15 Mar There Is No Such Thing As A Forever Stock – Part II
In our January 4th Market Insights piece found here, we highlighted the importance of having a sell discipline as it applied to our recent sale of Apple Inc (NYSE: AAPL) stock in one of our internal equity strategies.
Since publishing that piece, we’ve received a lot of feedback and comments on this sell decision. While the decision of whether to buy or sell a stock can certainly be debated, the piece emphasized having a sell discipline, as selling can be one of the hardest decisions for investors to make. Yet, as the facts about a business change, one’s opinion of the company should evolve. It takes a significant amount of time and energy to maintain this working knowledge of a company. Unfortunately, many investors put a lot of time and energy into the buy decision while giving little thought to the sell decision.
Evidence of this complacency is starting to show up in stock prices, specifically in the consumer staples sector. This observation brings us to The Kraft Heinz Company (KHC), some reasons KHC moved down ~30% in a single day, and ways our investment process is designed to avoid these mental shortcuts.
Owning for the Wrong Reason #1: Idol Worship as a Shortcut for Research
While we usually will take note of portfolio changes in Warren Buffett’s Berkshire Hathaway, these changes cannot be relied on to make investment decisions. First, Berkshire Hathaway has special access to management teams, which allows it to make deals that you or I cannot make (e.g., the unique preferred stock investments Berkshire made in the financial sector in 2009).
Second, investment idols can be (and have been) wrong. Think of Buffett’s recent disaster with IBM or Nelson Peltz’s issues with GE. Because we don’t know the true intentions of any institutional investor, we cannot attach expected outcomes to their decisions. Therefore, it is not worth the effort to guess.
Owning for the Wrong Reason #2: It Can’t Be Just for the Dividend
While a high dividend yield may seem attractive at first glance, a stock with a high yield usually got into the high-yield category because of a share price drop. Whether or not the drop is warranted is an entirely different discussion. Yet, sharp drops in seemingly “stable” dividend stocks should be a signal worth monitoring.
For example, General Electric’s (GE) drop from $30 to $20 per share during 2017 was signaling that the business was under duress even though GE had not yet cut their dividend or indicated anything was wrong. Other companies we observe that are at risk of either cutting their dividend or not increasing their dividend include highly leveraged companies like AT&T (T) and Kimberly-Clark (KMB).
Sector Designation Doesn’t Correlate to Low Risk
It used to be that a stock or bond’s sector categorization was a good proxy for the relative risk the position was bearing. In other words, utilities historically could have been considered as “low risk” equities, given that the demand for their product (electricity) doesn’t change very often and they paid out above-market dividend yields. Similar thoughts apply to the other historically “low-risk” sector: consumer staples. Recent examples in both sectors (The Kraft Heinz Company in the consumer staples sector and PG&E in the utilities sector) indicate that there is risk in the “safe” sectors of the equity and fixed income markets, thus sector designation is no longer a useful proxy for risk.
Brand is Less Valuable
In an era of Publix brand aspirin and Whole Foods 365 window cleaner, brand value in certain segments of the consumer products market is becoming less relevant to a company’s intrinsic value. Here is an interesting graphic depicting estimated change in brand value over the last 18 years:
Brand value, however, is subject to changes in consumer taste. Consumer taste is very difficult to predict. If brand value is becoming less useful in the calculation of the underlying company’s overall worth (which we believe is the case), then various consumer product companies need to have a lower stock price than the market is currently reflecting.
The recent experiences of The Kraft Heinz Company and PG&E are cautionary tales for the reasons listed above. KHC has been a stock that (1) had high profile investors, (2) had a sizable yield, and (3) was in a “low-risk” sector. It turns out that these observations were just mental shortcuts that many used in evaluating KHC.
Recent price performance in companies like KHC and PG&E should help reinforce the idea that there is no such thing as a buy-it-and-forget-it stock. An understanding of a company’s fundamentals helps relate price movement to changes in intrinsic value. Using this understanding, we anticipate there will be many opportunities in the coming years to purchase stocks for less than their intrinsic value.
Todd Jones, MBA, CAIA®
Gratus Capital is an SEC-registered investment adviser. Registration with the SEC does not imply any level of skill or training. Our ADV documents are available upon request. The opinions expressed are as of March 2019 and may change as economic conditions vary. The information provided is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any securities. Examples provided are based on current market conditions, and there is no guarantee that any applicable condition will remain in place. Portfolio holdings are subject to change at any time and may differ materially in the future from case studies presented. No graph or chart by itself can be used to determine which securities to buy or sell or when to buy or sell them. As with any investments, past performance is not a guarantee of future results. There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses.