Day one of the SLO is in the books. I was pleased to be able to enter buy orders for the stocks I wanted to buy and even squeeze out a very small gain for the day after 'commissions.' I didn't read the commission rates carefully enough, at 5 cents a share buying a 3 dollar and change stock (Northgate Minerals) for the portfolio probably wasn't the smartest move.

All the initial buy orders filled except Rubio's, which is a small cap, thinly traded stock and there wasn't enough volume to completely fill the order under Marketocracy's algorithm. The mix of stocks was enough to get the portfolio compliant under the system rules.

My initial set of buy orders would have left the portfolio about 30% in cash. I had a chance to check on things mid-day and put a little of the cash to work in GSF and PSEC, which had both fallen quite a bit since the open. That leaves me with just under 28% in cash to put to work as bargains pop up. GSF recovered some during the day, but PSEC remains one of the losers.

Comments: View Comments |  Tuesday July 31, 2007

In case you haven't read my profile, I'm an engineer in my late 40's. I've been following the stock market to some degree and investing in mutual funds for a little over 20 years. Lately, I've been shifting my retirement portfolio from mutual funds to individual stocks - I believe an individual can beat the pros since we don't have the 1-2% management fee headwind to fight year after year. As part of that process, I'm taking advantage of opportunities like the Strategy Lab Open to practice and learn more about stock picking. Like everything else, I believe practice improves performance. My primary goal here is to learn, both from practice and observing what other players are doing. Hopefully I'll be able to share some of what I learn in the process.

The investment approach for my SLO portfolio is best described as a blend of value and growth at a reasonable price. A large portion of the portfolio will be invested in dividend paying stocks with good prospects for increasing the dividend over time. The factors I look for in core holdings are good current dividend, reasonable earnings growth, fairly low payout ratio, and a history of raising the dividend. The portfolio will also include some growth and cyclical stocks. I also won't rule out swinging for the fence with a small piece of the portfolio if a compelling opportunity presents itself. I don't expect this approach to be in contention for the top (or bottom) spot, but I believe it is consistent with someone my age building a foundation for retirement.

The initial buy orders should put the portfolio at close to 40% core dividend paying stocks, 30% growth and cyclical and 30% still in cash. I expect to put most of the cash to work over the next month or two, but want to be in a position to take advantage of any 'fire sales' that may occur.

The initial stock picks and rationale behind the selection are:

Core dividend paying stocks (about 40% of the starting portfolio)

WFC
Wells Fargo offers retail and commercial banking, insurance and investment services. The company trades at a forward PE of 11.1. The dividend yield is 3.7% with a payout ratio of 43% and WFC continued their track record of raising the dividend by recently upping the payout from 28 cents to 31 cents per share. WFC is the only major bank in the country with the highest credit rating from both Moody's and S&P. Return on assets of 1.82% and return on equity of 19.6% are among the top in the industry.

I believe WFC's price is depressed because of concerns over the mortgage business, they are the second largest mortgage originator in the country. However, company management has done an excellent job of managing the risks by selling off most of their loans and avoiding the riskiest loan types. They've made a habit of meeting or slightly beating analysts' estimates and continue to grow earnings at a double digit or near double digit pace.

RPM
RPM International produces paints, coatings, sealants, and adhesives for industrial and consumer markets. You're probably familiar with some of their products like Rustoleum and Testors glue. They get a fair amount of business from overseas markets. The market cap is $2.8 billion. It trades at a forward PE of 11.8, PEG of 1.14, 0.8 times sales and EV/EBITDA of 8.6 on the trailing twelve months. The dividend payout is 3.0% and they've raised the dividend every year for the past 33 years.

BAC
Bank of America recently raised its quarterly dividend to 64 cents per share. That's a 5.33% yield. It will take the payout ratio up to about 50%, not great but still leaves some cushion.

At the 15% tax rate for dividends, the yield is equivalent to almost 7% taxable assuming a 35% tax rate. In order for this stock to go down relative to the market from here, you've got to believe the dividend is in jeopardy, which it isn't.

BAC is trading at a forward PE of 9, a PEG of 1.3 and 1.6 times book.

CVX
Chevron is the second largest integrated oil company in the U.S. Forward PE of 10, analysts only project about 5% earnings growth over the next five years, but I believe oil prices will stay higher than what's in the analysts' models. EV/EBITDA is 4.7, which would make someone interested in buying it out if it wasn't such a large company. Pays a dividend of 2.7% and has room to raise that.

