A model portfolio of large cap stocks

I’ve started an experiment where I’m keeping a public portfolio of large cap stocks via the Motley Fool CAPS system- you can view it here.  I would like to see if I can generate value on the long side… something that I find much, much more difficult than shorting.

My criteria are:

  1. Pick only the quality businesses in a particular sector.  For example, Dollarama is the clear leader among discounters.
  2. Not overpriced.  For that reason, Amazon and Netflix don’t make the cut (just look at what happened to Amazon during the Dot-Com Bubble).
  3. I avoid industries where there are no clear industry superstars.  Oil and mining stocks simply don’t make the cut as none of them are quality businesses.
  4. Lastly, I avoid dying or shrinking industries.  Profits ultimately don’t grow in dying industries and therefore those stocks almost never do well.

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What happens when technology is good enough?

There are some areas in technology that have reached maturity and are at the point of being good enough.  Take JPEG image compression for example.  This old technology is used on websites everywhere to compress images.  There is a newer JPEG2000 format which is technically superior.  However, this superior technology has seen very little adoption on websites.  Internet speeds are so fast that the benefits (webpages loading slightly faster) aren’t important enough for webmasters to switch.

For some shareholders, there may be a disappointing future ahead.  Once the demand for more computing power stops, there is no longer room to create value with newer technology.  Often what happens is that mainstream consumer demand goes away first.  This can devastate the business model of companies developing new technology as it can only be sold on a smaller scale to niche markets.

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Insiders giving themselves special pensions

Defined benefit pension plans give pensioned a defined amount of money each year for the rest of their life.  Unfortunately for shareholders, the risks on this liability are very difficult to estimate and can get out of hand.  Warren Buffett explains the relevant concepts in a 1975 memo to Katherine Graham.  Shareholders are likely better off if the company offered its employees a defined contribution plan rather than a defined benefit plan.

When reading a DEF 14A filing (I have a previous post on things to look for in a DEF 14A filing), it may be worth checking to see if management is giving itself a defined benefit plan while the workers beneath them are receiving a defined contribution plan.  I believe that this is an area where management can basically hide some of its compensation.  Intel and TJ Maxx are examples of companies that have defined benefit plans for management.  In the grand scheme of things however, this practice isn’t that bad compared to other ways that insiders compensate/enrich themselves.

*Disclosure:  Long TJX via calls.  No position in INTC.

Portfolio Update Nov. 30 2012

Queenston Mining (QMI.TO) – closed at a profit

Sold Queenston Mining at $5.27ish for a nice profit.  Osisko announced a takeover of Queenston (0.611 Osisko shares for every Queenston share).  I sold because it seemed to me that Queenston was close to fair value.  At this point in time, a competing bid seems unlikely to me.  One reason is that Osisko’s bid has a non-solicitation clause that Queenston management agreed to.  Agnico Eagle Mines, which has a strategic investment in Queenston, will not be bidding on Queenston as it struck a deal with Osisko.

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Book Review: Only the Paranoid Survive (by Andy Grove, former Intel CEO)

Key ideas in the book are:

  1. Sometimes there are inflection points in an industry that changes everything, e.g. containerization of the shipping industry and the rise of the personal computer.  The trick is to (A) correctly identify what things are and aren’t inflection points and (B) re-invent the business if you are on the wrong end of an inflection point.
  2. It is difficult for CEOs to make decisions that may be obvious to outsiders and to a company’s customers.

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