2020.08.17 Trimming TSLA

Today an order to sell two shares of Tesla (TSLA) at $1750.00 each was executed. I sent the order about two weeks ago due to the following issues with Tesla’s stock:

• Elon Musk is an eccentric leader who has been in trouble with the SEC for improper disclosures.

• Tesla’s accounting practices have been questioned as overly aggressive or even downright fraudulent and there has been turnover in the executive suite on – either CFO or controller or Chief Accounting Officer.

• Musk’s employment contract rewards performance of the common shares – I don’t remember the particulars of the rewards – and a manager with a track record of improper share price manipulation being compensated for share price appreciation are not a shareholder-friendly setting.

• Tesla is the most highly valued auto manufacturer in the world with a history replete of consistent profits.

Now, I still want exposure to TSLA in our portfolio:

• Musk is a visionary leader operating a company that is revolutionizing auto manufacturing, solar-powered electricity, and electrical storage.

• As the world becomes more concerned about carbon emissions TSLA is well positioned to become a leader in solar electricity and electric vehicles and I like their ability seize opportunities not yet commercialized.

• TSLA has taken steps to manage its stock’s suitability for inclusion in widely tracked indices (bolstering the profit of the company’s most recent reporting period by pulling forward revenue from selling carbon credits corresponding to future periods and announcing a stock split). Inclusion in such indices would likely require purchases by funds designed to earn the return of said indices. Index funds are very popular with both investors and academics and now control a significant share of all invested capital. TSLA’s addition to the S&P 500 (and potentially the Dow Jones Industrial Average) would likely propel shares of the company even higher.

TSLA has been a portfolio constituent since 2016 when I bought shares for roughly $200 each. After opening Monday’s trading as 2.1% of our portfolio, the execution of today’s limit order reduced our position to 1.7% of the portfolio as of the market’s close. The $3,500 liquidated is more than double our original cost basis (roughly $1650). Though I like the company’s prospect for the future, I plan to write another limit order that would sell another two shares at $2000-2500. Exposure to this company is important, but shares are so richly valued It’d be unfortunate to not take profits.

A Virus Testing Steamroller

Quidel Corporation (QDEL) has potential be one of the heroes of the 2020 pandemic. Correspondingly, the “developer, manufacturer, and marketer of rapid diagnostic solutions at the professional point-of-care of infections diseases and reproductive health,” per the Motley Fool, has more than doubled its market value since January began. Much of this market enthusiasm may be irrational exuberance for the company’s potential market, or each of us may be testing and tracing on a monthly basis for the next few years. Bottom line, QDEL has been remarkably volatile in 2020. For just one unfortunate moment, I failed to adjust my trading strategy.

QDEL performance over the last 12 months, via the Motley Fool.

Selling put contracts is colloquially referred to as picking up nickels in front of steam rollers. You can make a steady living selling put contracts, but it’s risky and the risk can be so severe premiums earned are often not worth the risk.

Below I’ve included a list of my trades in QDEL put contracts. By May 12, 2020 I have made almost $1200 trading QDEL contracts, but, as you can see on the above chart, QDEL had just leaped about $60 from $140 to $200 or about 40% in just a few days. I happily closed my June contract with a strike at $115 for a mere $0.05 per share, but, in my enthusiasm, I turned around and sold another June put with a strike at $170. Sure, $170 was a 14% discount to the market price, $197.82, but almost 50% above the strike I had just closed. Did I really want to buy QDEL at $170?

Almost immediately after my $170 strike transaction closed, I realized my mistake, but so did the market. To compound my error, I held the position for two weeks, even after I opened a more appropriate short position in a June QDEL put with a strike at $145 on May 20th. With $31,500 tied up in the two QDEL short put contracts I was over extended. QDEL was effectively 5.5% of my portfolio when 3% was a more reasonable target.

Yesterday, after QDEL had fallen below my $170 earlier in the week, I decided to address the holdings before they became even more untenable. To close the $170 strike contract I was required to buy it at $21.88 a share. Then I sold another put contract ($145 strike, July expiration) for $12.35 per share. With $29,000 still committed to QDEL, I plan to close the June expiration as soon it is profitable. Let’s root for a rally!

