to-no near-term negative earnings impact. Longer-term we believe Novartis will be able to extract cost synergies that will provide upside to 2012 and 2013 earnings estimates. In conjunction with closing the deal, Novartis also reinstated their buyback program with the aim of repurchasing $10 billion in stock by the end of 2012. With the purchase of Alcon favorably concluded, we believe that investors will refocus on Novartis’s growth prospects and solid drug pipeline. Novartis maintains the strongest pipeline relative to its patent exposure of any major pharmaceutical company. Notable drugs in development include Gilenia (multiple sclerosis), Ilaris (gout), Afinitor (kidney cancer), Lucentis (diabetic macular edema), Tasigna (leukemia), and a meningitis B vaccine. The company’s only meaningful upcoming patent expiration is for Diavon in 2012. Trading at only 10x 2011 estimated earnings, we believe NVS will reward shareholders in the coming year and believe the stock warrants a larger position in the Quality Growth portfolio.
Trims / Deletions
Caterpillar (CAT) January, 2011
The Investment Committee has decided to reduce the Quality Growth portfolio’s position in Caterpillar. Since purchasing CAT in the summer of 2009 the stock has risen an impressive 150% and we believe it is prudent portfolio management to realize gains in the position. The strength in CAT shares reflects the company's exposure to the global economic rebound and the company’s market dominance in construction and mining equipment. We continue to remain bullish on CAT shares and believe there is still room for fundamental improvement and earnings growth at the company, which is why we will continue to maintain a position in the stock.
The Investment Committee has decided to reduce the Quality Growth portfolio’s position in Caterpillar. Since purchasing CAT in the summer of 2009 the stock has risen an impressive 150% and we believe it is prudent portfolio management to realize gains in the position. The strength in CAT shares reflects the company's exposure to the global economic rebound and the company’s market dominance in construction and mining equipment. We continue to remain bullish on CAT shares and believe there is still room for fundamental improvement and earnings growth at the company, which is why we will continue to maintain a position in the stock.
Union Pacific (UNP) January, 2011
The Investment Committee has decided to reduce the Quality Growth portfolio’s position in UNP. The stock has almost doubled since our initial purchase in the spring of 2009. While we believe there are several long-term trends in place that will continue to benefit rails – increased pricing power, higher energy prices, improved business efficiencies, international trade – we also believe it is prudent to realize gains in the position on the heels of such impressive returns. UNP will remain in the portfolio, albeit at a lower weight, as long as the company’s valuation remains reasonable and our outlook for economic expansion remains intact.
The Investment Committee has decided to reduce the Quality Growth portfolio’s position in UNP. The stock has almost doubled since our initial purchase in the spring of 2009. While we believe there are several long-term trends in place that will continue to benefit rails – increased pricing power, higher energy prices, improved business efficiencies, international trade – we also believe it is prudent to realize gains in the position on the heels of such impressive returns. UNP will remain in the portfolio, albeit at a lower weight, as long as the company’s valuation remains reasonable and our outlook for economic expansion remains intact.
Fourth Quarter 2010
Purchases / Additions
JPMorgan Chase (JPM), December 2010
The Investment Committee has decided to add to the Quality Growth’s existing position in JPMorgan Chase. We remain confident in our original thesis for JPM and the stock favors long-term investors. The company’s future earnings power looks strong with improving conditions in their Credit Card, Investment Banking, Mortgage, and Commercial Banking segments. The Company continues to maintain a "Fortress Balance Sheet," with strong capital ratios and strong credit ratings. Since purchasing the stock our outlook for the economy has improved, as we have received additional clarity on Basel III, the mortgage foreclosure issue, and credit quality. We continue to believe the company’s strong balance sheet will provide the wherewithal to increase dividends and also repurchase shares in the New Year. Despite these positive developments, shares have remained flat and still provide an excellent entry point for long-term investors.
The Investment Committee has decided to add to the Quality Growth’s existing position in JPMorgan Chase. We remain confident in our original thesis for JPM and the stock favors long-term investors. The company’s future earnings power looks strong with improving conditions in their Credit Card, Investment Banking, Mortgage, and Commercial Banking segments. The Company continues to maintain a "Fortress Balance Sheet," with strong capital ratios and strong credit ratings. Since purchasing the stock our outlook for the economy has improved, as we have received additional clarity on Basel III, the mortgage foreclosure issue, and credit quality. We continue to believe the company’s strong balance sheet will provide the wherewithal to increase dividends and also repurchase shares in the New Year. Despite these positive developments, shares have remained flat and still provide an excellent entry point for long-term investors.
Whirlpool (WHR) December, 2010
The Investment Committee has decided to initiate a position in Whirlpool Corp, the world’s leading appliance company. Whirlpool operates in more than 130 countries and nearly half of total sales come from outside the United States. The Company’s strong portfolio of brands includes Whirlpool, Maytag, Kitchen Aid, Brastemp, Embraco, and Consul - all with annual sales over $1 billion. With nearly 70% of international revenue derived from Emerging Markets, Whirlpool has a strong, growing, and profitable presence in the developing world.
The Investment Committee has decided to initiate a position in Whirlpool Corp, the world’s leading appliance company. Whirlpool operates in more than 130 countries and nearly half of total sales come from outside the United States. The Company’s strong portfolio of brands includes Whirlpool, Maytag, Kitchen Aid, Brastemp, Embraco, and Consul - all with annual sales over $1 billion. With nearly 70% of international revenue derived from Emerging Markets, Whirlpool has a strong, growing, and profitable presence in the developing world.
Whirlpool is in an excellent position to capitalize on two powerful economic themes: pent up demand for consumer durables and appliances in developed markets and the rise of the middle class in emerging markets. In the United States, we believe that there is growing pent up demand for new housing and renovations. We expect that better-than-expected US GDP growth in 2011 will provide a near-term catalyst to move WHR’s shares higher. Housing prices have also stabilized and we believe employment gains will materialize in 2011, which should lead to a modest improvement in housing turnover and spur demand for Whirlpool’s products. In addition, housing starts are currently well below the long-term average and the rate needed to meet the demands of a growing population. A return to historical levels will create a tailwind of demand for Whirlpool’s household appliances. The company’s strongest prospects for growth remain in emerging markets such as Brazil, India, and China, where a rapidly growing middle class is increasingly demanding high quality household appliances. Whirlpool’s dominant position in these markets, with large and efficient local production will allow the company to fully benefit from these trends.
We believe analyst consensus expectations for the company are far too low. Management recently outlined long-term goals which were significantly above analysts’ expectations, including projected 2014 EPS of $15 versus Street expectations of only $12.15. Trading at only eight times projected 2010 EPS of $9.81 and our view that Whirlpool is well positioned for growth, we believe this is an excellent opportunity.
