We are up 27.6% for 2013. This is our second best performance on a full year basis since we started in May 2008. The bad news is our performance is a full two percentage points worst than S&P500. You may think we are disappointed, however, we certainly are not. Why not disappointed? Because we achieved these returns while holding a significant amount of cash throughout the year (varying from 25% to 30%). As a reminder, we have been holding significant amount of cash since end of 2011 and we have outperformed the S&P500 by 1.7% in the past two years.
Because of our significant cash position, it became an anchor to our portfolio performance. Our actual performance on common stocks owned was greater than the overall portfolio performance as can be seen from the below table.
Our common stocks' performance have outperformed the various benchmarks by double digits in 2013.
We are happy with our performance whether on an absolute, relative or risk-adjusted basis for the last one and two years.
The following shows the breakdown of our portfolio:
Although the proportion of cash as a percentage of the portfolio remains unchanged from last year, the absolute amount of cash increased by 27.8%. That means we have more cash than last year. Hopefully, we get a good opportunity to deploy more of those cash. But we will not rush.
Below table shows the significant positions of stocks in our portfolio:
Discussion on portfolio changes:
1) Payment network companies: We have reduced our exposure to both Mastercard and Visa. At one time, we held 20% of our portfolio in these two stocks. Today, it is 10.9%. When we first started buying them, they were selling for less than 16x forward earnings. Now, Mastercard is selling for 27x, while Visa 25x. Most of the return on the stock is driven by multiple expansion rather than earnings growth - the same is true for the main U.S. benchmark indices in 2013 as well. For example, Mastercard's stock has risen by 139% since we bought, while earnings increased by 41%. And this isn't too long ago, we started buying in Jan and Feb 2012 (less than two years). Besides reducing our exposure to the payment network companies, the other measure which we took to protect downside is by switching more of our exposure from Mastercard to Visa. At the start of the year, 82% of our holdings in the payment network companies were in Mastercard, the rest in Visa. Now, 64% are in Visa and 36% in Mastercard.
2) Berkshire Hathaway: We have reduced our BRK holdings. This is the first time we made changes to our BRK holdings since May 2011. We would not have touched BRK had we not decided there were better alternatives to BRK, taking into consideration we do not want to reduce our cash position in a significant manner.
3) DirecTV: During the first half of 2013, we added to our DTV holdings when it fell to as low as $48, resulting in DTV to constitute 13% of our portfolio. We have since halved it. The reason why we reduce is the same as BRK where we think there are better alternatives.
4) IBM: IBM is a major disappointment since we bought them in terms of stock price performance. Although IBM's "as a percentage of portfolio" is less than last year, we hold 16.5% more shares than last year - that means we added to our IBM holdings. We think IBM's price has been significantly de-risked. Going forward, we expect decent results primarily because of the following reasons: 1) IBM sells for 11x forward earnings versus S&P500 of 16x; 2) IBM has terribly underperformed the S&P500 whether on a one or two years basis (on a two year basis, it has underperformed to the tune of 40%); 3) IBM is the worst performing stock in the DOW - the only DOW stock that is in the red for 2013.
5) In the second half of the year, we opened a number of new positions. Namely, Posting Holdings, Valeant Pharmaceuticals, Colfax and a bunch of companies that are linked to John Malone. As a group, these companies make up almost 30% of our portfolio. We have followed these companies for a couple of years, particularly, the managers leading these companies. We simply love the managers in these motley crew of companies. Most of these managers have a long proven record. And they share a common trait - they are all very focused on growing "per share" value. In short, they are competent capital allocators in addition to most of them being a good operator. In fact, we have a few other of such companies which we would love to own but unfortunately, the price is not where we like it to be. These includes Transdigm, Jarden, Danaher, Teledyne, Roper Industries, B&G Foods, Credit Acceptance Corp, for example. All of them are led by outstanding managers.
The following tables shows the stocks which drove our 2013 performance:
These group of stocks contributed to 75.5% of our total return in 2013, with the payment network companies contributing almost a third of the return. Starz, another company linked to John Malone, contributed to our performance in the first half - we have sold out our position by the first half of the year. Post Holdings, which we only added in Sep and Oct 2013, contributed to our second half performance.
