Creating A Rock Solid Growth Orientated Model Portfolio Of Stocks And Equity Funds
Summary Buy monopoly like businesses with a wide moat. Buy quality companies, ideally with a low debt, low PE and high growth. Buy where there is a strong tailwind (macro theme). When creating an equity portfolio I like to screen stocks and funds according to a eight point checklist. I give most emphasis to the first few points on the list, and where possible try to buy monopolistic stocks at reasonable valuations. 8 point Checklist 1) Monopoly or duopoly (“wide moat”) 2) Quality – liquid, reoccurring & stable earnings, low debt 3) Growth – revenue, earnings 4) Value – low PE 5) Dividends 6) High net profit margin 7) Growing sector or region 8) Strong macro theme, or demographics, low household debt I will briefly discuss each of the above points. 1) Monopoly or duopoly (“wide moat”) A stock that has a high market share in their industry, ideally with high barrier to entry (“wide moat”). These stocks have pricing power and usually strong profit margins, and growing businesses. Some examples would be; Stock exchanges Intercontinental Exchange (NYSE: ICE ), Hong Kong Exchange & Clearing House ( OTCPK:HKXCF ) (HKSE), London Stock Exchange (NYSE: LSE ) are three of the largest global stock and derivatives exchanges. Intercontinental Exchange (owner of the NYSE) has more than one-third of the world’s cash equities volume. Globally there are millions of investors, brokerages, and fund managers, all sending a large portion of their trading business into just a few stock exchanges. Just remember that in bear markets stock exchanges do poorly. Internet search engines Alphabet Google (NASDAQ: GOOG ) (NASDAQ: GOOGL ) and Baidu (NASDAQ: BIDU ) dominate this area and are monopolies. Both have such strong brand recognition that it would be hard for competitors to break in to this area. Both are currently reasonably priced (given their growth and monopoly positions), with Alphabet Google PE of 34 and Baidu PE of 35. Google C non voting stock has recently announced a $5b buyback , and Baidu announced a $1b stock buyback in July. Large Aircraft manufacturers Boeing (NYSE: BA ) and Airbus ( OTCPK:EADSY ) dominate the large aircraft market and have orders booked out years in advance. Smaller players such as Embraer (NYSE: ERJ ) or Bombardier ( OTCQX:BDRBF ), and China’s relatively new entrant Commercial Aircraft Corp of China (COMAC) may well pose some competition in the near future. Chip designers/licensees Arm Holdings (ARMF) has an estimated ~85% market share of the chip design business. It is expected to do well as the next big thing (the Internet of Things (NASDAQ: IOTS )), takes off. It trades on a PE of 34. Another top chip designer to consider would be Skyworks Solutions (NASDAQ: SWKS ) currently on a PE of 18.6. Its stock price is $79, with an analyst target of $113. 2) Quality – liquid, stable, re-occurring earnings, low debt Ideally invest in companies will good stock market liquidity, stable earnings, and ideally reoccurring and growing earnings. A quality company will have a good track record of being well managed, and a strong brand name and reputation such as Apple (NASDAQ: AAPL ). Typically the banks are great for reoccurring earnings provided their loan books are growing. Many IT companies such as Microsoft (NASDAQ: MSFT ) collect reoccurring earnings each time they release an upgrade. Finally, check that the debt to total capital ratio is low – preferably well below 50%. For example Google’s is only 4.31% . Also look for a high Net Tangible Assets (NTA), or Book Value. 3) Growth – revenue, earnings Ideally find companies that have both growing revenue and Earnings Per Share ((NYSEARCA: EPS )). This way you know they are increasing sales and increasing profit. 4) Value – low PE I prefer to buy at PEs at or below 10 and sell at PEs at or above 20. I break this rule only if companies or funds have exceptional growth outlook or are a monopoly or market dominator. 5) Dividends I view dividends as a nice bonus and a sign the company has good cash flow. Off course the payout ratio should not be too high, so the dividends are sustainable and grow year after year. Be wary of companies that pay a high dividend but cannot sustain it due to EPS falling or weak. 6) High net profit margin Often the companies with low or fixed expenses, low head count, and smart business models, and/or strong pricing power (monopolies) have the highest net profit margins. These companies can be real cash cows. Many of the earlier mentioned companies in the monopoly section are examples of this. 7) Growing sector or region It is much easier to swim with the tide than against it. Try to chose a sector or region that is growing strongly. Right now that would be US technology. The iShares US Technology ETF (NYSEARCA: IYW ) is an easy and safe way to play this. Another strong sector is the real estate funds such as iShares US Real Estate ETF (NYSEARCA: IYR ). real estate does well when interest rates are low or falling. 8) Strong macro theme, or demographics, low household debt My articles on this can be read here. Demographics and Urbanization , The rising Asian middle class , Chinese electric vehicles about to boom , and Take your PIIC – Philippines, Indonesia, India and China . Finally, the table below give an example of the eight point checklist at work. Intercontinental Exchange HKSE GOOGL BIDU Price as of 3 Nov 2015 US $261 HK $199 US $721 US $195 Monopoly/Duopoly Yes Yes Yes Yes Quality Yes – but high debt Yes Yes Yes Growth in EPS Yes – 19.4% Yes -56.8% Low- 5.92% No- minus1.9% Value – low PE No – 23.8 No – 29.8 No – 34.59 No -35.68 Dividend yield 1.1% 3.0% 0.0% 0.0% Net profit margin Good – 35.9% 59.2% 21.2% 20.79 Growth sector Yes – medium Yes Yes Yes Macro theme Energy & stock trading, IPOs China & HK stock trading Global Internet Search, IoTs China Internet Search, IoTs TOTAL 6.5/8 7/8 6/8 5/8 NB: Intercontinental Exchange got a half point for quality due to its slightly higher debt levels of 20.72% debt to total assets. I would be interested to hear from readers if they know of any stocks that score 8/8 on the above checklist. Thank you for reading. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.