Trims / Deletions
Best Buy (BBY), December, 2010
The Investment Committee has decided to eliminate the portfolio’s position in Best Buy Co. We purchased the stock to take advantage of a strengthening consumer, a strong holiday shopping season, and the rapid adoption of mobile computing. Our thesis was bolstered following the company’s increase in sales and earnings guidance in September, following a strong back-to-school season. Best Buy subsequently missed earnings expectations substantially and lowered guidance for the rest of the year, citing market share losses to competitors in an increasingly competitive landscape. Best Buy was able to maintain healthy levels of margins, but in doing so sacrificed a great deal of sales growth as consumers moved their purchases to on-line and discount retailers. Recent missteps have called into question Best Buy management’s judgment and credibility, and we believe the trends affecting the retailer will likely persist for the foreseeable future. Accordingly, we see more attractive investment opportunities elsewhere.
The Investment Committee has decided to eliminate the portfolio’s position in Best Buy Co. We purchased the stock to take advantage of a strengthening consumer, a strong holiday shopping season, and the rapid adoption of mobile computing. Our thesis was bolstered following the company’s increase in sales and earnings guidance in September, following a strong back-to-school season. Best Buy subsequently missed earnings expectations substantially and lowered guidance for the rest of the year, citing market share losses to competitors in an increasingly competitive landscape. Best Buy was able to maintain healthy levels of margins, but in doing so sacrificed a great deal of sales growth as consumers moved their purchases to on-line and discount retailers. Recent missteps have called into question Best Buy management’s judgment and credibility, and we believe the trends affecting the retailer will likely persist for the foreseeable future. Accordingly, we see more attractive investment opportunities elsewhere.
Microsoft (MSFT), December, 2010
The Investment Committee has decided to trim the Quality Growth portfolio’s position in Microsoft. While we believe the fundamental arguments for owning Microsoft are still intact, as the largest position in the portfolio we believe it is an appropriate source of funds for other opportunities. Microsoft has shown strong performance recently due to positive news on their new gaming system (Kinect) and cloud computing platform (Azure). The funds raised by trimming this position will be invested in holdings we expect will more directly benefit from our forecasted US economic recovery and continued expansion of the emerging market middle class.
The Investment Committee has decided to trim the Quality Growth portfolio’s position in Microsoft. While we believe the fundamental arguments for owning Microsoft are still intact, as the largest position in the portfolio we believe it is an appropriate source of funds for other opportunities. Microsoft has shown strong performance recently due to positive news on their new gaming system (Kinect) and cloud computing platform (Azure). The funds raised by trimming this position will be invested in holdings we expect will more directly benefit from our forecasted US economic recovery and continued expansion of the emerging market middle class.
October, 2010
Purchases / Additions
Johnson Controls, Inc. (JCI)
Johnson Controls is a diversified global enterprise in the building and automotive industries. JCI serves these markets through three distinct business segments, each with excellent growth prospects. With over $12.5 billion in annual sales, the Building Efficiency group provides heating, ventilating, and air conditioning (HVAC) products, controls, and security systems. The Automotive segment ($12 billion) is a global leader in high-quality automotive seating, overhead systems, door and instrument panels, and interior electronics. The Power Solutions business ($4 billion) is the global leader in automotive lead-acid, hybrid, and electric batteries. With 76% of battery sales coming through the replacement market, this business is insulated from the cyclicality of new vehicle sales.
Johnson Controls is a diversified global enterprise in the building and automotive industries. JCI serves these markets through three distinct business segments, each with excellent growth prospects. With over $12.5 billion in annual sales, the Building Efficiency group provides heating, ventilating, and air conditioning (HVAC) products, controls, and security systems. The Automotive segment ($12 billion) is a global leader in high-quality automotive seating, overhead systems, door and instrument panels, and interior electronics. The Power Solutions business ($4 billion) is the global leader in automotive lead-acid, hybrid, and electric batteries. With 76% of battery sales coming through the replacement market, this business is insulated from the cyclicality of new vehicle sales.
The Investment Committee believes JCI’s businesses will post solid gains in sales and earnings as the company capitalizes on several secular growth trends. Building Efficiency, which is JCI’s fastest growing and most profitable segment, will continue to benefit from global infrastructure spending and additional opportunities stemming from the company’s acquisition of York. The company’s products reduce energy costs through increased efficiencies and will therefore benefit from “green projects” and government stimulus spending in the U.S. Management expects to win $2 billion - $3 billion of projects through 2012 directly attributable to the American Reinvestment and Recovery Act. We also believe there is an extraordinary level of pent-up consumer demand for automobiles. On a per capita basis U.S. light-vehicle sales last year were the lowest since 1950. A return to historical levels of vehicle sales suggests an impending surge in demand for the company’s automotive interiors. We believe it is inevitable that the replacement cycle will take hold, affording a significant tailwind to earnings.
Best Buy (BBY)
Best Buy is a multinational retailer of technology and entertainment products and services with a commitment to growth and innovation. The company generates more than $49 billion in annual revenue and has operations in the United States, Canada, Europe, China, Mexico and Turkey. Domestic Best Buy stores offer multiple categories of electronics and appliances to customers, while its international stores – which account for approximately 25% of revenue – focus mainly on mobile phone sales and subscription services. Profits are growing rapidly as the company’s “Connected World Initiative” drives increased sales and margin expansion.
Best Buy is a multinational retailer of technology and entertainment products and services with a commitment to growth and innovation. The company generates more than $49 billion in annual revenue and has operations in the United States, Canada, Europe, China, Mexico and Turkey. Domestic Best Buy stores offer multiple categories of electronics and appliances to customers, while its international stores – which account for approximately 25% of revenue – focus mainly on mobile phone sales and subscription services. Profits are growing rapidly as the company’s “Connected World Initiative” drives increased sales and margin expansion.
The Investment Committee believes the company’s prospects are underappreciated and that the company is poised to exceed expectations during the coming holiday season. At only 11.5x this fiscal year’s earnings, the market is discounting the company’s ability to grow. We believe several opportunities for growth exist, most notably in their International operations, but also domestically where a focus on driving wireless market share will likely pay off in higher margins and improved profitability. Best Buy commands only 5% market share in wireless, but aims to increase it through its expansion of smaller-format Best Buy Mobile stores. Best Buy is also focused on maximizing profitability and maximizing shareholder return through its prudent use of cash. The company recently raised its dividend by 7%, and during the past three years has reduced its share count by 14% through stock buybacks. As economic conditions continue to improve worldwide, we believe Best Buy will be a beneficiary of improved consumer confidence and will be able to achieve our double-digit earnings growth target.
