I have recently finished the construction of my portfolio, with an aim of holding 10 stocks in diversified sectors. I had sought to build a value-oriented portfolio with moderate concentration. Today, I decided to take a look at how the portfolio and its various sectors are doing.
As a whole, the portfolio is slightly up over the last 3 months, out-performing the S&P 500 index modestly. Commodity stocks (TX and MEOH) are up, and financial stocks (FMD) are down, in line with the performance of their respective sectors. Consumer goods stocks are mostly treading water. Of greatest concern to me are two stocks with a close to 20% loss, SAFM and CCIX. The commonality between these two stocks is that both carry rather high debt loads. Evidently, the market is concerned about companies with high debt loads in an uncertain economic climate. Compounding the problem is the lack of credit, which has caused LIBOR to soar to above 6% recently, and since the revolving credit facilities of most companies are tied to LIBOR, debt servicing costs are expected to rise. In the near-term, this means that I expect both SAFM and CCIX to take a hit to earnings due to increased interest expenditure. However, both companies command large market shares in their industries, have competent management with high insider ownership, and are pursuing rational business strategies. I continue to have faith in these companies, and feel that with their market positions and strong cash flows, it is unlikely that they will fail amidst a credit crunch. While some banks may make use of the current lack of liquidity to impose extortionary interest rates on company, in the long run, it harms their own interests if they raise interest rates to the point that fundamentally sound companies fail.
Overall, I am a little disappointed by the performance of the portfolio. I had expected a value-oriented portfolio to hold up relatively well during times of market stress, considering that most stocks were bought with huge margins of safety. Instead, portfolio performance has sunk to nearly risk-free return rates. I think the chief culprit is an outsized position in CCIX, which is probably overweighted relative to the merits of the other stocks in my portfolio (despite the underperformance of SAFM, I think that its position size is reasonable). I walk away from this analysis with several conclusions. Firstly, I should pay greater attention and establish hard rules regarding position sizes. While value investors have had a tradition of holding ultra-concentrated portfolios, for my personal portfolio, I feel that sacrificing some return for reduced volatility is worth it. Secondly, I should pay more attention to sector diversification. I’m thinking that 5 uncorrelated sectors each with 2 stocks would be appropriate. Lastly, the total and individual debt levels in the portfolio must be monitored. I think that at most I’ll hold 1-2 stocks with a debt to equity ratio above 0.5, striving for minimal debt in the rest of the holdings.
I’m not sure whether imposing the above restrictions on my stock holdings will make it so difficult to find new stock picks that investing becomes impossible. At least in the current climate, there are plenty of stocks at attractive valuation levels, so these conditions should not prove to be too onerous. In the near-term, I’ll probably seek to take my profits in my commodity stocks and rotate out of them when and if the market rebounds, and invest the proceeds in another sector. In line with these thoughts, I have recently bought a small position in VPHM, a pharmaceutical company. Normally, I avoid pharmaceuticals because they are too risky, but VPHM has an exceptional capital cushion, and pharmaceutical companies whether recessions well, since medical costs is probably the last expenses one can cut.
