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Day 295: How I Made This Portfolio 2

Mother's Little Helper portfolio was DOWN today -$3,539.87 (-0.42%)

Overall GAIN YTD: +$263,105.18 (+45.06%).

Our benchmark index, the S&P 500 is up +14.32% Year To Date.

Part 2

This is Part 2 in a series about how I created the Mother's Little Helper Portfolio.

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 above +45% and nearly crossed +46% threshold a few days ago.

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:

Theme 4 - Financials & Close Cousins

I may have gotten this one category wrong. What I was looking for here were companies that would directly benefit from a rising interest rates. Last December the talk in the news was that the new administration would insist on lower rates for longer, but at the same time there was an enormous amount of debt on the Feds books and a need to encourage banks to lend. I think I allowed my contrarian brain to win the debate. While our financial choices have done well, I think we could have done better. In retrospect I would have allocated money to Citigroup, JP Morgan, Morgan Stanley and possibly Key Corp as I think these financial benefit the most from rising rates. Bershire Hathaway BRK-B, I think you just have to own this juggernaut, no matter what your portfolio looks like. I placed BRK.B in my financials because of the large positions Berkshire Hathaway has in this sector, like Bank of America, Wells Fargo, American Express, US Bancorp, Bank of New York Mellon, Moody's Visa, Goldman Sachs and others. Kingstone is an insurance company that seems to continually outperform but never achieves household name status. The stock's price/earnings ratio is at a significant discount to its peers while its sales growth exceeds the industry average. If KINS low P/E was the result of loosing market share I wouldn't expect to see sales growth outpacing the industry. KINS is up 31% for us so far. Mid Penn Bancorp, up 26% YTD, has 23 locations in Pennsylvania that specialize in commercial banking and trust business services to individuals, partnerships, non-profit organizations, and corporations in Pennsylvania. It offers various time and demand deposit products, including checking accounts, savings accounts, clubs, money market deposit accounts, certificates of deposit, and individual retirement accounts. The company also provides a range of loan products comprising installment loans, mortgage and home equity loans, secured and unsecured commercial and consumer loans, lines of credit, construction financing, farm loans, community development loans, loans to non-profit entities, and local government loans. It also offers Internet banking, telephone banking, cash management services, automated teller services, and safe deposit boxes; and trust and retail investment services, as well as a range of personal and commercial insurance products. Pacific Premier Bancorp , up over 15% YTD and operates 25 regional banks in southern California. PPB was a tough choice because it was trading at a premium price (we didn't buy at a discount) but this best of breed regional bank absolutely dominates when it comes to sales growth, consistently showing a sales growth rate about 8X the rest of the industry. Charles Schwab, I've been asked many times why I like this company so much and my answer is always the same, I never heard the name Schwab during the financial crisis. I like the business model, I like the quality of the management and while not a huge growth company I really like the safety of this financial. My secondary thinking was that Schwab would ultimately benefit from all the individual investor money that has been sitting on the side lines. I think this later thesis is just starting to unfold.