Trims / Deletions
Automatic Data Processing (ADP)
The Investment Committee has decided to eliminate Automatic Data Processing from the Quality Growth Portfolio as organic growth in earnings will likely remain elusive. Stubbornly low U.S. employment growth, a prolonged low-interest rate environment, and lack of international exposure are all significant headwinds for the company. Although the economy is improving, unemployment will likely remain high for an extended period of time and the Fed is dedicated to its zero-rate policy for the foreseeable future, making it difficult for the stock to outperform. ADP still offers investors high current income through its generous dividend, but its relatively lackluster estimated earnings growth precludes its continued inclusion in the Quality Growth Portfolio.
The Investment Committee has decided to eliminate Automatic Data Processing from the Quality Growth Portfolio as organic growth in earnings will likely remain elusive. Stubbornly low U.S. employment growth, a prolonged low-interest rate environment, and lack of international exposure are all significant headwinds for the company. Although the economy is improving, unemployment will likely remain high for an extended period of time and the Fed is dedicated to its zero-rate policy for the foreseeable future, making it difficult for the stock to outperform. ADP still offers investors high current income through its generous dividend, but its relatively lackluster estimated earnings growth precludes its continued inclusion in the Quality Growth Portfolio.
Bank of New York Mellon (BK)
The Investment Committee has decided to eliminate Bank of New York Mellon from the Quality Growth Portfolio. Low interest rates, below-average trading volume, and tight spreads continue to hamper the company’s ability to deliver on its growth prospects. The transaction allows LOM to reposition the portfolio into companies with more attractive growth prospects and better risk/reward profiles given our current economic outlook.
The Investment Committee has decided to eliminate Bank of New York Mellon from the Quality Growth Portfolio. Low interest rates, below-average trading volume, and tight spreads continue to hamper the company’s ability to deliver on its growth prospects. The transaction allows LOM to reposition the portfolio into companies with more attractive growth prospects and better risk/reward profiles given our current economic outlook.
September, 2010
Purchases / Additions
International Business Machines (IBM)
The Investment Committee has decided to add to the Quality Growth portfolio’s position in International Business Machines. We continue to believe the stock is dramatically undervalued - IBM offers stability and strong earnings visibility while trading at just 10 times 2011 earnings. During the past decade, the company has divested low-margin, commoditized businesses such as personal computers, and strengthened their position in software and services through strategic investments in more than 100 companies. With roughly 65% of revenues generated outside the U.S., IBM is well diversified globally and will continue to benefit from the synchronized global economic recovery currently underway. IBM’s transformation to a services-oriented company should allow it to continue to grow earnings at a double-digit pace as the company continues to shift its revenue mix toward high-margin services and software.
The Investment Committee has decided to add to the Quality Growth portfolio’s position in International Business Machines. We continue to believe the stock is dramatically undervalued - IBM offers stability and strong earnings visibility while trading at just 10 times 2011 earnings. During the past decade, the company has divested low-margin, commoditized businesses such as personal computers, and strengthened their position in software and services through strategic investments in more than 100 companies. With roughly 65% of revenues generated outside the U.S., IBM is well diversified globally and will continue to benefit from the synchronized global economic recovery currently underway. IBM’s transformation to a services-oriented company should allow it to continue to grow earnings at a double-digit pace as the company continues to shift its revenue mix toward high-margin services and software.
Hewlett –Packard (HPQ)
The Investment Committee has decided to add to the Quality Growth portfolio’s position in Hewlett-Packard. In recent years, HPQ has undergone a powerful transformation from a hardware company selling PCs and printers to a diversified leader in information technology products and services. Representing HPQ’s largest segment, services constitute almost 35% of sales, ahead of PCs (30%) and printers (20%). HPQ can now deliver bundled - software, services, and hardware - product solutions to its clients, reducing its exposure to stand-alone hardware, which has grown increasingly commoditized.
The Investment Committee has decided to add to the Quality Growth portfolio’s position in Hewlett-Packard. In recent years, HPQ has undergone a powerful transformation from a hardware company selling PCs and printers to a diversified leader in information technology products and services. Representing HPQ’s largest segment, services constitute almost 35% of sales, ahead of PCs (30%) and printers (20%). HPQ can now deliver bundled - software, services, and hardware - product solutions to its clients, reducing its exposure to stand-alone hardware, which has grown increasingly commoditized.
Recently, HPQ’s shares have come under pressure for a number of reasons. A seasonal softness in demand, the abrupt exit of Mark Hurd, and the firm’s bidding war to acquire the storage solutions firm 3Par, have worried investors. However, we believe that these concerns will prove transitory, providing a compelling buying opportunity. While news flow related to the potential acquisition of 3Par and the replacement of Mark Hurd may continue to be an overhang in the short run, the business remains strong, generating almost $10 billion in free cash flow each year.
Trims / Deletions
Medtronic Inc. (MDT)
The Investment Committee has decided to eliminate its position in Medtronic Inc. from the Quality Growth Portfolio. Medtronic’s most recent quarter highlighted the many headwinds plaguing the stock. A significant decrease in physician office visits, in-hospital admissions, and elective procedures has pressured revenue growth and forced company management to decrease forecasts below our already low expectations. Medtronic’s second largest division, Spinal, continues to weigh on the company’s results due to a number of concerns, including competitive issues, an FDA warning regarding off-label usage of their InFuse product, and disappointing results from their Kyphon acquisition. Hospital budget pressures and increased skepticism concerning the benefits of spine surgery have only magnified worries, resulting in lower procedure volumes and a significant increase in pricing pressure. In short, these changes have accelerated an underlying structural change in investor perceptions and prospects for the company.
The Investment Committee has decided to eliminate its position in Medtronic Inc. from the Quality Growth Portfolio. Medtronic’s most recent quarter highlighted the many headwinds plaguing the stock. A significant decrease in physician office visits, in-hospital admissions, and elective procedures has pressured revenue growth and forced company management to decrease forecasts below our already low expectations. Medtronic’s second largest division, Spinal, continues to weigh on the company’s results due to a number of concerns, including competitive issues, an FDA warning regarding off-label usage of their InFuse product, and disappointing results from their Kyphon acquisition. Hospital budget pressures and increased skepticism concerning the benefits of spine surgery have only magnified worries, resulting in lower procedure volumes and a significant increase in pricing pressure. In short, these changes have accelerated an underlying structural change in investor perceptions and prospects for the company.
July, 2010
Purchases / Additions
Teva Pharmaceutical Industries (TEVA)
The Investment Committee has decided to initiate a position in Teva Pharmaceuticals, the worldwide leader in generic pharmaceuticals. Headquartered in Israel, Teva derives approximately 80% of its sales from the United States and Europe. The company has 35,000 employees and production facilities in Israel, North America, Europe, and Latin America.
The Investment Committee has decided to initiate a position in Teva Pharmaceuticals, the worldwide leader in generic pharmaceuticals. Headquartered in Israel, Teva derives approximately 80% of its sales from the United States and Europe. The company has 35,000 employees and production facilities in Israel, North America, Europe, and Latin America.