QDEL Transactions through 5/28/2020

If I can get out of the June $145 contract, relatively unscathed, I may be able to salvage this situation. Perhaps I am fortunate to have a cash account. With a margin account, I would be able to enter many, many more positions like this one which may lead to similar errors due to the complication of managing more trades and positions. Paying $2,188 to get out of that position hurt. It still hurts.

Trading Activity May 18-24, 2020

Not as many transactions this week. Much of my capital was occupied with current holdings be they options or strict equity ownership.

On Monday May 18th I sold put contracts for Rollings (ROL) and Fastly (FSLY).

The ROL contract was intended to grow my stake in the pest-control parent of Orkin. Okin is a core position in my portfolio, but I have bee slowly growing my position after the market fell in March 2020. This trade offered exposure to one contract of 100 ROL shares at a strike price of $35 for a premium of $0.50 per share. For those scoring at home, $35.00 was 12% from the $39.70 market price as of the time the trade was entered and the premium’s annualized yield was about 16%.

My current exposure to ROL is now 300 shares owned with 3 contracts that obligate me to buy 100 shares, each, at $35.00. If shares of ROL are greater than $35 at the market’s close on June 19th, I will keep the roughly $120.00 in premiums and my capital - and sell more options of ROL. ROL has not fallen below $35 since the end of March and its low, during the recent market action, was roughly $31.57 on March 23rd.

The FSLY are not as near and dear to me, but I like the company because it is focused on improving cloud computing speed. I bought shares for about $22.90 in mid-April after the put contracts I had previously written had expired. Thanks to the subsequent appreciation of those shares, I now have a handsome 79.47% paper profit (as of Memorial Day 5/25/2020).

This FSLY trade was intended to sell time value on an expiring (May 22nd) contract - queue the nickels and steamroller joke. Contract details: strike $36; expiry 5/22/2020; premium $0.24; I sold two contracts. So I made a bit more than $23 for lending my $3,600 for almost 5 trading days. I can’t take my wife for sushi for that, but its payday loan math - $23 on $3500 is over 47% annualized over 5 days, or 33.7% if you annualize by weeks.

Time out for some real talk - were I able to earn 33% on capital for a whole year, I’d have investors bribing me to take their money. Here’s a reality check:

These are small trades. It is difficult to find trades like this to employ millions of dollars - and I’ve never done it!

I make trades like this (out-of-the money put option sales) on only companies I’d like to own. The above FSLY trade required the market price to fall 14% in 5 days for my capital to be distributed. It’s a calculated risk.

Most importantly, I actually want to own FSLY. If executed, the above nickel/steamroller trade would have doubled the FSLY shares in my portfolio. Since the contracts expired worthless, my stake in FSLY is 1.5% of my total portfolio.

Tuesday, May 19th, saw four trades executed. I sold put contracts on match.com (MTCH) and Beyond Meat (BYND). Then I exchanged a short position in Peloton (PTON) put contracts.

The MTCH contract netted about $23 for its occupation of $7,750 in capital over four days. On a weekly basis an annualized return of 15.7%. This position also hedges against the call I wrote the week prior - if my shares would be called away this contract would expire worthless.

The BYND trade was another expiring contract that paid about $50 for a put contract expiring 5/22 in which the $122 strike price was 12% below the market - with four days to play.

I must not want the PTON shares as badly as I thought! But seriously, the share price had run up quite a bit and this was an opportunity to lower my potential cost basis. Originally I sold a put contract for PTON on 5/12 for $1.05 per share and a $43 strike. That’s a 2% premium yield for roughly two weeks or 63% if you could repeat the trade every other week. $43 was 9% below the market, and the market was running hard.

On the 19th PTON had fallen more than 5% over the past week but my option was more valuable than when I had sold it. I bought to close the first contract for $81 (netting about $23) and wrote another put with a lower strike price. The new contract had a strike of $40 (89% below market) and yielded about 14% annualized on a weekly basis. 14% is below my required return so that one’s on me. I am fortunate it expired worthless at the end of the week.

On May 20th I bought back two US Bancorp (USB) put options. The strike was 15% below the market as USB had appreciated since I wrote the option and the contracts were significantly devalued. After originally selling the puts for $0.29 per share I bought to close them for $0.07. Were the contract expiring that Friday, I may have let them expire on their own, but these contracts were dated for 5/29. By buying to close two (effective) weeks early I have the capital available for another two week trade - and this one still netted about 19% annualized.

Also on the 20th, I sold a contract for Quidel Corp (QDEL) put for $2.80 per share before commissions with a strike of $145. That’s a 23% annualized return on a contract that expires on June 19th. Quidel has had a rough week since the 20th. When I entered the contract, QDEL traded north of $190 per share (needed to fall 24% to reach my strike).

This $145 contract was supposed to replace another QDEL contract with a strike at $170. The contract at $170 remains on my account as I mistakenly tried to wait for a more favorable exit point. As a virus testing company, QDEL has been very volatile during this pandemic and traded at $173.49 as of the close on Friday before Memorial Day weekend. Were the $170 contract executed, my cost basis would be about $161.50 so maybe I will hold contract through its expiration.

On the 21st I went back to the PTON well and sold another contract expiring the following day - which almost makes my previous transaction look silly when I bought to close a $43 strike contract. After commission, this trade provided annualized return of 16.6% over the five days my capital was occupied. This was Thursday before along weekend, I had about $5,000 available to invest in my account and when this contract expired worthless less than two days later I had enough money to take my wife out for coffee (but don’t tell her).

May 11-15th, 2020

Here’s a brief summary of my transactions from last week (May 11-15).

From the week prior, I had seven positions in put option contracts expire. My positions in Beyond Meat (BYND), Square (SQ), Slack (WORK), and Match.com (MTCH) expired out-of-the-money so I kept the premiums and maintained the liquidity. Because US Bancorp closed Friday above $33 but below $36 per share, I was assigned two hundred shares from the two contract I sold with a strike at $36, but my contracts at $33 expired worthless.

On Monday, May 11th, I bought back a contract for 100 DocuSign shares at $0.10 per share. This was a short-lived position due to DocuSign’s strong performance. I originally sold the put on May 7th for $0.65 a share. After the $0.65 commission fee (both in and out of the position), I earned $53.70 over five days while occupying $10,500 of capital (since I only have a cash account, it was really six days because I had to wait for the purchase to settle). While margin account would not force me to ration my capital, the 31.1% annualized return is nothing to complain about.

Also on May 11th, I sold a put for JP Morgan Chase and Peloton. The JPM contract was set to expire on June 12th with a strike of $80.00 for $1.65 per share. The market had been trading JPM at $89.90 at the time I submitted my ask so It would have been a 23.5% annualized return had the shares not fallen 11% in about a month. The PTON contract was just five days from expiration $0.17 per share with a strike of $38 (when shares were trading at $43.25). The value proposition was an annualized 40.8% premium yield (contract price divided by strike price) with 12% margin to execution (spread between market and strike).

Tuesday the 12 of May was very busy - I had capital available after the prior week’s expiring trades settled and I wanted to sell as much time value as possible. I sold a put contract for PTON that expired at the end of the week and contracts that expired in three weeks for US Bancorp (USB) and Salesforce.com (CRM). I closed two put contracts for Rollins (ROL) that expired on the 15th for $0.07 per share to free up capital.

Wednesday, May 13th I sold soon-to-expire puts in Datadog (DDOG) ($0.60 per share on a $65 strike while shares traded for $70.08), two USB put contracts ($27.50 strike with market at $29.90 for $0.07), and a Square (SQ) put contract ($64.50 strike while the market was $72.02 for $0.10). These three transactions only yielded $81.21 after the contracts expired worthless two days later

On an annualized basis, $81.21 on $18,450 over two days is over 80%. Hold on - just because I held the position for two days doesn’t mean I cycled investment on that capital every two days. Consider I wait till Wednesday to take last minute investments on expiring options contracts every week. A weekly return of $81.21 on $18,450 is still 22.9% with the benefit of being out of the market for three of five trading days each week.

March 14th I sold a call on the 100 shares of Match.com in my account (strike at $80 for a $0.79 premium while the market opened at $73.82 and closed at $77.37; May 22nd expiration). Boy was that another mistake. Not only has the market made up the three-plus percent from my call’s strike, but (as of May 21) MTCH is trading north of $84 with one day left till expiration.

MTCH is not a holding I consider to be among my core positions, but we’ve owned it for years - quite successfully - and this will be another lesson in patience.

As the 14th came to a close, made a move in my position in 3M (MMM). My long-term holding in MMM was underwater thanks to the recent market downturn so I sold to realize the capital loss. Ever since, I have had short positions in MMM put contracts to reacquire my shares.

MMM had been trading around $130-140 this week, but the strike price on my option was $155. To initiate my next long position in MMM at a lower basis I bought to close the contract with a $155 strike and sold a put contract with a strike at $140.

The net of repositioning cost me roughly $1,400, but executing at $140 would save $1,500. I had sold the $155 strike contract for $6.50 per share. The market was at $134.57 when I initiated the newest put position. Considering the contract swap was basically free, execution at $140 would result an effective basis of $133.50.

I had a learning experience with Appian (APPN) that seemed to last all week. I held 400 shares when the 11th of May began - with two call contracts written at strikes of $40 and $50. I resolved to let 100 shares go for $40, but bought to close the $50 strike contract (for $2.35 per share). To offset the costs of buying the call at $50, I sold a different call at $55 ($0.45 premium per share) and a put at $45 ($1.90 per share).

On May 14th, APPN had a crazy day. After closing May 13th at $45.58, APPN opened 2.5% lower at $44.42 and promptly fell another 2%. At this point, I was exhausted by APPN’s downward march I sold a call at $45.00 ($0.75 per share premium, it expired in less than two trading days) and took my kids outside. A 3% move in two days is not unlikely so I took a chance to earn an extra $75.

When the options expired on May the 15th, APPN had last traded at $51.10, 17% higher than when I sold my last call option. 400 shares of APPN was more than I cared to hold but, man, I should have diversified the market timing risk by selling contracts with different expiration dates; the 200 shares that were called away after the May 15 close netted a cumulative discount of $1,720 to market value.

https://www.marketwatch.com/investing/stock/appn/charts

Option Closing Day May 8, 2020

Options are closing today, as on most Fridays, but today I have several options expiring - more than usual. Most of the positions were initiated this week, in an attempt to optimize capital utilization. Thanks to limited downside volatility (the value of the underlying companies did not drop below the exercise price), I should stand to clear the premiums on the below positions - roughly $200 on about $35,000 or 32%, annualized. If I could replicate this result every week (assuming I entered these positions this week) I would earn about $11,000 in a year.

Short-held option positions expiring today.

Another position expiring today was initiated for a different purpose. I had been a U.S. Bancorp (USB) shareholder for a long time. Actually I had inherited the holding from my grandmother who held it for decades. With the market downturn in February, I had a capital loss available to harvest (realize a loss to offset gains in other positions for tax purposes). USB is widely recognized as one of the most efficient banks in the world.

As shown below, I sold a pair of put option contracts for a total of $600 with a strike price of $36.00 per share. Since the market price at today’s close will likely be below $36, my broker will assign 200 shares to my account in exchange for $7,200. Effectively, I will own 200 shares at a $33.00 cost basis.

USB, bought at a discount.

Kids Buy Berkshire - I Max out Portfolio Exposure Ahead of Friday's Option Expirations

Just a quick one to get back on the blogging horse.

During the Berkshire Annual meeting, I realized the newly depreciated Berkshire B-shares are in the kids’ price range. Each bought a share for their accounts; they are proud owners of Dairy Queen (among other valuable assets that are not nearly as exciting as Dilly Bars).

Functioning on little sleep, after updating my long-forgotten Quarterly Earnings Calendar Sheet into the wee hours of the morning, I placed 6 orders today - three of which were executed before exhausting my available funds. I closed a short put position in FTNT (glad to also be a shareholder today as FTNT jumped 20%+ on last night’s earnings release). In an effort to pick up nickels - I sold two out-of-the-money put contracts (BYND and USB) that expire at the end of trading tomorrow.

