Overall I’m pretty pleased with the ATG portfolio’s performance since inception 5 months ago. We’ve stuck to our guns of investing in 8-10 stocks with a patient deployment schedule (we’re still over 50% in cash), taking some gains in response to quick abnormal up-ticks as well as adding to positions on down movements. For the most part we’ve been able to stay ahead of the major index returns without taking too much risk, carrying responsible diversification without watering down our best ideas, and I believe we’ve done a good job of sticking with the principals of the ATG investment philosophy which I provided in the very first ATG blog post:
- Look for companies that are the best or near the best at what they do and have “moat-like” characteristics.
- Ask yourself if this is a company that you would be willing to invest in for 15 years based on their product, industry, and reputation.
- Pay close attention to a company’s balance sheet and capital investments. A High amount of leverage is not necessarily a bad thing, but make sure you believe the company is properly capitalized to execute their business plan and that they adequately invest in growth and development.
- Once you have identified companies that fit criteria 1-3, filter out the companies that appear to be undervalued relative to their peers and the general market based on factors such as P/E ratio, return on equity, and price to book.
- Pay more attention to how companies perform and the hard numbers than what their executives say or the guidance they provide. As an example, I love buying companies that dip on disappointing guidance and profit beats for the current quarter.
- Once you have picked your investments, track them closely and don’t be afraid to either take gains or cut losses based on the movements of the market. I don’t necessarily advocate short-term trading, but taking advantage of quick, abnormal movements in specific equities is an advantage the individual investor has over institutional investors and mutual funds. I truly believe a disciplined active management approach to specific equities can help an investor mitigate the impacts of larger adverse macro movements and help take chips off the table in a bubble environment.
Having said all of this, the portfolio has taken a major hit the past month, primarily due to two stocks: Enseco (ESV) and Och-Ziff (OZM). Below is a chart showing the performance on these two stocks over the last few months:
It has been a rocky ride- at one point ATG was actually up over 10% in both stocks before they started their painful descent.
Naturally the question comes down what we should do about it. There are three choices:
- sell and move on,
- double down and buy more, or
- do nothing and see if comes back. Let’s break it down individually:
Ensco, PLC (ESV). This is company that owns and operates offshore drilling rigs around the world. They are generally recognized as one of 2nd or 3rd the largest rig providers and pride themselves as having the newest fleet of rigs amongst their competitors. Along with all the offshore rig companies, ESV’s stock has been under pressure lately due to concerns about over-supply of rigs through 2016 which could impact their utilization combined with a dramatic drop in oil prices over the past month. What attracted me to ESV in the first place was their market-leading position combined with a great dividend (6%) and cheap P/E ratio around 9% due to negative buzz on the rigs in general as highlighted below.
I’m not smart enough to know where oil prices are going. They may continue to lag due to international events and the fracking boom, but history suggests a bounce back up. As for the company, I don’t see any negative developments- their utilization rates remain high, an impairment of older fleets on their balance sheet is behind them, and I don’t see any financial burden that would leave me to believe that would force them to cut their 6.9% dividend. At a forward P/E of 7.59, there is plenty of room for slack as supply risk on the rig-side plays out over the next few years. In fact I see this dynamic playing into ESV’s favor over the long run as competitors are currently discouraged from building new rigs and putting long-lead capital dollars to work. To put a long story short, we’re doubling down on ESV.
Och-Ziff (OZM). Och-Ziff is one of the largest alternative asset management firms in the world. In simple terms, they invest billions of dollars in various vehicles on behalf of large institutional investors and charge both asset management fees and performance fees. Their recent drop has been due to:
- Negative publicity surrounding a lawsuit involving bribery and fraud (see moMANon’s prior post detailing the issue);
- Calpers’ recent announcement (Calpers is the largest pension fund in the country) that they are exiting the hedge fund arena due to excessive fees and monitoring costs and
- Lackluster fund performance. Through August, their three funds have reported paltry YTD returns of 2.57%, -1.47%, and -4.25%.
Despite all the bad news above, OZM is still making money and attracting fund inflows ($400 million in the last month alone). Last quarter’s earnings surprised to the upside, there’s excess cash flow to cover their 6.6% dividend, and if they can improve fund performance over the remainder of the year there could be additional performance fee distributions at the end of the year. In fact, the consensus forward P/E ratio for OZM is an astounding 6.75, which is less than half of what the overall S&P is valued at currently.
When faced with disappointing stock picks and what action to take, I try to step back and apply the investment principals at the top of this post before making a decision.
In this circumstance it has led me to hold my faith in ESV (passed all 5 criteria) and question whether OZM belongs in the portfolio. Given OZM’s weak fund performance and negative publicity, I question whether they can sustain their position as a market leading money manager with moat-like characteristics. There is a decent chance their performance and reputational issues are a temporary blip and this is the perfect time to buy into their stock, but I’m strongly considering pulling the rip-chord and switching them out for a group like Blackstone (BX).
moMANon- speak now or forever hold your peace!