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Cabot Benjamin Graham Value Investor 282

2017 was a great year for investing in stocks. In this issue, I briefly review my recommendations and market performance in the past year. I also introduce a new stock in the retail space, move one stock to Hold and another stock to Sell.

Cabot Benjamin Graham Value Investor 282

Benjamin Graham is called The Father of Value Investing. His influence has inspired many successful investors, including Warren Buffett.

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As we begin 2018, let me start with a brief review of our portfolio and the market.

We transitioned from the Value Model and Enterprise Model to the Prudent Model on October 12, and I recommended stocks to sell and others to hold, consolidating the two portfolios from 60 stocks to 29.

The benchmark S&P 500 has risen about 7.5% since the October transition. Among the stocks that I recommended to sell on October 12, a few of them have done well—FleetCor, FiveBelow, LyondellBasell, Citizen Financial Group, Alliance Data System, Chicago Bridge and Iron, VMware and United Healthcare have risen more than 15%. And the conservative approach of the Prudent Portfolio saved us from significant losses in stocks such as GNC, which fell more than 50%, and Celgene, which has declined more than 20% since October 12.

Reflecting on my choices, I wish I had carried more stocks from the previous portfolios. In hindsight, I was overly conservative in the climate of the strong bull market.

That said, many stocks in the Prudent Portfolio gained robust returns. Ross Stores, Nike, Stifel Financials, Thor Industries, Toll Brothers, T. Rowe, Home Depot and Lowe’s returned more than 15% since the transition. And we did not see any significant losses among the carried-forward stocks except Allergan’s 12% loss after the Restasis saga. Happily, we sold it before it skidded further. Again, our conservative strategy helped us to stay immune from some significant losses while still capturing some bull market gains.

I will continue to fine-tune the portfolio in 2018. Listed in the table are unrealized gains of individual stocks and their performance relative to the S&P 500 benchmark during the same period. I’d like to remind you that many of the stocks we bought recently are underdogs and may continue to stay low in the near term until the market realizes its true value—it is the very nature of value investing.


Now, let’s take a quick review of the overall market in 2017.
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” — Benjamin Graham

Economic and Market Update

2017 began with cautious optimism by most of the Wall Street analysts. After Trump’s victory, the political uncertainties were replaced with policy uncertainties. Wall Street’s consensus estimate called for the S&P 500 to gain about 5% by the end of 2017—the most bearish estimate in 12 years, according to CNBC.

Well, the analysts were wrong. The S&P 500 gained nearly 20%, and all three major U.S. indexes hit their all-time highs, coupled with the lowest market volatility in 24 years! The economy grew steadily, resulting in the lowest unemployment rate in 17 years. IPOs returned a staggering 27% with a 77% increase in the total number of IPOs.

As a value investor, I would not venture into predicting how the market will perform this year, but in the long run, you don’t need to be an expert to say that the American economy will continue to grow. We are at an exciting time! The productivity of almost all industries is bound to have extraordinary growth with the advent of artificial intelligence. Moore’s law has been catching up to afford highly efficient semiconductors for automated robots and vehicles, which were not possible until recently.

This month, I introduce Target (TGT) to the Prudent Portfolio, move Discovery Communications (DISCA) from Buy to Hold and FedEx (FDX) to Sell.

New Buy Recommendation

Target (TGT)


Target (TGT) was added to the Prudent Portfolio in the December 28 Weekly Update at 65.14 per share.

Investing in TGT aligns with two objectives a value investor seeks: value and strategy. Target is cheaper than its big-box peers like Walmart and Costco. With revenue of around $70 billion, Target generates free cash flow of about $4 billion. Its market cap is $37 billion, so it has a free cash flow yield of greater than 10%.

What’s more, the company has recently acquired Grand Junction (a transportation technology company for same-day delivery) and Shipt (a crowdsourced Uber-like delivery platform). Both companies, particularly Shipt, will help Target deliver groceries and other products in less than two hours. I believe a shorter delivery window is the right strategy for big box retailers to compete with online retailers like Amazon.


On the December 21 weekly update, I discussed the data from Skyhook on retail foot traffic for Black Friday (as shown to the right).

Higher foot traffic continued during the holiday season. Comparable sales growth increased 3.4% in the November/December period, and consequently, EPS guidance for 2017 and fourth-quarter adjusted EPS guidance of $1.30 to $1.40. Target expects $4.64 to $4.74 adjusted EPS for the full year, compared to the previous estimate of $4.40 to $4.60. The stock has reacted positively since then, but even at the current level, Target is a Buy for the long term.

With a fair value of about $85 per share, Target is a Buy. BUY.

Additional Buys

Hanesbrands (HBI) was recommended on December 14 with the expectation that management will continue to make prudent acquisitions with limited credit exposure, focus on organic growth and continue its supply-chain-efficiency scale-ups. Over the holiday season, Champion appeared to be performing very well. Once popular in the 1990s, Champion is again gaining organic traction from urban and pop culture. The estimated fair value is 28 per share. BUY.

