Investment portfolio spring cleanup | The Western Producer

While you’re busy seeding a new crop, I’m busy harvesting an old crop and simultaneously seeding a new crop of stocks. Over the past two months, as I have done for the past number of years, I reviewed year-end financials of all portfolio companies and some prospective portfolio companies. It gives me something productive to do in my retirement years! I aim to keep my overall annual portfolio turnover to less than 10 per cent, with most of that occurring at this time of year.

Prior to discussing a few examples of my spring-cleaning efforts, given the dramatic market action in April a few general market comments seem appropriate.

General market state

Geopolitical events can cause temporary market gyrations, but what the market really cares about is profits. Very strong first quarter results, with S&P 500 profits increasing almost 14 per cent over year-ago profits, drove index gains of 10 per cent in the month, while the tech-heavy Nasdaq was up 15 per cent on the back of spectacular 43 per cent technology sector profit growth.

Health care and, surprisingly, energy, were profit laggards down 10 and 12 per cent, respectively. The TSX was up a modest 3.6 per cent in the month with U.S. markets now eclipsing the TSX on a year-to-date basis.

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The closure of the Strait of Hormuz is having significant economic impacts around the world. The most susceptible areas are energy-deficit geographies reliant on imports from this area: Europe, which shut down a significant portion of their own production systems, and many parts of Asia. A year ago, I wrote about investing outside of Canada and the U.S. I have suspended this investment activity because of the energy impacts, with the exception of Latin American countries. The western hemisphere is rich in natural resources and should benefit from higher prices. Two ETFs I use are iShares Latin America 40 ETF (ticker ILF) and iShares MSCI Brazil ETF (EWZ).

Moving on to spring cleaning, I will provide a couple examples of efforts to upgrade portfolios.

Some personal examples

I sold my shares in Fifth Third Bancorp (FITB), which date back to 2008 and 2013, for an average holding period of 15 years. I more than tripled my purchase price and received a pretty good dividend along the way which averaged about an additional three per cent per year. That’s a decent if unspectacular result.

FITB was trading at about 15 times earnings while only earning approximately 12 per cent return on equity (ROE). It is also in the middle of a major acquisition which adds an element of risk — and an element of upside, if the merger goes well. However, its ROE over the past 10 years has averaged 12 per cent, as was the company it acquired, so it is unlikely to move off that mark much. (Reminder: ROE is the best profit metric for banks and life insurers.)

I added more shares of Mastercard (MA). Our first purchase of MA dates back to 2014 at about $75 per share. It traded as high as $600 eight months ago but has pulled back into the $500 range.

This example illustrates the importance of profitability metrics in performance. MA currently has a ROE and return on assets (ROA) of 210 and 29 per cent, respectively. The ROE has been distorted by share buybacks, but the ROA is reflective and above its 10-year average of 26. It also has a cash flow to asset ratio of 33 per cent. All three profit metrics are exceptional. It trades with a valuation of 29 times earnings and 26 times cash flow, almost all of which is free cash flow with limited capex requirements.

Looking strictly at valuation FITB is better; however, MA has vastly superior profitability. While FITB share price has doubled in a decade, MA has gone up five times. I must give credit to our then university-aged son, who was studying finance, for encouraging the first purchase of MA. Paying about 30 times earnings was foreign to me at the time, and while I knew the importance of profitability (there is a chapter in my book, Stocks for Fun and Profit: Adventures of an Amateur Investor, dedicated to it), only over time does its effect manifest.

Other spring-cleaning efforts include minor paring of Canadian banks and energy stocks. Banks are trading at their highest valuations in a decade, while the Canadian economy continues to struggle. Housing is in decline with average prices down 18 per cent across Canada, and about 30 per cent in a few of our largest urban centres. Delinquencies remain small, but are growing.

Energy stocks a conundrum

Energy represents a real conundrum. As mentioned in my last column, I have sold some energy into the recent strength. Basically, I sold enough so I don’t feel like a total fool if the Strait opens and oil retreats into the $60-$70 range, while holding most of my energy shares for the more likely scenario that prices stay higher for longer.

I sold CES Energy Solutions (CEU) for $18.05 per share, originally purchased for $1.43 in 2021. This is one of my biggest gains ever.

I also sold some ARC Resources (ARX), after the Shell buyout announcement. Purchased in 2018 and 2020 at an average cost of $7.25 I sold for $31.99. ARX also paid a large dividend along the way and was one of my favourite energy stocks.

Not all my spring-cleaning efforts were profitable. I sold NFI Group (NFI) after six years and at a 30 per cent loss. NFI is a Winnipeg-based bus manufacturer. It was once a market darling that hit hard times. I purchased way too early in its turnaround efforts. While it has started to finally make progress leading to a share price resurgence, it still lacks the profitability I am looking for and is in the notoriously difficult auto sector. Turnarounds are challenging.

Nothing guarantees the specific companies I sold won’t outperform the new ones purchased, or that any of these decisions will prove prescient in the end.

However, if we focus on companies with excellent profitability at reasonable valuations, the portfolio will perform well over time.