The company is in an excellent position to capitalize on the huge number of patent expirations over the next few years. The industry currently faces $39 billion in patent expirations in 2011 (Lipitor, Plavix, and Levaquin, among others), $34 billion in 2012 (Singulair, Lexapro, and Viagra), and $17 billion in 2013 (Cymbalta, Aciphex, and Niaspan). Teva also has a branded drug portfolio, most notably Copaxone, a highly successful Multiple Schlerosis drug that has a very attractive efficacy and safety profile. Although Copaxone currently represents 17% of Teva’s sales and 33% of its profit, this contribution should be drastically reduced over the next several years as new products are introduced.
Health care cost containment has been a major global issue for several years now, and will likely be an area of continued focus for years to come. This will likely drive increased adoption of generic drugs, and Teva is in an excellent position to benefit from this trend. Teva’s earnings should grow in excess of 20% over the next three years, with growth slowing subsequently from those lofty levels. We believe the stock, at approximately 12.0 times 2010 earnings, offers a compelling value given the company’s excellent growth prospects.
Accenture (ACN)
The Investment Committee has decided to add to the Quality Growth Portfolio’s position in Accenture. On the back of a strong earnings report and trading at just 13.5x their normalized 2010 full-year operating earnings, Accenture represents a very compelling opportunity. Accenture’s superior market position in consulting, systems integration, and outsourcing should enable it to achieve sustainable long-term earnings growth. Accenture recently reiterated its positive revenue growth outlook of 5%-9% for their fiscal fourth quarter and 7%-10% for next fiscal year. Accenture’s fiscal third-quarter earnings beat, bullish management commentary, and strong outlook should help to refocus attention on the company’s improving fundamental story, providing the catalyst for share price outperformance.
The Investment Committee has decided to add to the Quality Growth Portfolio’s position in Accenture. On the back of a strong earnings report and trading at just 13.5x their normalized 2010 full-year operating earnings, Accenture represents a very compelling opportunity. Accenture’s superior market position in consulting, systems integration, and outsourcing should enable it to achieve sustainable long-term earnings growth. Accenture recently reiterated its positive revenue growth outlook of 5%-9% for their fiscal fourth quarter and 7%-10% for next fiscal year. Accenture’s fiscal third-quarter earnings beat, bullish management commentary, and strong outlook should help to refocus attention on the company’s improving fundamental story, providing the catalyst for share price outperformance.
Trims / Deletions
Lockheed Martin (LMT)
The Investment Committee has decided to eliminate its position in Lockheed Martin from the Quality Growth Portfolio, primarily to make room for better growth opportunities. We believe Lockheed has good growth prospects over the next five years as the F-35 enters commercial production, but the profitability associated with the F-35 will likely be low in the early stages of the program. In addition, although manageable, there is added risk of future defense budget cutbacks as Washington begins to focus on deficit reduction. The stock still offers investors high current income through its generous dividend, but its relatively lackluster near-term estimated earnings growth precludes its continued inclusion in the Quality Growth Portfolio.
The Investment Committee has decided to eliminate its position in Lockheed Martin from the Quality Growth Portfolio, primarily to make room for better growth opportunities. We believe Lockheed has good growth prospects over the next five years as the F-35 enters commercial production, but the profitability associated with the F-35 will likely be low in the early stages of the program. In addition, although manageable, there is added risk of future defense budget cutbacks as Washington begins to focus on deficit reduction. The stock still offers investors high current income through its generous dividend, but its relatively lackluster near-term estimated earnings growth precludes its continued inclusion in the Quality Growth Portfolio.
Becton Dickinson (BDX)
The Investment Committee has decided to trim the Quality Growth Portfolio’s position in Becton Dickinson. While BDX remains a core holding in the portfolio, this transaction allows for the addition of Teva and increases the portfolio’s exposure to the fast-growing generic drug market. Not only does the pharmaceutical industry face $90 billion in patent expirations between 2011 and 2013, but political pressures on health care cost containment will likely benefit Teva for the foreseeable future.
The Investment Committee has decided to trim the Quality Growth Portfolio’s position in Becton Dickinson. While BDX remains a core holding in the portfolio, this transaction allows for the addition of Teva and increases the portfolio’s exposure to the fast-growing generic drug market. Not only does the pharmaceutical industry face $90 billion in patent expirations between 2011 and 2013, but political pressures on health care cost containment will likely benefit Teva for the foreseeable future.
Johnson & Johnson (JNJ)
The Investment Committee has decided to trim the Quality Growth Portfolio’s position in Johnson & Johnson. While JNJ remains a core holding in the portfolio, this transaction allows for the addition of Teva and increases the portfolio’s exposure to the fast-growing generic drug market. Not only does the pharmaceutical industry face $90 billion in patent expirations between 2011 and 2013, but political pressures on health care cost containment will likely benefit Teva for the foreseeable future.
The Investment Committee has decided to trim the Quality Growth Portfolio’s position in Johnson & Johnson. While JNJ remains a core holding in the portfolio, this transaction allows for the addition of Teva and increases the portfolio’s exposure to the fast-growing generic drug market. Not only does the pharmaceutical industry face $90 billion in patent expirations between 2011 and 2013, but political pressures on health care cost containment will likely benefit Teva for the foreseeable future.
Allocation Update
Reduce Small Cap; In-line with Strategic Target.
Historically, small-cap stocks have outperformed large caps during the initial stages of an economic recovery. Consistent with this pattern, the S&P 600 has outperformed the S&P 500 by more than 20 percentage points since the market bottom in March 2009. As the U.S. expansion moderates during the second half of the year we expect a rotation in market leadership away from small-cap stocks. With a normalized price-to-earnings ratio of approximately 20, we also believe the small-cap sector of the market is fully valued. We will continue to maintain a neutral strategic weighting in the sector.
Historically, small-cap stocks have outperformed large caps during the initial stages of an economic recovery. Consistent with this pattern, the S&P 600 has outperformed the S&P 500 by more than 20 percentage points since the market bottom in March 2009. As the U.S. expansion moderates during the second half of the year we expect a rotation in market leadership away from small-cap stocks. With a normalized price-to-earnings ratio of approximately 20, we also believe the small-cap sector of the market is fully valued. We will continue to maintain a neutral strategic weighting in the sector.
Increase Emerging Markets; Remain Underweight Strategic Target
Emerging markets continue to drive global GDP higher as the economies of South America and the Pacific Rim grow at a rapid pace. China, Brazil, and India have averaged 10% GDP growth over the past twelve months, slightly below their decade-long average of 12%. Many investors are worried that these spectacular growth rates will slow, especially given the Chinese government’s recent moves to slow growth. We agree that these economies will slow, but to a still impressive 8% annualized rate over the next several years. We believe that Chinese policies are prudent insofar as they can prevent their economy from overheating. As investor expectations for future growth have declined, the risk/reward ratio for investing in these economies has improved, warranting an increased weighting within the Quality Global Strategy.