Other Buy recommendations include Magna International (MGA), Williams-Sonoma (WSM), Apple (AAPL) and Alphabet (GOOG)

Sell Recommendations

Fedex (FDX) has hit its fair value of 248 per share, and I recommend selling the stock. SELL.

There were no other significant changes this month.

Some stocks may be trading slightly above the fair value, and still recommended as Holds. This is because fair values are approximate measures and the data may be updated.

Prudent Portfolio

Stocks in the Prudent Portfolio are ranked based on various factors, including the prospect of appreciation, maximum downside risk and expected annualized yield. I suggest that you allocate more capital to the stocks with the better rankings.


Updates on Current Recommendations

Discovery Communications (DISCA)’s rating has been changed from Buy to Hold as the stock nears its fair value.

Discovery Communication is a global media company that provides content through Discovery Channel, TLC, Animal Planet and The History Channel across multiple distribution platforms. In 2016, revenues from U.S. networks and international networks were $3.28 billion and $3.04 billion, respectively. Discovery will acquire Scripps Networks Interactive for $14.6 billion. Scripps provides lifestyle and interactive content on channels like Food Network, HGTV, Travel Channel, DIY Network, the Cooking Channel and Great American Country. Scripps’ annual revenue was $3.4 billion in 2016, with a net profit margin of around 20%. Discovery and Scripps expect the merger to provide $350 million in cost synergies and increase international exposure to Scripps’ female audience-targeted contents. The combined firm will also allow for better bargaining power with advertisers and distributors due to its sheer size.

There are two primary reasons to buy and hold Discovery. First, media stocks have been out of favor due to cord-cutting fears. But the industry is evolving much faster than market fears, so traditional television channels are creating their own online identity. For instance, Disney has already announced that it is going to release its streaming service. Discovery is well positioned in the market to supply its unmatched low-cost content to emerging online streaming services.

Second, with the Scripps acquisition, Discovery can also push content from Scripps Networks to its wide international audience. Having John Malone, who owns one of the widest cable assets in Europe through Liberty Global, on board will also help Discovery to move its content across the border.

Discovery’s long-term strategy to introduce new scripted content and establish content brand identity in streaming platforms such as Netflix is expected to gain traction in 2018.

Since I recommended Discovery Communications in November 2017, the stock price has soared more than 30%. The stock is now nearing its estimated fair value of 25, which was a very conservative estimate. An acquisition of Discovery is a strong possibility in 2018, and in that scenario, there could be a further upward movement. HOLD.

Signet Jewelers (SIG) was recommended as a Buy at 67 and then again at 52. Signet’s plunge since the last quarter was mainly due to the ongoing technical hiccups in credit outsourcing, declining foot traffic and negative Wall Street sentiment.

My original recommendation for Signet was broadly based on three strategic initiatives started by Signet:

1) Reducing the in-house credit risk of the Sterling division,
2) Focus on the omni-channel and online sales after the acquisition of R2Net, and
3) Improving operational efficiencies of the Zales division to Signet’s standards.

In the December Issue, I cited data from SimilarWeb, which indicated that overall web traffic to Kay and Zales had increased considerably. In the holiday season conference call on January 10, Signet announced a considerable increase (close to 50%) in online sales. However, the technical hiccups from credit outsourcing reduced the overall same-store sales growth in the Sterling division (which includes Kay and Jared). On the other hand, same-store sales of Zales increased 4%, as the credit outsourcing had no impact on Zales.

Two relevant questions to ask at this stage are: 1) Is Zales cannibalizing Kay’s sales? 2) How are customers dealing with the new credit standards of the ADS?

It appears that the number of engagement ring transactions was down only low single-digits at Kay, but the customers shifted to cheaper engagement rings due to technical problems with in-house credit sales. So it appears that Zales sales may not have cannibalized Kay’s sales. And the credit approval rates that were not impeded by technical concerns were as high as they were before the outsourcing.

Management, led by new CEO Virginia Drosos, is focusing on strategic initiatives. Signet is evidently targeting social media marketing. As the largest diamond retailer, Signet can apply its advantage of scale and brand awareness to improve its online presence. That said, it’s a long-term bet on Signet’s new management, so you should be aware of the risk associated with it. I am still long on Signet for the long term. HOLD.

Gentex (GNTX) announced the retirement of Fred Bauer from the position of CEO and Chairman of the Board. Bauer led the company from a startup to the world’s leading auto-dimming rear-view mirror supplier with a market share of 92%. Former COO and interim CFO Steve Downing replaced Bauer as the CEO.

Gentex is continuing to innovate in the space of connected cars. Gentex acquired HomeLink in 2013 to enter the interconnected vehicle-to-infrastructure space. It is becoming more apparent than ever that HomeLink technology can be used in complete vehicle-to-home connection. In CES 2018, Gentex exhibited HomeLink Connect technology in the 2018 Range Rover Velar. Gentex is further establishing its footprint in the connected car space with in-car payment systems and home connection systems. HOLD.


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