CWS Market Review – December 28, 2018

“If you can keep your head when all about you are losing theirs….” – Rudyard Kipling

It’s as if the stock market sat on its allotted volatility for the entire year, like vacation days, and is now frantically trying to use it all.

On Monday, Christmas Eve, the S&P 500 plunged to its lowest close in 20 months. On Tuesday, the market was closed for Christmas. Then on Wednesday, Boxing Day, the S&P 500 had its best day in seven years. The Dow soared, gaining over 1,000 points for an all-time record.

Then on Thursday, the stock market started off soggy but staged a frenetic turnaround. In the final 86 minutes, the Dow surged 810 points. Those were the first back-to-back gains we’ve had all month.

Confused? Don’t worry. In this week’s CWS Market Review, I’ll try to make sense of the chaos. At least, to the extent that that’s possible. But first, let’s discuss next year’s Buy List.

The 2019 Buy List

On Christmas Day, I sent you the 25 stocks for 2019 Buy List. Here they are again:

AFLAC (AFL)
Becton, Dickinson (BDX)
Broadridge Financial Solutions (BR)
Cerner (CERN)
Check Point Software Technologies (CHKP)
Church & Dwight (CHD)
Continental Building Products (CBPX)
Cognizant Technology Solutions (CTSH)
Danaher (DHR)
Disney (DIS)
Eagle Bancorp (EGBN)
FactSet Research Systems (FDS)
Fiserv (FISV)
Hershey (HSY)
Hormel Foods (HRL)
Intercontinental Exchange (ICE)
Moody’s (MCO)
Raytheon (RTN)
Ross Stores (ROST)
RPM International (RPM)
Sherwin-Williams (SHW)
Signature Bank (SBNY)
JM Smucker (SJM)
Stryker (SYK)
Torchmark (TMK)

The five new stocks are Broadridge Financial Solutions (BR), Disney (DIS), Eagle Bancorp (EGBN), Hershey (HSY) and Raytheon (RTN).

The five sells are Alliance Data Systems (ADS), Carriage Services (CSV), Ingredion (INGR), Snap-on (SNA) and Wabtec (WAB). The new Buy List goes into effect at the start of trading on January 2, the first trading day of 2019. For track-record purposes, the 25 stocks are assumed to be equally balanced based on the closing prices as of December 31.

I’ll send you an email on January 1 with all the details. I’ll also summarize the results for the 2018 Buy List. With two days left, our Buy List has a very, very, very tiny edge over the S&P 500. We’re down 6.83% for the year compared with a loss of 6.91% for the S&P 500. That doesn’t include dividends, but the final numbers will. (The Buy List yields a little less than the market, but our dividends have grown faster.)

I should add a few caveats. One is that in May, we were trailing the market by 3%. We’ve made up a lot of lost ground since then. Also, this has been a very difficult year for stock-pickers. An indicator to watch is the equally weighted S&P 500 versus the regular cap-weighted index. This year, the equal-weighted index has lagged, which means fewer stocks are reaping the gains. Considering the fractious environment we’ve been dealt, I think we’re doing quite well. Fourteen of our 25 stocks have beaten the market. The problem is that we were weighed down by two 40% losers this year. Both are being sold.

The Five Sells

Now let’s discuss the five sells. Deciding what to sell is one of the most important and least-discussed issues in finance. Probably the worst investor in the world is the person who buys a stock at, say, $30 per share and then finds the stock is hanging around $27 or so. The investor doesn’t want to take the loss, so he or she holds on needlessly. As painful as it can be, the best way to sell a stock is to sell it. Just let it go. Be ruthless and focus on your next move. That’s why I think our once-a-year approach works for us.

The most common reason why I decide to sell is a stock is that it turns out to be something quite different from the company I bought. A good example of that is Wabtec. I like this company a lot, but we have to face the reality that once it combines with GE Transportation, it won’t be the same old Wabtec. Maybe it will be better. I certainly hope so, but it’s not the stock we bought. Companies are dynamic entities, and they change.

I should add that there are times when the acquiring company is quite good. A good example is Becton, Dickinson. The only reason why we have BDX is that they bought out CR Bard. After looking at the details, I thought BDX would be fine for us, and it’s been a decent performer for us this year.

Two more stocks that didn’t turn out to be what I thought they were are Carriage Services and Ingredion. Carriage was a bit of an oddball selection for us, but you need to comb through overlooked areas to find bargains. The problem is that I no longer have faith in its management. Their forecasts were far too optimistic. I should have been more skeptical. The same holds for Ingredion, but I think it’s a better company. Still, the company lowered guidance a few times this year. You can see why I rave so much about companies like Fiserv or AFLAC. They never let down investors like that. Again, I should have been more discerning.