In fact, DirecTV is another company operated by a sensible capital allocator - Michael White, the CEO of DTV. Michael White is somewhat of an outsider in the industry when he first joined DTV. He worked all his life in consumer staples prior to being DTV's CEO. He was the Vice-Chairman of Pepsico before he lost out to Indra Nooyi for the CEO position. So for him to do so well at DTV is a pleasant surprise. We have gotten very attractive return from DTV since we started holding them. DTV is one of the most, if not the most, aggressive repurchaser of its own stock, and being aggressive is not good enough, it gotta be cheap. And cheap it was, so being aggressive using its significant cash flow and under-levered position to repurchase its cheap stock is a good thing.
The following table will show the performance of those stocks which drove our portfolio return in 2013:
As a group, these stocks delivered an average of 33.8% return - slightly besting the S&P500 index by 4.2%. However, this return is understated. The reasons that it is understated are because: 1) Post Holding was only added from Sep 2013; 2) part or most of the capital plowed into Post Holdings were originated from the proceeds from the sale of Starz, Mastercard or other stocks during the year, for example. So these proceeds from such sale were recycled into new positions such as Post and Valeant, have acted as a drag to the reported gain in percentage.
The following table shows our significant bet on the earlier mentioned motley group of stocks operated by extraordinary managers:
This group of stocks makes up 29% of our portfolio and has delivered an average of 12.3% return. More than 90% of this group were only added during Sep to Dec 2013. We only held a small position of both Liberty Media and Spectrum Brands in the first eight months of the year.
1) John Malone's stocks: We own 6 different Malone-linked companies. The largest stake among the six is Discovery Communication. Discovery is expected to grow at high teens to low twenties level and is selling for 21x at the price we bought at. It is not cheap in the traditional sense but a fair price to pay for for such growth. We had bought Discovery partly because we thought Mastercard is more expensive, and has a lower growth rate than Discovery. So we swop part of our Mastercard holdings to Discovery. Another Malone's stock we own is Sirius XM which we just bought in Dec 2013. We are likely to add more at current price. We also own Liberty Interactive and we may add more when QVC is separated to be a standalone company if the price is good. If QVC is priced at anything with a market capitalization of less than $14b, we will add.
2) Post Holdings: We added Post in Sep and Oct 2013. We started with a very small position (1% of portfolio) at a cost of $41.77. This is not abnormal of our strategy. We only build a significant position when it falls from our target entry price. And Post fell to as low as $38, and as a result, we managed to build a meaningful position. We adore Bill Stiriz and most of all, we like that Post is selling at 12-13x normalized earnings and is at the same time, managed by a top notch manager who is laser-like focused on growing per-share value.
3) Valeant Pharmaceuticals: We started buying VRX in Oct 2013 and added in Nov and Dec 2013. Like Mastercard and Visa, we sucked on our thumbs for too long and only started buying when we could have bought it at less than half the price. We started tracking and studying VRX 1.5 to 2 years ago when it was selling for mid $40s. However, even at the price we bought at, $100+, we think we are getting a good deal. VRX is selling for about 12x normalized earnings and it is led by a top-notch capital allocator - Michael Pearson. Pearson is not a conventional pharmaceutical guy, he didn't raise from the industry but rather he came in from the consultant side of the industry. But like Michael White (DirecTV's CEO), this doesn't act as an anchor to his performance.
4) Spectrum Brands: Spectrum Brands sells a variety of products, mostly consumer staples, from batteries, to insect repellent, to pet foods and kitchen hardware and door locks. Most of its consumer staple products are what people need rather than want. Although we don't expect high top line organic growth from its consumer staples, but we think the growth from its Home and Hardware division should provide aid to the overall growth in revenue if housing picks up. In any case, management has guided for at least $6.7 free cash flow per share for the fiscal year ending Sep 2014. So even at current price, we don't think it is expensive.
5) Colfax: This is an insignificant position for us, although we'd like to have a more meaningful position. But the price didn't bulge further from our entry price. So we did not have the chance to add. We love Colfax management. The CEO and many of its top executives are ex-Danaher executives. Colfax, like Danaher, were started by the Rales' brothers, and they own significant stake in both. The record of the Rales' brothers in Danaher are simply legendary stuff.