T
AT&T forward PE of 12.6 and projected earnings growth of about 8% over the next five years. Pays of dividend of 3.6%.

PSEC
From the company's investor relations web page; "Prospect Capital Corporation is an energy finance company focused on investing mezzanine debt and equity into energy-related companies. Areas of interest include upstream, midstream, and downstream/power companies and assets, as well as other energy-related businesses that transact with the direct energy value chain. Prospect Capital typically seeks investments in the range of $5 million to $50 million, with the ability to address larger opportunities with co-investment partners." It's a closed-end fund focusing on paying high dividends.

PSEC trades at a forward PE of about 10 and analysts estimate earnings growth of 10% over the next five years. The dividend yield is 9.5% with a payout ratio of 87%. The dividend payout has increased every quarter since the fund went public in 2004.

Key risks to this one include all the news about liquidity and credit quality issues in the debt sector and the potential for rising interest rates.

Cyclical and long term growth (about 30% of the starting portfolio)

GSF
Global SantaFe is an offshore oil drilling company. They recently announced a merger with Transocean (RIG) which will create a dominant market player. At recent prices GSF is the less expensive way to buy in to the new company. I did a rough valuation of the newco on my blog at The Motley Fool here.

GSF currently trades at a forward PE of 8 and PEG of 0.3. The offshore drillers continue to be able to roll rigs over to new contracts at higher day rates. Oil companies are having to reach into deeper waters to produce oil, the RIG-GSF combination will be the big dog in deepwater drilling. GSF pays a dividend of 1.2%, however RIG doesn't so I don't expect this to be a dividend paying stock after the merger.

CSCO
If it moves over the internet, an intranet or a set top box, it's probably moving through Cisco products. This is the dominant player in networking equipment. The price has moved up some over the past couple of months, but I think it still has some room to go further. CSCO trades at a forward PE of 18.7, PEG of 1.46 and has profit and operating margins of 20 and 25% respectively. Earnings growth is estimated to be 15% over the next 5 years. They have over $22 billion of cash with about $6.5 billion of debt. They don't pay a dividend, but are rumored to be considering it. I believe CSCO will trade at $35 - $40 per share by year end.

ARII
American Railcar Industries trades at a fwd PE of 12.65, PEG of 0.73. It pays a small dividend of 0.3%. Profit and operating margins are a little thin at 6.3 and 7.9%, but revenue and earnings growth have been strong. They are one of the few pure plays on railcars and are an industry leader in tank cars. Ethanol is creating demand for tank cars since it can't be transported by pipeline. They had been debt free, but recently took on $250 mil in debt to expand operations. The order book is solid going forward.

NXG
Northgate Minerals is an $800 million market cap gold mining company with actual earnings. Trades at a forward PE of 8. I'm concerned with the potential for inflation in the US and believe the growth in China, India, et. al. will create increased demand for gold both from individuals and governments holding it in reserve.

RUBO
Rubio's operates 160 fast-casual Mexican restaraunts, mostly located in So. California and the US Southwest. For what it's worth, given a choice between eating at Chipotle or Rubio's, my choice would be Rubio's.

The company has no debt and just under 60 cents a share in cash. Forward PE is 22.4, PEG of 1.9 - both a little on the high side. Enterprise Value to EBITDA is 7.8 based on trailing 12 months, price-to-book is about 2.5 and price-to-sales is 0.6. With a little earnings growth, they could be a buyout candidate. Cash flow is plowed back into expanding the business by opening new stores. Rubio's has potential to become a regional-to-national story, but to date expansion has been focused on the Southwest.

For comparable metrics, Chipotle trades at a forward PE of 39, PEG of 1.95 and EV/EBITDA on ttm of 23.2 and p/b of 5.75. So, Chipotle is quite a bit pricier than Rubio's, but also has much stronger predicted growth.

MTSN
Mattson Technology is a small semiconductor equipment manufacturer. It has a market cap of a little over $500 million. Currently trading at a forward PE of 11.9 and PEG of 0.4. They have $147 million in cash, or $2.78 a share, and no debt. The company is focusing on expanding their margins and the last earnings report showed them making some progress. They also announced a $20 million share repurchase program recently.

Edited to add:
Disclosure - At the time of posting, I own shares of CVX, WFC, RPM, GSF, T & CSCO but none of the other companies in my Strategy Lab Open portfolio. Don't think we're required to do that for the competition, but I think it's a good practice.

Comments: View Comments |  Monday July 30, 2007