Day 282: How I Made This Portfolio


Mother's Little Helper portfolio was UP today +$4,322.61 (+0.51%).

Overall GAIN YTD: +$268,380.49 (+45.96%).

Our benchmark index, the S&P 500 is up +13.35% Year To Date.

http://money.cnn.com/data/markets/sandp/

In a previous post I discussed questions I've received about how I selected the stocks that are in the portfolio. The best way I can explain it is with the info-graphic below. I think every portfolio should have what I call structure. Don't confuse structure with diversification, that's like saying twins are the same; their similar and related but not the same. Because of the amount of detail I'm going to cover I'm splitting this post into two parts.

What's Structure

I don't know anyone who uses the term structure to define a stock portfolio. I wasn't trained in traditional stock analysis so I had to figure this out on my own terms, which has lead me to create some of my own language too. I guess I borrowed a little from my architecture background. I could adapt my language and use all the same terms that you hear and read in financial news but that's not me; I don't think that way and the purpose of this post is to help my readers get inside my head and understand how we got here with a portfolio that is about to cross the +46% threshold.

In it's simplest form structure is how I remind myself to select companies that by themselves are good, but together in a portfolio form a stronger framework that makes them great. Diversification is about spreading out your risk which also has the unintended consequence of lowering your returns. Diversification has a bigger negative impact on me personally, it distracts me. The greater my diversification the more distracted I become from the big picture of what the portfolio is suppose to be doing.

Structure, as I define it, is a process of selecting good companies within a theme, learning their business in depth and then weaving the themes together the way re-bar interlocks in a foundation. A web of themes will benefit from the growth drivers in the greater economy. With structure I'm not hedging my potential mistakes I'm looking to put growth into hyper-drive. I can sell a mistake faster than I can rebuild a portfolio with good structure.

Warren Buffett famously stated that

"diversification is protection against ignorance. It makes little sense if you know what you are doing." In Buffet's view, studying one or two industries in great depth, learning their ins and outs, and using that knowledge to profit on those industries is more lucrative than spreading a portfolio across a broad array of sectors so that gains from certain sectors offset losses from others. - quote from: Investopedia.com

Theme 1 - Building a foundation

Start at the bottom, climbing is hard but it hurts less than falling from the top.

At the base of our structure is a group of stocks that were all selected from the DOW 30 component list. While there are other DOW stocks in the portfolio, these seven were selected for specific purposes. They all pay a nice dividend, they all showed potential for growth and they could all benefit from the new administration in Washington. They all have another characteristic that makes them part of the web of my structure, at times they have been safe havens where money rotates back to when growth stocks get a bit too rich or when geo-political events spook the markets.

