For the second year in a row, 2012 started strong, ended weak, and left us with portfolios up-slightly which held stocks with significant upside to their Fair Values.
In 2012 the Growth Portfolio was up just 2%, the Aggressive Growth Portfolio 3%. My reaction to this return is sadness. I’m really disappointed in myself, I’ve let you down. The S&P 500 gained 13% and my history (before this year) has been that I doubled the stock market returns (good or bad). In 2013, my management of the portfolios is the reason we didn’t perform better. My Top Ten Stocks for 2012 gained an average of 19% yet my managed portfolios gained 2% to 3%.
2012 Q1 was excellent, as the Growth Portfolio gained 31% and the Aggressive Growth Portfolio jumped ahead 34%. Both portfolios dropped more than 12% during the 2nd and 4th quarters, with the 4th quarter’s partially attributed to the Obama victory and tax selling to end 2012. The tax selling was a big drag on 2012 returns as my largest holdings have had big long-term gains.
I was also hurt by short sellers knocking down some of our holdings such as Netflix (NFLX), Green Mountain Coffee (GMCR), Nu Skin (NUS), Chipotle (CMG) and Herbalife (HLF).
Herbalife got the most headlines late in 2012 when hedge fund manager Bill Ackman stated he was short HLF stock and claimed Herbalife was a pyramid scheme. HLF was around $42 before this news struck and proceeded to drop around 15% a day, until I sold it at $29 on December 21st. We had a cost basis of $27 in HLF.
In addition to selling to retail stores, HLF has independent distributors who sell product independently and recruit other independent distributors (getting a cut of their revenue in the process). The issue Ackman has with HLF is moral. He believes the company dupes people into thinking they can be successful selling Herbalife products, yet in real life it is difficult to do so.
The SEC has investigated Herbalife in years past and HLF has passes the SEC requirements. Since HLF also sells direct to retailers, it’s not a pyramid scheme. But the problem now is independent distributors have a January deadline to re-up for 2013 by purchasing product and paying money to Herbalife to continue the journey. With Ackman coming out and saying HLF is a pyramid scheme, I’m sure some will not re-up in January and this will hurt HLF sales and thus cause them to miss earnings estimates. This is why I sold HLF.
Comments on Certain Stocks
The big story of 2012 was Facebook (FB). When FB came out in Q2 at $45 I immediately thought it was worth $20 – and soon it dropped to $20.
What I don’t like about FB is management acts like they are untouchable, that they can blow money and we the investors just have to take it. This is like Google (GOOG) in a way – cocky and arrogant. What I don’t’ like about this is you may not get anything back in the end, like a dividend. By Q3 I thought FB could go to $10.
In the 4th quarter of 2012 I turned positive on FB as the company started putting ads inside the blog of everyone’s Facebook News Feed. This solved the problem of mobile advertising – the ad is now buried in as friends stories are. I started liking FB at $21. Here’s my FB Q4 Fair Value:
The positive response of the new advertising caused a spike in FB before I could react and invest. At the time the market was in a correction, and looked scary. I had four stocks I wished to purchase and started stepping in one at a time, buying Francescas (FRAN), a fashionable young lady clothing store, and GNC (GNC), the nutritional store. Both have been good investments, but I missed FB (now $30) and Ulta Salon (ULTA), a makeup retailer and salon.
My best investments continue to be Apple (AAPL), Priceline.com (PCLN) and Baidu.com (BIDU) and these continue to be my top holdings. During 2012 AAPL rose 36%, PCLN 33% and BIDU lost 14%. All three stocks are significantly undervalued, and if they get to their Fair Values in 2013 it will be a significant boost to our returns.
Part of the reason for my dismal 2012 performance is there is a lack of young growth stocks. As stated earlier, “my management of the portfolios is the reason we didn’t perform better”. We already own most of the best growth stocks, like AAPL, PCLN, BIDU, Michael Kors (KORS), Express Scripts (ESRX), Celgene (CELG) and Lululemon (LULU). I’m paid to find new winners, and am working with what’s left in the market. Some of new investments work, some do not. I made a half-investment in Mellonax Technologies (MLNX) which lost 58%. I also got Quihoo 360 (QIHU) and that’s up 14%. FRAN and GNC are up 16% and 12% respectively. I feel KORS (up 20%) will compound in value the next three-to-five years.
There are two solutions to the problem I’m having with young companies letting us down. One is to over-diversify and increase the positions in the portfolio from 15 to 30-40. That will mean taking funds from AAPL, PCLN and BIDU. These stocks have carried us for years and are undervalued so I’m reluctant to do this. The second solution is to really avoid most of the young growth stocks, and to invest more conservatively.
Shift in the Market
In my 2011 Review I felt 2012 would be the Year of the Dow. The Dow rose 7% in 2012 while the S&P 500 gained 13%. Right now, conservative stocks are undervalued and have less risk than growth stocks. I’ve recently developed a Conservative Growth Portfolio which will invest in some of the most conservative growth stocks in our universe like IBM (IBM), JP Morgan (JPM) and CVS (CVS). My belief is the returns will be lower than the Growth Portfolio, as will the risk. Clients wishing to take a more conservative stance are free to switch to this portfolio, but I feel the Growth Portfolio is significantly undervalued and those doing so now might be selling low. My Top Ten Stocks for 2013 have average upside of 63%, more than double the 30% upside of the top ten stock ideas in the conservative portfolio.
The Market’s Cheap
The stock market (S&P 500) is currently inexpensive from a historical perspective and has huge upside for the next three-to-five years. In a low interest rate environment like this, the S%P should have a P/E of 18. Right now its 14.
This month we have seen positive indications the market has started to rise. First, the Dow Transportation Average broke out of a multi-year base to an All-Time high. Transportation stocks lead the market, because the raw materials are being shipped, to make goods, to sell. Second, we’ve just seen the biggest two week inflows into stocks since April 2000 (source: Lipper). Money is starting to flow into stocks. The faucet is now on.
My gameplan for 2013 is to take profits in stocks if we have a nice spike. The past three years I’ve had gains of 11%, 17% and 31% during Q1. If that happens again I will build cash and wait for opportunities. I will also be more prudent when investing in new ideas. We can be successful sticking with our winners and letting them work.
Thank you for your business,
CEO, Shareks, LLCFor a printable version of this report, click here.