Emerging markets continue to drive global GDP higher as the economies of South America and the Pacific Rim grow at a rapid pace. China, Brazil, and India have averaged 10% GDP growth over the past twelve months, slightly below their decade-long average of 12%. Many investors are worried that these spectacular growth rates will slow, especially given the Chinese government’s recent moves to slow growth. We agree that these economies will slow, but to a still impressive 8% annualized rate over the next several years. We believe that Chinese policies are prudent insofar as they can prevent their economy from overheating. As investor expectations for future growth have declined, the risk/reward ratio for investing in these economies has improved, warranting an increased weighting within the Quality Global Strategy.
May, 2010
Purchases / Additions
Bank of New York Mellon (BK)
The Investment Committee has decided to add to the portfolio’s position in Bank of New York Mellon. BK continues to win asset-servicing mandates and attract inflows to its asset management funds, but earnings growth has been subdued due to low interest rates, tight trading spreads, and lower volumes and volatility. Below average earnings growth during the past year has capped share price gains, leading the stock to significantly underperform during the past year. We believe earnings growth is poised to reaccelerate as the company benefits from recent restructuring and operational efficiencies and short-term interest rates rise from their exceptionally low levels. BK has estimated that a one-point rise in short rates will boost profits by thirty cents a share. BK shares are attractive by historical measures - the stock has traded at a premium to the S&P 500 in the past, but now trades at a slight discount (13x the 2010 consensus EPS estimate versus 15x for the S&P 500). The stock’s attractive valuation and potential for double-digit earnings growth creates an excellent opportunity and warrants a higher weighting within the portfolio.
The Investment Committee has decided to add to the portfolio’s position in Bank of New York Mellon. BK continues to win asset-servicing mandates and attract inflows to its asset management funds, but earnings growth has been subdued due to low interest rates, tight trading spreads, and lower volumes and volatility. Below average earnings growth during the past year has capped share price gains, leading the stock to significantly underperform during the past year. We believe earnings growth is poised to reaccelerate as the company benefits from recent restructuring and operational efficiencies and short-term interest rates rise from their exceptionally low levels. BK has estimated that a one-point rise in short rates will boost profits by thirty cents a share. BK shares are attractive by historical measures - the stock has traded at a premium to the S&P 500 in the past, but now trades at a slight discount (13x the 2010 consensus EPS estimate versus 15x for the S&P 500). The stock’s attractive valuation and potential for double-digit earnings growth creates an excellent opportunity and warrants a higher weighting within the portfolio.
JPMorgan Chase (JPM)
The Investment Committee has initiated a position in JPMorgan Chase in the equity portfolios. JPMorgan Chase’s businesses include U.S. consumer and commercial banking, which continue to be operated under the Chase brand, while asset management, investment banking, and affiliated services are delivered to clients worldwide under the J. P. Morgan brand. Approximately 55% of the company’s revenues are derived from retail, commercial, and credit card services. Twenty-five percent of revenues are derived from investment banking, with the remainder coming from asset management, treasury, and other services. Led by highly regarded and straight-talking CEO Jamie Dimon, the company has successfully navigated the financial crisis and has emerged as one the best capitalized and preeminent banks in the nation. Management’s focus on maintaining a "Fortress Balance Sheet," with strong capital ratios and strong credit ratings, has meant they are willing to sacrifice short-term growth for long-term opportunity. We believe this approach is indicative of a high-quality company and management team.
The Investment Committee has initiated a position in JPMorgan Chase in the equity portfolios. JPMorgan Chase’s businesses include U.S. consumer and commercial banking, which continue to be operated under the Chase brand, while asset management, investment banking, and affiliated services are delivered to clients worldwide under the J. P. Morgan brand. Approximately 55% of the company’s revenues are derived from retail, commercial, and credit card services. Twenty-five percent of revenues are derived from investment banking, with the remainder coming from asset management, treasury, and other services. Led by highly regarded and straight-talking CEO Jamie Dimon, the company has successfully navigated the financial crisis and has emerged as one the best capitalized and preeminent banks in the nation. Management’s focus on maintaining a "Fortress Balance Sheet," with strong capital ratios and strong credit ratings, has meant they are willing to sacrifice short-term growth for long-term opportunity. We believe this approach is indicative of a high-quality company and management team.
From a position of strength, we believe JPMorgan Chase is poised to grow its market position, earnings, and dividends at an exceptional pace as the economy expands during the next several years. After earning $2.24 in 2009, we believe earnings will quickly accelerate in the coming years - with an earnings potential approaching $6.00 by 2012. In order to maintain their capital strength, the company was forced to slash its dividend in early 2009, but based on management’s statements and our analysis of the company’s earnings power we expect a sizable dividend increase by year-end. These extremely positive factors are currently being overshadowed by near-term political risks. While the possibility exists for draconian measures guised as financial regulation to come out of Washington, we do not believe the ultimate legislation will have a material long-term impact on Morgan’s businesses and earnings power. Accordingly, we believe the risk/reward profile favors long-term investors focused on the future earnings power of the company.
Trims / Deletions
AFLAC (AFL)
The Investment Committee has decided to eliminate the position in Aflac in our equity portfolios. The stock has significantly outperformed the market over the past year, led by improving business fundamentals. At the same time, however, the stock's risk profile has increased given the company's exposure to European credit, which constitutes a significant portion of Aflac's asset base. At current price levels, we believe investors are not likely being compensated adequately for this balance sheet risk. In addition, while Japanese and U.S. operations remain strong, the company faces increasing competition as deregulation in Japan has allowed large life insurance companies to compete directly with Aflac.
The Investment Committee has decided to eliminate the position in Aflac in our equity portfolios. The stock has significantly outperformed the market over the past year, led by improving business fundamentals. At the same time, however, the stock's risk profile has increased given the company's exposure to European credit, which constitutes a significant portion of Aflac's asset base. At current price levels, we believe investors are not likely being compensated adequately for this balance sheet risk. In addition, while Japanese and U.S. operations remain strong, the company faces increasing competition as deregulation in Japan has allowed large life insurance companies to compete directly with Aflac.
April, 2010
Purchases / Additions
Chevron Corporation (CVX)
The Investment Committee has decided to add to its position in Chevron Corporation (CVX). Chevron has one of the most attractive portfolios of development projects, and the best profile for future production growth among the major integrated oil companies. Their portfolio of investment opportunities is strong with 37 new projects in promising areas such as Australia, Angola, and the Gulf of Mexico. CVX has a healthy financial position that offers a great deal of flexibility. They are expected to earn around $18 billion of free cash flow from 2010 through 2012, likely leading to higher dividends, share repurchases, and other investments in growth opportunities. Trading at approximately 8.4x normalized EPS with a dividend yield of 3.3%, Chevron remains the least expensive of the US majors and one of the best values within the integrated sector.