Theme 2 - Staying Healthy

At the time I was creating this portfolio healthcare stocks were in the toilet and the campaign trail looked a lot like angry villagers carrying torches and pitch forks to get the beast that is drug companies. My view is that the best way to lower healthcare costs is to keep people healthy. To that end I began with UnitedHealth, the 800 pound gorilla of healthcare services and also a DOW component weaving it back into the foundation group. The biggest resource consumed by UnitedHealth is people, 230,000 people and AMN Healthcare is the big dog when it comes to supplying healthcare professionals. Once facilities, insurance plans and staff are sorted out you need a lot of equipment to fill those healthcare facilities. Trying to figure out which medical device companies would be the best for the portfolio was a challenge. To simplify it for myself I thought about every trip I've every made to a hospital, clinic, senior center or veterinary hospital. What's the one thing they all do for every patient, check your pulse, heart rate and oxygen content. Masimo is only a $4.5 billion dollar company, not exactly a giant when you look at a company like Thermo Fischer at over $77 billion; but I saw some thing in the company that showed more potential for growth, I liked their focus and I liked the way it tied up the web. Continuing with my staying healthy theme, the next thing we need are the drugs used to treat the patients. This was the hardest part of the entire portfolio because there are just so many choices. Ultimately I selected companies that best suited the portfolio versus companies that sold the most pharmaceuticals. My first pick was Pfizer, a DOW component and at $215 billion dollars is the worlds largest drug maker. CEO Ian Reid has also been proactively communicating with President Trump how competition in the drug industry is what will drive costs down the fastest. From mega size to mega innovator, my next choice had to be Celgene. I think of Celgene as the venture capital firm of micro cap biotechnology. Celgene Corporation is a global integrated biopharmaceutical company primarily engaged in the discovery, development and commercialization of innovative therapies designed to treat cancer and immune-inflammatory related diseases in patients with limited treatment options. Celgene is developing treatments in one of the most important areas of healthcare, cancer. And no where in that description did they say, "Drugs have to be made in our labs". Since 2000, Celgene has acquired 12 companies. Since 2007 Celgene has invested in 37 companies. Year to date Celgene has appreciated over 26% through organic and acquisition growth. Next I looked at small biotech with a focus on the very latest developments in cancer research, immunotherapy. Dynavax was a standout located right in my backyard in Berkeley, CA. Dynavax Technologies Corporation, is a clinical-stage immunotherapy company, focuses on leveraging the power of the body's innate and adaptive immune responses. DVAX was once the poster child of what was wrong at the FDA which put the company on the top of my list under the Trump administrations promises to streamline the agency. Today DVAX is a darling of the healthcare sector up over 483% year-to-date due to the successes of their clinical trials and efficacy of their new drugs. My next selection was really hard because it became an either or choice but I'm glad I went with Omeros. Omeros Corporation, a biopharmaceutical company, discovers, develops, and commercializes small-molecule and protein therapeutics, and orphan indications targeting inflammation, coagulopathies, and disorders of the central nervous system. The company markets OMIDRIA for use during cataract surgery or intraocular lens replacement. According to the non-profit Prevent Blindness America, there were 24,409,978 cases of cataracts in the United States for 2013. Over 3.6 million cataract eye surgery procedures are conducted annually in the United States with the number expected to grow. The wholesale acquisition cost for Omidria is $465, and for Part B patients, Medicare reimburses at wholesale acquisition cost plus a 6% handling fee, followed later by the average selling price plus 6%. My take at the time I selected Omeros was, this is a cash register with an ever growing customer base. I like the business, I like the product, it's not that expensive for all the good it does and doctors love it. OMER is up over 124% year-to-date. My next choice was also a small biotech company headquartered in Tel Aviv, Israel, RedHill BioPharma. RDHL is a specialty biopharmaceutical company, which primarily focuses on the development and commercialization of late clinical-stage, proprietary, orally-administered, small molecule drugs for the treatment of gastrointestinal and inflammatory diseases, and cancer. What I like about RDHL is that they have several key products in late stage development, existing revenues, good partnerships and several catalysts that are just beginning to unfold. Hopefully I wasn't too early on this one, early is the same as being wrong.