I plan to blog more often; most frequently, a terse summary of the day’s orders. My investment strategy has changed significantly in execution or tactic, but hopefully not in overall, long-term investing strategy. My broker recently added options trading to its offering and I have been using options in an attempt to improve my investment performance. Hopefully a new post will soon be up on the strategy portions of this site - No Promises!

Investing with Children - A Spicy Addition to their Portfolio's Recipe

Our kiddie-capitalists just added a bit of spice to their portfolio. In our last round of family investing, we chose the world’s leading flavor manufacturer McCormick & Company (NYSE: MKC). Though McCormick is a company priced for outstanding performance, I am confident the business will be a staple of our children’s portfolios for many years, if not decades.

This quarter, the children were excited to invest in either Hasbro (NASDAQ: HAS) or Costco (NASDAQ: COST) because they love Hasbro’s toys and games and Costco is our favorite place to shop, but both businesses face significant challenges because their customer’s preferences are evolving toward digital entertainment and online shopping, respectfully. I managed to redirect our discussion to their excitement for cooking (they love to help in the kitchen). On a whim, I spontaneously found five or six different McCormick spices and our bottle of Red Hot and asked if the would like to own the company that makes our food taste delicious. Pro tip: props improve almost any presentation - especially when you pitch to elementary school kids.

McCormick’s business is attractive for several reasons. Not only does McCormick own the spice aisle in your local grocery store, its commercial business supplies spices to food manufacturers and foodservice providers. As we progress through economic cycles, McCormick’s commercial business may weaken as consumers forgo meals out for cooking at home, but this activity will bolster the retail spice and flavor business. As an inexpensive solution to enhance any meal, budgetary constraints are not likely to negatively impact sales of McCormick’s spices and flavors. Further, the business is diversified geographically; only two-thirds of McCormick’s sales are generated in its Americas region.

Though McCormick’s stock is trading at a high earnings multiple, this is a small position (roughly $200 per child) and with the market at such an elevated valuation I am more confident investing in this steady business than a more aggressive position. Further, McCormick’s business generates considerable free cash flow and has raised its dividend every year for several decades.

MKC is a significant position in our family’s portfolio and I am happy to add it to the children’s portfolios. The company has excellent potential, but, more importantly, we don’t have to leave the kitchen for the children to be reminded about the companies they own. Every meal now provides a seamless transition into a conversation about their business and investing.

Disney's Shares are More Tasty than Chipotle's

Actively managing our family portfolio over the past 15 months, I have made some mistakes and had several successes but, most importantly, I have learned and become a better investor. Today’s transactions are the manifestation of my recent resolution to focus more critically on a company’s competitive advantage. 

With the confluence of potentially historic hurricane activity and CEO Bob Iger’s warning regarding lower-than-expected earnings in fiscal 2017, shares of The Walt Disney Corporation (NYSE: DIS) traded lower on Thursday. As a cautious-opportunistic, I executed a measured approach to increase our stake in DIS by 50%. Today I invested half of the new capital allocated to DIS with the residual due to be invested in two weeks (if Mickey’s theme parks are still standing).

DIS has not kept pace with the overall market over the past year due in part to increased competition for its cable television business, but the company’s ability to create, distribute, and license its media properties (especially action blockbuster franchises and family-focused content) provides a unique opportunity for investors. Long-term-focused investors can capitalize during the current market weakness due to uneven growth in revenue and earnings. 

I love burrito bowls, but Chipotle’s (NYSE: CMG) success is difficult to expand and may be more challenging to defend against competition. After buying shares of CMG at $396.35 per share in June 2016, I liquidated our stake at $305.03 and realized a gain-offsetting capital loss. 

CMG prides itself on the quality of its food and service, but recent operational miscues and the tight labor market are significant challenges to attract and retain “top-performers.” Employees of our local Chipotle confirmed staffing shortages delayed new store openings. Though expansion provides employee advancement opportunities, new locations are less likely to be well positioned (a suburban strip mall just can’t compete with the foot traffic in urban areas), and, to fill openings created by redistributing talented employees to manage new stores, CMG may need to relax hiring. New store profitability will struggle to match the profitability of existing stores and may even cannibalize existing sales.