The Investment Committee has decided to add to its position in Chevron Corporation (CVX). Chevron has one of the most attractive portfolios of development projects, and the best profile for future production growth among the major integrated oil companies. Their portfolio of investment opportunities is strong with 37 new projects in promising areas such as Australia, Angola, and the Gulf of Mexico. CVX has a healthy financial position that offers a great deal of flexibility. They are expected to earn around $18 billion of free cash flow from 2010 through 2012, likely leading to higher dividends, share repurchases, and other investments in growth opportunities. Trading at approximately 8.4x normalized EPS with a dividend yield of 3.3%, Chevron remains the least expensive of the US majors and one of the best values within the integrated sector.
International Business Machines (IBM)
The Investment Committee has decided to add to our existing position in International Business Machines. During the past decade, the company has divested low-margin, commoditized businesses such as personal computers, and strengthened their position in software and services through strategic investments in more than 100 companies. With roughly 65% of revenues generated outside the U.S., IBM is well diversified globally and will continue to benefit from the synchronized global economic recovery currently underway. IBM's transformation to a services-oriented company should allow them to continue to grow earnings at a double-digit pace as they continue to shift their revenue mix toward high-margin services and software. Consulting services bookings grew 18% year over year, which we believe signals improving IT spending trends and reinforces our outlook for the industry. First-quarter results solidly beat expectations, and while management raised guidance, we believe earnings estimates are still conservative. In addition to the positive quarter, management also announced an $8 billion share repurchase program and an 18% dividend increase.
The Investment Committee has decided to add to our existing position in International Business Machines. During the past decade, the company has divested low-margin, commoditized businesses such as personal computers, and strengthened their position in software and services through strategic investments in more than 100 companies. With roughly 65% of revenues generated outside the U.S., IBM is well diversified globally and will continue to benefit from the synchronized global economic recovery currently underway. IBM's transformation to a services-oriented company should allow them to continue to grow earnings at a double-digit pace as they continue to shift their revenue mix toward high-margin services and software. Consulting services bookings grew 18% year over year, which we believe signals improving IT spending trends and reinforces our outlook for the industry. First-quarter results solidly beat expectations, and while management raised guidance, we believe earnings estimates are still conservative. In addition to the positive quarter, management also announced an $8 billion share repurchase program and an 18% dividend increase.
Trims / Deletions
Goldman Sachs (GS)
The Investment Committee has decided to sell Goldman Sachs out of the Quality Growth portfolio. Although we continue to consider Goldman Sachs a high quality company with excellent growth prospects and an attractive valuation, the recent civil action against the firm - as well as the possibility of regulatory overreach within the financial industry - has resulted in an increased risk profile for the stock.
The Investment Committee has decided to sell Goldman Sachs out of the Quality Growth portfolio. Although we continue to consider Goldman Sachs a high quality company with excellent growth prospects and an attractive valuation, the recent civil action against the firm - as well as the possibility of regulatory overreach within the financial industry - has resulted in an increased risk profile for the stock.
Although the final outcome of the civil case is difficult to predict, we believe the company has a good legal defense and the ultimate damages, if any, will not likely be material relative to Goldman's financial position and cash flow generation. That said, Wall Street firms have been the focus of populist angst, and it is entirely possible that the SEC's actions could be used for political leverage in the debate on the future of financial industry regulation. Given the potential of Goldman Sachs being used as a scapegoat, as well as the possibility of future investigations and legal actions, we believe it is prudent to move to the sidelines until there is greater clarity on both the specific SEC complaint and financial regulatory overhaul.
March, 2010
Purchases / Additions
Goldman Sachs (GS)
The Investment Committee has decided to initiate a position in the Goldman Sachs Group, the preeminent investment banking firm, in the Portfolio's. Headquartered in New York, Goldman has approximately $850 billion in assets and employs 32,500 people in offices across 30 countries. Approximately 44% of the company's net revenues are derived outside the Americas. Goldman Sachs operates in three major segments: Trading and Principal Investments (66% of revenue, on average, over the last three years), Asset Management and Securities Services (19%), and Investment Banking (15%).
The Investment Committee has decided to initiate a position in the Goldman Sachs Group, the preeminent investment banking firm, in the Portfolio's. Headquartered in New York, Goldman has approximately $850 billion in assets and employs 32,500 people in offices across 30 countries. Approximately 44% of the company's net revenues are derived outside the Americas. Goldman Sachs operates in three major segments: Trading and Principal Investments (66% of revenue, on average, over the last three years), Asset Management and Securities Services (19%), and Investment Banking (15%).
Although brokerage firms are known for the volatility of their revenue and profits, Goldman Sachs has exhibited relatively stable earnings and book value growth since its initial public offering in 1999. Despite tumultuous markets, the company has generated annual profits each year since its IPO, and posted only one quarterly loss (in the fourth quarter of 2008) during this time period. Goldman posted average annual earnings and book value per share growth of 15.6% and 19.8%, respectively, over the last ten years. Return on equity has averaged approximately 19% each year.
Goldman has considerable opportunity in capturing market share in the aftermath of the financial crisis. There are now fewer competitors within the industry, and clients - mindful of their counter-party risk - are seeking to do business with only the strongest firms. Goldman is extremely well capitalized, with industry-leading regulatory capital ratios. Leverage (assets/common equities) is currently at a historical low, at 12 times, but management expects this to increase as markets return to a state of normalcy. Investor uncertainty regarding the capital markets, as well as political risk, has resulted in Goldman Sachs stock trading at a discount to its historical average, creating significant opportunity. The stock trades at approximately 1.2 times estimated 2010 yearend book value per share, compared to the historical average of between 1.7 and 2.2 times book.
Trims / Deletions
United Technologies (UTX)
The Investment Committee has decided to trim the United Technologies position within the Portfolio's. UTX and its industrial brethren have outperformed the broader market over the last year, leading to a relative overweight position for both the stock and the sector. United Technologies continues to be a core position in the Quality Growth Portfolio based on its impressive track record and dominant position in the end markets that it serves, but the company's exposure to the global commercial real estate market tempers its near-term earnings growth. In line with our "cyclical-to-predictable" thesis for 2010, reducing the weighting in UTX will free up proceeds for more compelling growth opportunities.
The Investment Committee has decided to trim the United Technologies position within the Portfolio's. UTX and its industrial brethren have outperformed the broader market over the last year, leading to a relative overweight position for both the stock and the sector. United Technologies continues to be a core position in the Quality Growth Portfolio based on its impressive track record and dominant position in the end markets that it serves, but the company's exposure to the global commercial real estate market tempers its near-term earnings growth. In line with our "cyclical-to-predictable" thesis for 2010, reducing the weighting in UTX will free up proceeds for more compelling growth opportunities.
