The CK-35: How NOT to Build a Portfolio

By Carol K.

On Monday, June 29th, I sold six holdings from my CK-35 portfolio. For the uninitiated, the CK -35 was a “paper” portfolio (not real money), of individual stocks selected by me, at the urging of GMM head honcho, Gregor Samsa.

CK_Jun30

Personal Portfolio

After a rough start managing my personal portfolio around 2013, I’ve dramatically turned my performance around by devoting the necessary time and effort to learning as much as I can about investing, portfolio management, and the importance of having a disciplined system. I have learned one must clearly define the goals for the portfolio.

First, is define your time horizon. Are you a long term buy-and-hold investor or a short-term trader looking to hop in and out of stocks or ETFs and perhaps scalping few dollars along the way?

Second, is your primary goal capital appreciation (growth), dividend income, or a combination of the two?  I believe a mix of pure growth stocks coupled with select high-quality dividend-paying stocks offers a less volatile, more stable, and sustainable portfolio for the average self-directed investor (SDI).

I plan to address the significance and my preferences in-depth in a future article, as it is a cornerstone of my evolving investment philosophy.

The CK-35:  A Flawed Project

First, a little background on the creation of the CK-35 portfolio.

As a trader his entire career, I finally convinced Gregor that one could make lots of money picking individual stocks with a longer-term buy and hold strategy.  Moreover, it is much less work and aggravation than whipping and driving in the market on a daily basis, especially after the machines are now dominating trading.

After a few exchanges, he convinced me to select my current top stock picks, and after a long debate, we settled on thirty-five stocks as the optimal number of holdings.  We came up with the idea of the CK-35 and then put together the hypothetical portfolio based on some of the top holdings from my portfolio and watchlist of stocks, which I maintain to add at appropriate valuation levels.

Though CK-35 has significantly outperformed the S&P500 for the year, why isn’t this group of high-quality stocks not up more YTD at what appears to the tail end of a roaring 11-year bull market?

There are several reasons.

First, I didn’t take seriously or plan for what Gregor repeatedly tried to warn us all in his January 31st post about some new flu out of Wuhan, China. He speculated it could quickly become a global pandemic, causing both a major supply and demand shock to the global economy.  In hindsight, he was spot-on in his call on what would later become known as the COVID-19 global pandemic.

Gregor also strongly urged all of us to sell our riskier holdings (stocks) and hide out in cash and gold until the anticipated market upheaval had passed.  Dismissing his warning on the pandemic as part of his seemingly (to me, at the time) “perma-bear nature” was one of my first mistakes.

The economic and political consequences of COVID-19, which led to shuttering much of the U.S. and global economy, coupled with my stubborn refusal to take the warnings seriously, hurt the performance of the CK-35 portfolio.

More importantly, however,  the nature of how the CK-35 hypothetical portfolio was constructed does not reflect my investing philosophy or practice.  I would never, for example, buy full positions all at once to create a new portfolio.

I learned the painful lesson long ago that valuation does matter. Part of my due diligence and selection process for stocks is determining what constitutes fair value for a company’s stock.

There are a plethora of finance textbooks devoted to the topic of valuation and won’t go into the myriad of valuation metrics and algorithms.  Nevertheless, I rely primarily on trusted analysts or publications that I have found to have good track records and have helped me make money over the years.

Morningstar Analysis

I generally use Morningstar’s Fair Value price as a baseline, as the firm’s analysts tend to be more conservative in arriving at a fair value stock price.

In the spirit of Benjamin Graham and Warran Buffett, I also look for a valuation cushion in determining a stock’s fair value. My decision to start or add to a position always takes into account the Margin of Safety (MOS) at a given entry price.  Buying high-quality stocks with a reasonable margin of safety assuredly generates better portfolio returns over the long-term.   To reiterate valuation matters and purchasing stocks near or below fair value with a margin of safety is essential to a portfolio’s long term success.

The way the CK-35 portfolio was constructed ignored all of the above.  All the positions were hypothetically purchased in full, with equal weights, at the year-end 2019 closing price.  Most of the stocks were trading at or near all-time highs.

The market continued to rise until February 19th until the traders began to internalize the economic fallout of COVID-19, then sold off fast and furious, setting a record for the deepest sell-off in the shortest timeframe.

Having a well-defined selection system coupled with the patience and discipline to see it through are hallmarks of the most successful stock pickers and investors.

High-Quality Stocks

Nevertheless, there are some stocks, which almost always seem to trade at a premium to their fair value price.  Most are high-quality names, which rarely experience the outside or extreme drawdowns, as was the case for many in the February 19th to March 23rd  30 percent plus market sell-off and the 2018 Nightmare Before Christmas mini bear market.

In these stocks, I don’t have a problem paying a premium and keeping some dry powder to deploy the cash and pick them up on the rare pullback during market sell-offs.

Remaining Cautious – Pandemic And Politics

Most states are now at some level of economic reopening, with several, including Florida and Texas, now backtracking as their COVID cases spike.

I anticipate extreme volatility through the summer and fall months. I suspect the Q3 earnings reports will come in weaker than expected as more of the uncertainty and economic fallout of the COVID crisis is realized in the bottom line of publicly traded companies.

Moreover, the markets will have to come to terms with the likely outcome November general election, which results in Biden victory and the Democrats taking back the Senate.

There is also heightened political risk of a contested election, a low probability/high impact event given the current polls, however.

A Democratic sweep of both houses of Congress and the White House will result in higher corporate and capital gains taxes in 2021.

Candidate Joe Biden has unequivocally stated, if elected, he will seek to raise the corporate tax rate from 21% to 28%, which is not good, to say the least,  for U.S. based companies.  He is also on record in favor of making the capital gains tax similar to personal income tax rates.

The market seems to be betting on the Republicans holding the Senate, which can block the Biden tax plan. Still, as we move closer to the election day, I suspect volatility will pick up, and some significant tax selling to take place in the late Q3 and into Q4.

Sectors

Nevertheless, I believe the technology and healthcare sector will outperform throughout the rest of the year as many companies will continue to thrive regardless of any economic fallout brought about by the pandemic or politics.    I am less comfortable with the financials, industrials, materials, and consumer discretionary sectors, with a few notable exceptions.

Again, I want to thank Gregor and the staff at Global Macro Monitor for providing me this platform to share my ideas and help self-directed investors, such as myself, to achieve their financial goals by focusing on high quality, long term equity investments.

While we plan to shutter the CK-35 hypothetical portfolio, I hope you will stick with me as I plan to write a series of posts sharing some of my favorite stock ideas along with my equity selection process from start to finish.  In all things from constructing a screen to identify stocks for a more in-depth research dig, and my due diligence algorithm for constructing a watchlist of vetted stocks and ETFs to purchase attractively valued shares.

The information in this post represents our own personal opinions and are not investment recommendations.  We may or may not hold positions or other interests in securities mentioned in the post or have acted upon what has been written.  

All information posted is believed to be reliable and has been obtained from public sources believed to be reliable. We make no representation as to the accuracy or completeness of such information.

 

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