Theme 3 - Stealth Growth

If you listen to the financial news you might think that the whole US economy is at the mercy of five companies, but in reality there is tremendous growth in many parts of the US and global economy. National Beverage and Constellation Brands were two of my first thoughts, I chose National Beverage. National Beverage is a 100+ year old beverage company that specializes in waters, juices, soda and energy drinks making their products less subjected to changes in consumer taste and has a potentially larger target market vs. Constellation Brands which is focused on beer, wine and alcohol. Both companies have performed well, but at the time I was buying shares National was not loved as much and I got a better price for what looked like similar growth; I was wrong, National Beverage has grown 120% YTD and Constellation has grown just 31.22%. My next choice was based on an aging population and the millennial generations penchant for experiences. Having been on some cruises I will attest to both, it can be a great way to travel. Best in class, Carnival Cruise Lines. With shares up over 25% YTD I'm pleased with the choice and hope to get on a boat again soon. The Children's Place was a tough call. I was looking for a retail name but retail everywhere looked horrible. PLCE has a history of keeping costs down, quality up, stores are loved by customers and earnings have a habit of beating estimates. The one thing about kids clothes is that it's pretty hard to buy them on Amazon, you really need to take the kids to the store and try stuff on; Children's Place wins on this metric regardless of mall traffic. At the end of last year I was reading a report on the massive increase in the number of sub-prime auto loans. Yeah I need to get a life. On first pass this looked like another failure of the banking industry to diversify their risk, then it dawned on me that many of these loans are being made on used cars as well as new. All this got me thinking about the used auto industry, insurance companies, buying and selling of all those trade-ins and wondered, who benefits from all those transactions? Copart became the next addition. headquartered in Dallas, Texas, Copart is a global leader in online vehicle auctions, and a premier destination for the resale and remarketing of vehicles. Copart’s innovative technology and online auction platform links buyers and sellers around the world. Copart currently operates more than 200 locations in 11 countries, and has over 125,000 vehicles up for auction every day. All those used cars need a lot of parts as do new cars and trucks. The auto supply retailers were already looking expensive so I went looking for the company selling gold pans to miners, the stealth auto parts play. This hunt turned up Dorman Products. Dorman hasn't been a big success for the portfolio so far, but this may change by year end due to hurricanes Irma, Harvey and Maria. "New Since 1918", Dorman Products is a leading supplier of original equipment dealer "exclusive" automotive and heavy duty replacement parts, automotive hardware, brake parts, and fasteners to the Automotive and Heavy Vehicle Aftermarkets. I kept seeing the ads on TV and had to take a closer look at NutriSystem. While NTRI takes a 2nd row seat to WeightWatchers, NutriSystem is the number 1 home food delivery service; which I thought was impressive given all the food delivery startups that were coming on the market. With Nutrisystem’s focus on innovation, data-obsessed, technology-loving CEO Dawn Zier NTRI looked more and more like a winner and the financials proved that out. NTRI is up over 67% YTD. Harman Industries came out of all the auto research I was doing. Most of us think of Harman as an audio company (Harman Kardon) but Harman is integrated into innovative auto technologies and is a leader in the connected car space. HARMAN designs and engineers connected products and solutions for automakers, consumers, and enterprises worldwide, including connected car systems, audio and visual products, enterprise automation solutions; and connected services. In March Samsung Electronics purchased Harman for $112/share cash, a premium to our cost. Millenials love experiences over stuff and travel over roots which led me to Thor Industries, the maker of best in class RV's in every class of RV. Unless the motor-home or trailer says Winnebago on the side, it's probably built by Thor. I love this company, great management, an impeccable balance sheet, hardly any debt and as consistent as the sun rises. Up atmost 22% YTD, I bought Thor for myself and expect that I will always own it. The next names weaves in and out of multiple themes, it's a prime example of structure because it creates a web between themes. ULTA Beauty has been a hyper-growth story for a while now but YTD is down over 13%. Ulta is at teh center of the selfie millennial generation and their need to look great all the time. But facing stiff competition from Amazon and other online retailers Ulta took a big hit after an earnings miss. However I'm still confident in Ulta's management and their omni-channel distribution strategy. Ulta will return to growth but maybe not in time for the year end close of this portfolio. With an increasing number of people looking to get advanced degrees or travel while working on an education I came back to this core theme of growth and the millennial generation by adding Grand Canyon Education. Grand Canyon Education Inc. is a regionally accredited provider of online post secondary education services focused on offering graduate and undergraduate degree programs in its core disciplines of education business and healthcare. With a nearly 55% return YTD I think this theory worked out well. One of my favorite stealthy growth companies is Cognex Corp. Up over 80% YTD I have reason to like this stellar company. Cognex Corporation is the world’s leading provider of vision systems, vision software, vision sensors and industrial ID readers used in manufacturing automation. Cognex vision helps companies improve product quality, eliminate production errors, lower manufacturing costs, and exceed consumer expectations for high quality products at an affordable price. Typical applications for machine vision include detecting defects, monitoring production lines, guiding assembly robots, and tracking, sorting and identifying parts. Integrated through all these products and services is a busy system of delivery. Products ordered online from a multitude of vendors, documents for a cruise being sent to a customer, marketing materials being sent from a beverage company to a retailer, the list goes on and on as Stamps.com becomes another part of the growth theme and overall web of the structure. Stamps.com is a leading provider of Internet-based postage services and has delivered an 86% return YTD. Stamps.com’s online postage service enables small businesses, enterprises and online retailers to print U.S. Postal Service-approved postage with just a computer, printer and Internet connection, right from their home or office. The Company targets its services to small businesses and home offices, and currently has PC Postage partnerships with Avery, Microsoft, HP, the U.S. Postal Service and others.

It's easy to see someone drinking a National beverage, in their Harman connected car on the way to Carnival Cruise Lines, applying ULTA cosmetics so that the selfies look great, taken with a phone that was inspected by Cognex cameras and lasers, as they board the ship, where for the next week they will enjoy amazing experiences while working on an advanced degree from Grand Canyon University and when they get home various products ordered online will have been shipped to their door using stamps.com. That's structure.

I'll get to the other three themes and the cash position in my next post.

Stay Invested

Clay Baker

Disclosure: I am personally invested long in these stocks that appear in the MLH portfolio and may purchase or sell shares within the next 72 hours. I am also invested in other stocks that do not appear in the MLH portfolio: BA, BRK.B, CELG, CSCO, CTXS, CVX, DOW, DVAX, FB, IBM, NTES, NVDA, OMER, PFE, PG, RDHL, SCHW, THO, TWX, VEEV, VZ, XLNX, XOM

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is not intended to offer investing advice, guarantee 100% accurate predictions, or to be interpreted as providing a personal recommendation.

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This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice.
This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities.

© 2016 by Clay Baker all rights reserved