February, 2010
Purchases / Additions
PepsiCo (PEP)
The Investment Committee has decided to add to our US and global portfolio's position in PepsiCo. PepsiCo's strong stable of diversified brands, including Frito-Lay, Gatorade, Tropicana, Quaker, and strength in international markets all provide growth long-term growth opportunities well beyond the mature carbonated-soft-drink (CSD) market and the company is well positioned to deliver consistent double-digit earnings growth as the economic recovery matures. The imminent closing of the bottler acquisition will provide a further catalyst to the stock, as we believe company management will articulate a clear framework for earnings growth through merger synergies, share buy-backs, and reinvestment in strategic growth initiatives. We believe the stock currently offers significant upside and limited downside thanks to its subdued valuation and our expectation for future earnings growth. We expect PepsiCo, which has historically generated 12% earnings per share growth, to continue to do so for the foreseeable future and the stock trades at only 15x 2010 and 13x 2011 expected earnings versus a historical average of 18-20 times forward earnings.
The Investment Committee has decided to add to our US and global portfolio's position in PepsiCo. PepsiCo's strong stable of diversified brands, including Frito-Lay, Gatorade, Tropicana, Quaker, and strength in international markets all provide growth long-term growth opportunities well beyond the mature carbonated-soft-drink (CSD) market and the company is well positioned to deliver consistent double-digit earnings growth as the economic recovery matures. The imminent closing of the bottler acquisition will provide a further catalyst to the stock, as we believe company management will articulate a clear framework for earnings growth through merger synergies, share buy-backs, and reinvestment in strategic growth initiatives. We believe the stock currently offers significant upside and limited downside thanks to its subdued valuation and our expectation for future earnings growth. We expect PepsiCo, which has historically generated 12% earnings per share growth, to continue to do so for the foreseeable future and the stock trades at only 15x 2010 and 13x 2011 expected earnings versus a historical average of 18-20 times forward earnings.
Abbott Laboratories (ABT)
The Investment Committee has decided to add to the US and global portfolio's position in Abbott Labs. Abbott is a diversified healthcare company with market-leading positions in four categories: pharmaceuticals, diagnostics, cardiovascular, and nutritional products. After successfully navigating the patent expiration of blockbuster-drug Depakote in 2008, the pharmaceutical division is currently experiencing high growth thanks to Humira (for the treatment of rheumatoid arthritis, psoriasis, and Crohn's Disease) and its hypertension franchise (Tricor, Trilipix, Niaspan). Another major growth driver for Abbott continues to be its cardiovascular division, with its new drug-eluting stent, Xience V, which is gaining market share in all major geographies. The nutritional products (Similac, Ensure) and diagnostics divisions, while more mature, provide the company with consistent and predictable cash flow generation. Abbott Labs has an excellent track record with mergers and acquisitions, and recently closed the purchase of Solvay Pharmaceuticals. Solvay will be immediately accretive to earnings and gives Abbott additional exposure to emerging markets. Abbott has posted historical EPS growth of about 11%, and consensus projections call for earnings growth in the 10%-12% range over the next five years. The stock trades at a very reasonable 13 times 2010 earnings, generates substantial free cash flow, and offers a current dividend of about 3%.
The Investment Committee has decided to add to the US and global portfolio's position in Abbott Labs. Abbott is a diversified healthcare company with market-leading positions in four categories: pharmaceuticals, diagnostics, cardiovascular, and nutritional products. After successfully navigating the patent expiration of blockbuster-drug Depakote in 2008, the pharmaceutical division is currently experiencing high growth thanks to Humira (for the treatment of rheumatoid arthritis, psoriasis, and Crohn's Disease) and its hypertension franchise (Tricor, Trilipix, Niaspan). Another major growth driver for Abbott continues to be its cardiovascular division, with its new drug-eluting stent, Xience V, which is gaining market share in all major geographies. The nutritional products (Similac, Ensure) and diagnostics divisions, while more mature, provide the company with consistent and predictable cash flow generation. Abbott Labs has an excellent track record with mergers and acquisitions, and recently closed the purchase of Solvay Pharmaceuticals. Solvay will be immediately accretive to earnings and gives Abbott additional exposure to emerging markets. Abbott has posted historical EPS growth of about 11%, and consensus projections call for earnings growth in the 10%-12% range over the next five years. The stock trades at a very reasonable 13 times 2010 earnings, generates substantial free cash flow, and offers a current dividend of about 3%.
Trims / Deletions
AT&T (T)
The Investment Committee has decided to eliminate AT&T from all portfolios. The company has been enjoying substantial subscriber growth as the exclusive carrier of the iPhone, but the growth in the wireless business has not been able to offset secular declines in the traditional wire-line telephone business. At the same time, the company faces a potential price war with Verizon Wireless, and has significantly higher capital spending requirements to upgrade its wireless network for the tremendous increase in data usage stemming from the success of the iPhone. The stock still offers investors high current income through its generous dividend, but its relatively lackluster estimated earnings growth precludes its continued inclusion in our portfolios.
The Investment Committee has decided to eliminate AT&T from all portfolios. The company has been enjoying substantial subscriber growth as the exclusive carrier of the iPhone, but the growth in the wireless business has not been able to offset secular declines in the traditional wire-line telephone business. At the same time, the company faces a potential price war with Verizon Wireless, and has significantly higher capital spending requirements to upgrade its wireless network for the tremendous increase in data usage stemming from the success of the iPhone. The stock still offers investors high current income through its generous dividend, but its relatively lackluster estimated earnings growth precludes its continued inclusion in our portfolios.
January 2010
Purchases / Additions
McDonald's Corp. (MCD)
The Investment Committee has decided to initiate a position in McDonald's in our US and Global strategies. McDonald's is a leading global retailer with more than 32,000 system wide (includes franchised and company-owned) restaurants in 118 countries. The company generated 2008 revenues of $23.5 billion with system wide sales of close to $70 billion. McDonald's is a geographically diverse company - the U.S. accounts for only 34% of revenues, Europe 42%, with the remainder generated in Asia, Africa, South America, and the Middle East. After outperforming in 2008, MCD shares have significantly lagged their industry group and the overall market in 2009. This is primarily due to the market's correct perception of the company's stock as being a safe haven investment. Despite the company's global footprint, MCD's remains under-penetrated in many markets. Growth in these international markets is central to our advisor's thesis in purchasing the company. We believe the company can deliver 10% earnings per share growth and continue to generate substantial cash flow to fund future dividend growth. The stock, currently trading 14x next year's estimated earnings, is priced at a discount to the S&P, and well below its historic average. After their recent dividend hike the stock yields 3.5%. McDonald's is one of the highest quality and best run consumer companies in the world. Their global exposure, highly predictable growth outlook, and defensive characteristics improve the overall characteristics of the portfolio.