Theme 5 - Stealth Tech

Stealth technology are those companies that you probably haven't heard of or just aren't very common to most people. While these names may not be the subject of your dinner time conversation they all play a role in many peoples daily lives. NetEase , up 24.5% YTD, operates an interactive online community in the People's Republic of China. The company operates through Online Game Services; Advertising Services; and E-mail, E-commerce and Others segments. We can't invest in technology without looking at China for opportunities. NetEase is still a screaming buy today as its penetration in the PRC is still growing and has a long runway ahead. If your part of the new, growing middle class in China you most likely have a NetEase account. Management at this gaming and internet services companies just seems to consistently get it right. Every time the stock has sold off it was for all the wrong reasons and has presented investors with several opportunities to buy on a dip. My price target on this company by year end is $300/share and over $350/share over the next 12 months. I own NTES in my own portfolio and now consider it a core holding, I won't sell it. Logitech, designs, manufactures, and markets products that allow people to connect through music, gaming, video, computing, and other digital platforms. My thinking on Logitech was that even if PC sales declined this year, PC accessories like the ones Logitech makes could still show growth. LOGI Price/Sales ratio is below the industry average suggesting that investors are discounting the value of Logitech, but the companies Sales Growth and Earnings Growth are significantly higher than its industry peers. Logitech is simply stealing market share and owning the space and investors don't seem to be taking notice. Our shares of LOGI are up over 50% YTD. Facebook, up over 50% YTD, I think this might be the most important technology company now and over the next decade. Why is it in this portfolio? Growth, Facebook will continue to deliver growth at unprecedented levels for a long time to come. Every company in this portfolio uses Facebook. Most of you reading this blog, use Facebook. When I'm done writing this post I'll post it on Facebook. I think every portfolio should own some shares. Citrix Systems, up over 79% YTD, Citrix Systems, Inc. provides an integrated platform for secure app and data delivery, and network functionality as a cloud-based service worldwide. Citrix is a story about re-invention as they transition from a software company model to a cloud based services company. I've written about Citrix in a previous post so I won't expand here. The company looked under valued to me last December and I still anticipate that Citrix will get bought out, most likely after legislation is passed to free up overseas cash and reduce corporate taxes. Applied Materials up 66% and Lam Research up 79% were significantly undervalued last December. I was looking forward to a growing worldwide economy where technology would be one of the biggest drivers of growth. Technology doesn't just appear, it requires highly specialized equipment and AMT and LRCX are the ones who make that equipment. The semiconductor companies are on fire right now and if their R&D budgets are any indication, competition for future tech is not peaking it's growing. One company alone spent $10 billion on research and development of artificial intelligence. Chip companies have to have the latest and greatest technology to make those new chips for The Internet of Things, Artificial intelligence, Virtual Reality, Autonomous vehicles and much more. Nvidia up over 76% YTD, is one of my favorite tech companies. I first started buying NVDA for my personal portfolio when it traded at $22/share, it closed today at $197.75. I think NVDA could be the most misunderstood stock on wall street. Anytime the stock takes a big drop it's over some minor negative bit of news. Either investors are just looking for a reason to hate this stock or they don't understand why they should own it, forever. I added NVDA to this portfolio because they are in everything. When it comes to 'structure' you can't own any tech stock without owning NVDA. You can't make anything without NVDA. NVDA technology is found in computer graphics cards, autonomous vehicles, crypto-currency mining, virtual reality, artificial intelligence and much more. Last December I estimated that NVDA would reach $200 by year end. Over the next 12 months analysts believe NVDA will reach $250/share. IPG Photonics up over 106% YTD, is one of those companies that touches you every day and you've never heard of them. IPGP makes lasers, sensors and a variety of other products that are used extensively in the materials processing industry, micro machining, telecommunications, advanced scientific applications, medical and many other applications. All those cool new gadgets we all love to buy relied on the performance of IPG fiber lasers and senors to get manufactured. IPGP is at the core of 'structure' due to their interconnections with so many industries and products.

Theme 6 - Buy Out Targets

I probably won't include this theme in future portfolios because it's just to hard to ferret out enough information to decide when a buy out will actually happen. Trying to time a buyout is only slightly more difficult than timing the market itself. Add to that the unpredictable nature of regulators, unknown deal terms and investor sentiment. It's always easier to be a Monday morning quarterback. This also wasn't a category that has strong interconnected fibers through out the rest of the portfolio and for that reason alone I probably should have ignored this group, but I thought it was a good idea at the time. The merger of Dow Chemical and DuPont up over 21% (chart has not updated for merger), provided the portfolio with a nice return. I believe Xylinx up over 18% is one of the most likely chip companies to be bought out in an industry consolidation that has seen some major mergers recently. Time Warner, up about 8%, is working on a merger with AT&T. This merger is the poster child of what's wrong with investing in companies because you think they might get bought out of merge. Regulators hate this one, investors aren't sure they like it, it's just too messy. If Xylinx gets bought out and Time Warner complete their merger then we're big winners, but the uncertainty is killing me and nobody needs that grief in their portfolio.

Theme 7 - Cash

Cash in your account isn't exactly a theme but it plays an important role. The purpose of this portfolio has been to prove a point about buy and hold strategies so I invested 100% of the money. However I knew that the dividends would kick in some cash and if any of the companies were bought out that sale (aka: Harmon) would put more cash in the account. Most investment advisers will tell you that cash creates a drag on your account because it's just cash sitting there not growing. I'm always skeptical of this advice because I've never had an investment adviser who really wanted to see me get rich. So why is there so much pressure from investment advisers to get you fully invested; ummmmmm because they get paid on assets under management, or because they get a commission on sales. The advantage of having cash in your account is that you're prepared for any emergency and for any opportunity. If you need cash today you don't have to sell anything. Likewise if an opportunity in the market presents itself, you don't have to sell anything or transfer money to your brokerage account; you're ready instantly because you keep cash on hand. Nothing is harder than trying to figure out what to sell because you want to buy shares in a great company that has just taken a big dip in price. Rarely can anyone time the market. As a rule of thumb I like keeping between 10%-20% cash on hand. That's a lot of cash, so set your own amount based on how aggressive or conservative you are.

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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