Monday, June 10, 2013

Portfolio Review for May

In the end, numbers are just numbers and while they are an indispensable part of an investor's self-assessment, they do not always reveal the full details. For example, my last month closed with a negligible loss but the truth is, I started the month notably down after two profit warnings on the last day of April. In retrospect, it was a pleasing month and I think there are some useful conclusions to be drawn from it.

For the record, I'm down 2% for the quarter but up nearly 34% on a yearly basis. Readers can access previous write-ups here. April was a bad month for me, and much of that under-performance can be traced to decisions made in February, of which the articles linked below solely pertain.

Buy or sell when in doubt?

One of the hardest questions for any investor to deal with relates to what to do when you see short-term earnings risk but long-term value in a stock? If you sell out in anticipation the stock could easily fly away from your estimate of 'fair value' if it delivers a decent set of results. However, if it warns, you are delivered with a good buying opportunity.

Moreover, if you do decide to hold over the results and the company lowers and misses guidance, do you buy more or dump the stock? Frankly, I think the answer to the last question depends on your view of why the company missed.

For example, plenty of tech stocks missed in the last earnings season and I've argued here this is could be a good chance to start picking some up. The market is bidding up other sectors in anticipation of a resumption to growth in the second half, so why won't technology take part in this growth? Indeed, many of the statements of the leading tech companies (IBM, Oracle, etc.) specifically cite short-term hesitation (caused by sequestration fears) by customers in closing deals but at the same time, growing pipelines.

The usual format below with links to the articles discussed. All of them are from February and performance numbers are from the day they were originally published on the Motley Fool.

View Company+Article Link Performance Since Article
Buy Citrix Systems -13.2%
Buy Fortinet -21.7%
Buy Regal Beloit -17.6%
Buy Ixia -33.6%
Buy Nice Systems 2.9%
Buy Henry Schein 7.4%
Buy Intuit -12.2%
Positive Robert Half International -1.1%
Positive Cognex 7.3%
Positive Nordstrom 9.5%
Positive NetApp 9.5%
Positive Autodesk 9.5%
Evaluation Sherwin Williams 13.6%
Evaluation Allergan -8.1%
Evaluation Colgate Palmolive 5.4%
Evaluation Beacon Roofing Supply 6.7%
Evaluation Perrigo 2.6%
Evaluation V.F. Corp 14.4%
Evaluation Roper Industries 3.9%
Evaluation B/E Aerospace 15.3%
Evaluation Idexx Labs -13.5%
Caution McCormick 4.8%
Caution Rackspace -57.2%

It is a story of tech weakness and a conglomeration of the sort of factors that can gang up and assault the innocent investor. Intuit managed to report a weak tax return season and Regal Beloit managed to lose a key customer and warn that the commercial construction market wasn't as strong as it had previously expected. Ixia disclosed some accounting errors and then gave a (somewhat expected) disappointing earnings report. I bought some Fortinet after the warning, having been cautious over not holding too much tech going into the earnings season.

Those that warned

As ever, the key thing with investing is to hold your nerve and see what looks interesting. The first stock to consider is Citrix Systems (NASDAQ: CTXS), which reported a mixed set of results. On one hand, its growing application delivery controller Netscaler demonstrated that it was probably growing market share against F5 Networks' rival solution. One the other hand, Citrix's core virtualization solutions reported disappointing results as customers seemed to hesitate in making purchases, thanks to taking time to appraise the Q1 release of its XenMobile solution. The result was that its full year EPS guidance of $3.08-$3.11 fell short of analyst estimates of $3.14.

Frankly, I don't think this is a big deal and, if enterprise technology spending bounces back, these estimates could prove conservative. Citrix generates a lot of cash flow and its explanation for the earnings miss is plausible.

The next interesting stock is Allergan (NYSE: AGN). Its mix of ophthalmic products and Botox gives it impressive defensive growth prospects. However, the stock has taken a near-term hit, thanks to some disappointing clinical trial developments. It is inevitable that some will sell out when these things happen, but investors need to consider that the stock looks good value even if they (conservatively) assume no contribution from DARPin (macular degeneration) or Bimatoprost (scalp hair loss) in future.

Analysts have it on mid-teens earnings growth for the next few years even without any contribution from these two programs. Given its near 5% current free cash flow yield, I think it can 'do its earnings' in returns from here. I bought some.

Those with momentum

I would argue that Sherwin-Williams (NYSE: SHW) and Colgate-Palmolive (NYSE: CL) are good examples of companies that have momentum behind them but are arguably on stretched evaluations right now.

The housing trade has been winning lately, and very few companies have done better than paint company Sherwin-Williams over the last year. Its correlation to the U.S. housing market is obvious and the company should do well over the next year. The problem is that everyone else seems to think so too and the stock's evaluation of around 30x current earnings leaves little room for error. Even a cursory look at its evaluation...

SHW PE Ratio TTM data by YCharts

...suggests it's a crowded trade.

As for Colgate-Palmolive, I think the market has been keen to bid up blue chip consumer staples and the company has certainly executed very well in recent years. My question is, can it continue? It is in a highly competitive industry and the likes of Procter & Gamble are responding in its core North American market.

Furthermore, Colgate is embarking on a four year growth and efficiency program intended to drive growth in emerging markets. In order to achieve this, it will need to continue to lead the field with innovation. This creates pressure and given that it's on an evaluation of nearly 24x earnings with only single-digit earnings growth priced in, I don't think it is good value yet.

There is always value

I'm not the biggest fan of value investing, but it is notable how well NetApp (NASDAQ: NTAP) performed in an otherwise difficult market for technology. Despite the nice rise, NetApp still has around 35% of its market cap in net cash or financial instruments. Furthermore, it has generated around $1.1 billion in free cash flow (my calculations) over the last year. This equates to around 13% of its enterprise value as I write. Moreover, analysts have it on mid teens earnings growth for the next couple of years.

Quite clearly, the market is worried about something here and it is likely to be a combination of its Government and European exposure in the near to mid-term. As for the longer-term, the storage industry does face some existential questions over how data will be stored in a cloud computing age and will a smaller player like NetApp be a winner in such a world? I do not know the answers to these questions, but those with a stronger view may well be interested here

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