Danger Zone: Berkshire Focus Fund
Summary A very dangerous fund in one of the most dangerous sectors. This fund holds multiple stocks that have a history of blowing up on investors. BFOCX charges investors far too much for these risky holdings. The Berkshire Focus Fund (MUTF: BFOCX ) is in the Danger Zone this week based on our investment research due to its poor holdings. Looking into this mutual fund’s holdings reveals a number of stocks with the potential to blow up, including some companies recently placed in the Danger Zone themselves. BFOCX has failed to perform this year, gaining only 1.6% year to date. Its poor holdings threaten to erase this small gain and quickly turn it negative. Holdings Always Determine Returns At the beginning of November, I highlighted why the tech sector was a bad investment . On average, the ETFs and mutual funds in the Tech sector provide subpar stock picking and charge you higher fees to do so. BFOCX focuses on investing in the Tech sector, and actually ranks worse than average when it comes to stock picking and annual costs. The Three Biggest Problems With This Fund BFOCX earns my Very Dangerous overall rating because it allocates 15% of its value to three stocks that I’ve recently highlighted as high risk. Workday (NYSE: WDAY ) accounts for 5.9% of BFOCX’s holdings, while Salesforce.com (NYSE: CRM ) and Netflix (NASDAQ: NFLX ) each make up 4.9% of BFOCX’s portfolio. NFLX, WDAY, and CRM are all recent inductees to the Danger Zone. All three of these companies have negative free cash flow , massive amounts of debt, and major profit growth expectations baked into their valuations. WDAY and CRM are two companies that fail to even earn an operating profit despite consistently increasing revenues. The large allocation to these three stocks alone would be reason enough to avoid BFOCX. Unfortunately, the rest of BFOCX’s holdings aren’t any better. Over 86% of the fund’s holdings are allocated to Dangerous-or-worse rated stocks. Not a single Attractive or Very Attractive stock makes it into BFOCX’s portfolio. Other Toxic Holdings BFOCX over-allocates to overvalued companies with low returns on invested capital ( ROIC ) and in some cases low or no after-tax profit ( NOPAT ). WDAY, NFLX, and CRM are just the beginning of its poor holdings. Palo Alto Networks (NYSE: PANW ) and Service Now (NYSE: NOW ) are two other companies with negative ROICs and other issues. Palo Alto Networks has not earned a positive ROIC since going public in 2012. Its NOPAT has declined since 2012 and reached -$44 million in 2014. It has over $700 million in total debt (over 7% of market cap), and has generated negative free cash flow each the past three years. Just like Workday and Salesforce, Palo Alto Networks is growing revenue while NOPAT declines. Making matters worse, PANW’s current valuation of ~$120/share implies that the company will achieve positive NOPAT margins and grow revenue by 25% compounded annually for 34 years. Seeing as how PANW has failed to achieve positive margins in the past two years or grow NOPAT at all, the market’s expectations appear overly optimistic. While this company may be a growth story, its valuation gives PANW a very unattractive risk/reward ratio. Toxic Costs The last issue with BFOCX is something I have long advocated as a crucial issue for fund investors. BFOCX charges investors above average total annual costs of 3.29%. Included in this is 1% in annualized transaction costs due to the extremely high turnover of the fund. In 2014, the average turnover was 460%. Poor holdings combined with high fees make BFOCX a portfolio-killer . Need For Diligence Wouldn’t you like to know where the money you’re investing is being allocated? In the case of BFOCX, the managers are allocating investors’ money to poor stocks. Many of them have high revenue growth but no profits. Growing revenue comes at a cost, and the companies highlighted above also have free cash flow issues, making their future look questionable. Don’t get burned when the cash runs dry and the companies can no longer grow at the pace that the market demands. This trap has already been sprung on investors in AMZN, NFLX, WDAY, and GLUU. Stay out of the trap and avoid BFOCX. Kyle Guske II contributed to this report. Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, sector, or theme. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.