There are times when I’ll let a stock go simply because I think it’s overpriced. Sometimes, I may be premature on my value judgments. That happened last year with both Heico and Microsoft. What happened? Both had very good years in 2018. Just because something is expensive doesn’t mean it can’t get more expensive.

This leads me to another rule: don’t get too stressed out about the performance of a stock you’ve sold. Trust me, I’ve wasted far too much energy on this pointless endeavor. That’s history, and you should move on.

Alliance Data Services is another example of a company that soon will no longer be what it was. The company told us as much. ADS said it’s doing a top-to-bottom analysis of its business, and it may restructure its operations. Again, I wish them well, but the question for investors now is about how well management can transform the business instead of the business itself. I understand that these tough decisions have to be made, but I’d rather look for proven winners.

With Snap-on, I heard too many bad stories about the relationship between the company and its franchisees. The stories were often very similar. Many franchisees feel they’re being taken advantage of. I know there are many who don’t feel that way, but I think the risk with SNA is too great.

Since we have 25 stocks and we change just five each year, that means the average holding period for a stock is five years. (Incidentally, our 20% is absurdly low for an active portfolio, but it’s not that far from the 5% or so of the S&P 500.) Knowing that we hold each stock for an average of five years really forces us to concentrate on each position. Are we comfortable having this on the Buy List every day for a half a decade, on average? That’s a good way to scare you off from Wall Street’s latest fad.

The Five New Buys

Now let’s turn to the five new guys. Honestly. I’ve wanted to add Disney (DIS) for years. Many investors love Disney, and it’s easy to see why. It’s one of the strongest brands in the world. Charlie Munger described Disney’s business as like an oil company that can put the oil back in after its done drilling, and drill it out again. No matter how technology changes, Disney always finds a way to use it to profit from its old merchandise.

As much as I like Disney, the stock hasn’t done much over the past five years. The recent selloff gives us a good opportunity. One issue that bothered me was Disney’s ESPN division. Cord-cutting has taken a toll on ESPN, but the lower share price mitigates some of my concerns.

Hershey (HSY) is another great brand that hasn’t done much over the past four or five years. HSY is another defensive stock like Hormel or Church & Dwight. The stock currently yields over 2.7%, and Hershey has raised its dividend for the last several years in a row.

I was strongly leaning towards adding an aerospace/defense stock this year. There are some very good stocks, and I think the prices are quite good. Frankly, it was tough to decide between Raytheon, General Dynamics and Lockheed Martin. After speaking with people in the industry, I decided Raytheon (RTN) was the best stock. This is a very solid company. What I like is that there really aren’t many companies that can do what Raytheon does. The company is in the category of not-a-monopoly-but-kind-of-is. The stock currently yields 2.2%.

Speaking of monopolies, Broadridge Financial Solutions (BR) has market dominance in the field of proxy voting. It’s a great business to be in. Plus, the shares are currently down 30% from their 52-week high.

Eagle Bancorp (EGBN) is a small Maryland-based bank that’s well run. I always make the Buy List changes known before the end of the year so no one can claim I play games with timing. Unfortunately for the track record, Eagle jumped 6% on Wednesday (Disney was up 5%), and none of that counts for our track record. Even with the rally, Eagle is only going for 11 times 2018 earnings.

Also in 2019, Danaher will spin off its dental business as a publicly traded stock. That company will remain in our Buy List for the rest of the year. We’ll decide what to do with it next December.

Don’t Let the Market Scare You

I wanted to say a few words about the recent stock market. Obviously, it’s been highly volatile, and I won’t predict that the selling is over. However, I think the worst is probably over, and it’s reasonable for investors to act as if it were.

In most bear markets, the damage is concentrated in a short time period. This time, the S&P 500 lost 15.7% in 14 trading days. Even if we go lower, I doubt we’ll see another stretch quite that bad.

Please keep in mind that bear markets often have false rallies. Many of the best days in market history have come during bear markets. All that selling causes a massive reaction, but it doesn’t spell the end of the correction. Don’t be fooled. We’re going to see more volatility. Things will start to settle down once we cross above the 200-day moving average.

Bear markets are a natural part of investing. Expect a few more retests. Bear markets are usually over before anyone realizes it. It sounds obvious to say, but bull markets always start at the bottom of bear markets. The last few weeks have given investors a lot of bargains. This isn’t the time to get scared of them.

That’s all for now. Monday is the final trading day of the year. The stock market will be closed on Tuesday for New Year’s. On Tuesday, I’ll send you an email summarizing our 2018 Buy List. On Wednesday, we’ll get the ADP payroll report. Thursday is jobless claims and ISM. Then Friday is Jobs Day. Also on Friday, RPM International’s fiscal Q2 earnings are due out. Wall Street expects 68 cents per share. Be sure to keep checking the blog for daily updates.

I want to wish everyone a happy, healthy and profitable new year.

– Eddy

Posted by on December 28th, 2018 at 7:08 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.