The Investment Committee has decided to initiate a position in McDonald's in our US and Global strategies. McDonald's is a leading global retailer with more than 32,000 system wide (includes franchised and company-owned) restaurants in 118 countries. The company generated 2008 revenues of $23.5 billion with system wide sales of close to $70 billion. McDonald's is a geographically diverse company - the U.S. accounts for only 34% of revenues, Europe 42%, with the remainder generated in Asia, Africa, South America, and the Middle East. After outperforming in 2008, MCD shares have significantly lagged their industry group and the overall market in 2009. This is primarily due to the market's correct perception of the company's stock as being a safe haven investment. Despite the company's global footprint, MCD's remains under-penetrated in many markets. Growth in these international markets is central to our advisor's thesis in purchasing the company. We believe the company can deliver 10% earnings per share growth and continue to generate substantial cash flow to fund future dividend growth. The stock, currently trading 14x next year's estimated earnings, is priced at a discount to the S&P, and well below its historic average. After their recent dividend hike the stock yields 3.5%. McDonald's is one of the highest quality and best run consumer companies in the world. Their global exposure, highly predictable growth outlook, and defensive characteristics improve the overall characteristics of the portfolio.
International Business Machines (IBM)
The Investment Committee has decided to initiate a position in International Business Machines. IBM provides a wide range of services, software, and hardware solutions across multiple industries. With annual revenues of over $100 billion, approximately 400,000 employees, and operations in more than 170 countries, the company is the world's largest services vendor, largest enterprise hardware provider (ex PCs), and second largest software vendor. IBM has long been a company synonymous with quality. During the past decade, the company has divested low-margin, commoditized businesses such as personal computers, and strengthened their position in software and services through strategic investments in more than 100 companies. The company is now focused on the next generation of client needs, including business intelligence and analytics, virtualization, and green solutions. With roughly 65% of revenues generated from outside the U.S., IBM is well diversified globally and will continue to benefit from the global synchronized recovery currently underway. They are focused and well positioned to benefit from ongoing infrastructure growth in emerging markets; these growth markets currently account for 18% of total revenue, but are growing 5x faster than developed markets. IBM's transformation to a services oriented company should allow them to continue to grow earnings at a double-digit pace. The company's highly predictable earnings growth (100% Value Line earnings predictability score), attractive valuation (less than 12x 2010 earnings), diversified high-margin businesses, and global reach makes it a worthy addition to the portfolio.
The Investment Committee has decided to initiate a position in International Business Machines. IBM provides a wide range of services, software, and hardware solutions across multiple industries. With annual revenues of over $100 billion, approximately 400,000 employees, and operations in more than 170 countries, the company is the world's largest services vendor, largest enterprise hardware provider (ex PCs), and second largest software vendor. IBM has long been a company synonymous with quality. During the past decade, the company has divested low-margin, commoditized businesses such as personal computers, and strengthened their position in software and services through strategic investments in more than 100 companies. The company is now focused on the next generation of client needs, including business intelligence and analytics, virtualization, and green solutions. With roughly 65% of revenues generated from outside the U.S., IBM is well diversified globally and will continue to benefit from the global synchronized recovery currently underway. They are focused and well positioned to benefit from ongoing infrastructure growth in emerging markets; these growth markets currently account for 18% of total revenue, but are growing 5x faster than developed markets. IBM's transformation to a services oriented company should allow them to continue to grow earnings at a double-digit pace. The company's highly predictable earnings growth (100% Value Line earnings predictability score), attractive valuation (less than 12x 2010 earnings), diversified high-margin businesses, and global reach makes it a worthy addition to the portfolio.
Trims / Deletions
Nokia (NOK)
The Investment Committee has decided to sell our position of Nokia. Nokia has underperformed its peers, both fundamentally and in terms of price performance, since the portfolio's purchase in mid-2009. The company's number one market share position continues to be eroded by both high-end smartphone alternatives and low-end entrants to the market. We have also been disappointed by the pace and success of new product introductions and missteps at Nokia Siemens Networks (NSN). The Investment Committee believes the portfolio can be improved and better positioned for the next phase of the economic cycle by investing the proceeds from Nokia's sale in more predictable, lower volatility alternatives such as IBM.
The Investment Committee has decided to sell our position of Nokia. Nokia has underperformed its peers, both fundamentally and in terms of price performance, since the portfolio's purchase in mid-2009. The company's number one market share position continues to be eroded by both high-end smartphone alternatives and low-end entrants to the market. We have also been disappointed by the pace and success of new product introductions and missteps at Nokia Siemens Networks (NSN). The Investment Committee believes the portfolio can be improved and better positioned for the next phase of the economic cycle by investing the proceeds from Nokia's sale in more predictable, lower volatility alternatives such as IBM.
Target (TGT)
The Investment Committee has decided to eliminate its position in Target. The company has performed well during the market rebound, increasing 90% from its lows in March, outpacing both the broader market and its sector. This dramatic performance is indicative of a stock reliant on discretionary consumer spending, which usually tends to lead the market during the initial stages of a market recovery. As the market recovery matures we believe leadership will rotate away from stocks such as Target that have participated significantly during the recovery and into more defensive positions.
The Investment Committee has decided to eliminate its position in Target. The company has performed well during the market rebound, increasing 90% from its lows in March, outpacing both the broader market and its sector. This dramatic performance is indicative of a stock reliant on discretionary consumer spending, which usually tends to lead the market during the initial stages of a market recovery. As the market recovery matures we believe leadership will rotate away from stocks such as Target that have participated significantly during the recovery and into more defensive positions.
Lowe's Cos. (LOW)
The Investment Committee has decided to eliminate the portfolio's position in Lowe's Company. As the market recovery matures we believe discretionary companies such as LOW's will lag the market as investors favor more predictable stocks. We also believe that as consumers deleverage spending will continue to grow at a sub-par pace. In addition, much tighter credit standards and the difficult housing market will continue to weigh on the shares. The portfolio's risk/reward characteristics and positioning for the next stage of the economic recovery and market rally will be improved by deploying LOW's proceeds into more attractive opportunities.
The Investment Committee has decided to eliminate the portfolio's position in Lowe's Company. As the market recovery matures we believe discretionary companies such as LOW's will lag the market as investors favor more predictable stocks. We also believe that as consumers deleverage spending will continue to grow at a sub-par pace. In addition, much tighter credit standards and the difficult housing market will continue to weigh on the shares. The portfolio's risk/reward characteristics and positioning for the next stage of the economic recovery and market rally will be improved by deploying LOW's proceeds into more attractive opportunities.