The failure of the ShopHouse concept and uninspired offerings currently in incubation do not encourage confidence in CMG’s ability to expand to different types of cuisines. ShopHouse was a unique concept with potential for mass expansion, but, menu complexity proved a detriment to the customer's’ experience. Now CMG has turned its focus to upscale pizza and burger restaurants which, though not as challenging to operate as ShopHouse, face fierce competition from similar offerings from Five Guys, In and Out, and every town’s local favorite burger or pizza joint. 

Ultimately, I plan to avoid the restaurant business going forward. Restaurants are not difficult businesses to open or operate. Customers have many available direct or indirect substitutes (including services that deliver meal kits or groceries). Most importantly, investing in a restaurant distracts my focus from businesses that are more likely to repel aspiring competitors. 

Here's One for the Family - Gartner, May this New Addition Outlive Me

Wednesday, I added another new position to our family portfolio. In my most recent strategy blog post, I wrote about a podcast episode featuring a conversation with Pat Dorsey, an asset manager whom I greatly admire. One of the businesses he mentioned was Gartner; the consulting company focused on IT. Dorsey used Gartner as an example to describe a business with a moat based on its trustworthy reputation; clients pay for counsel from Gartner because they trust Gartner to provide expert knowledge.

One mention from a podcast guest is not enough to own shares, but Gartner was also a recent recommendation for the Motley Fool newsletter to which I subscribe. The Fool touted Gartner’s recent acquisitions and ability to provide “uniquely valuable services and advice to its growing roster of more than 11,000 global enterprise clients.”

Business durability is one of the characteristics I most admire in a company. I intend to purchase companies with sustainable businesses that have the potential to remain permanent constituents of our portfolio. A business model like Gartner’s is attractive because, like law practices, consulting businesses are built and sustained on culture and reputation. Clients choose Gartner because of their expertise and prestige, but the reputation also attracts talented consultants. This self-perpetuating cycle is a desirable investment.

As with the recent JD.com purchase, I split the expected Gartner investment into two purchases to diversify the cost basis and mitigate exposure to market-timing effects. The Gartner holding is projected to be about one percent of the overall portfolio, so the initial purchase was roughly 50 basis points of the portfolio’s value.

JD.com - A New Position to Fill (or contribute to the filling of) a Hole in our Portfolio

Today I initiated a small, aggressive position in the second-largest online retailer in China. Prior last Friday, when I read the latest Motley Fool Stock Advisor recommendation, I had never heard of JD.com – and now we own it.

With our family portfolio flush with cash but light on aggressive positions, I was ready to buy shares of the next Stock Advisor recommendation with a promising, but far from certain future. There are many risks involved with investments in China from the fits and starts of a burgeoning economy to the Chinese government’s heavy-handed role in their economy. JD.com can grow along with the massive Chinese population which will become the engine to drive their economy.  

The post from the Fool said JD.com’s prime competitor, Alibaba, has struggled to gain customers trust due to its lack of control over the quality of the goods for sale on its site. Alibaba is a platform, but JD.com is a retailer with the opportunity to gain the trust of its patrons through control of the customer experience. Think eBay vs. Amazon.

This position has not been over-contemplated.  I trust the Fool’s research, and JD.com has a specific role in our portfolio. First, the position is 0.2% of the overall portfolio. JD.com should occupy 0.4% of our investable assets, but I like to invest in half-positions to diversify exposure to any given trading day. If the Fool re-recommends JD.com several months from today, I will add to this holding. In Summary, JD.com is an interesting company well-poised to grow with the expanding Chinese consumer-class; if JD.com is half as successful as Amazon.com, today’s investment will have been money well committed; if today’s position is a complete failure, we will live to invest another day.

Investing with Children Update - Third Quarter, 2017

Six months since we started the experiment to encourage our children to become investors, both business owners in training are excited about owning companies they know, and business is often a topic of conversation in our family.

One of the most exciting days as junior business owners came during a recent trip to Yorkdale Mall when we stopped to explore the Tesla (NASDAQ: TSLA) showroom. Both children had fun climbing through the Model X, and the automatic front doors captivated my attention for more time than I would like to admit. We love Tesla for three reasons:

1.  our family’s portfolio maintains a small position (0.71%);
2. we use the company to discuss the energy revolution towards more sustainable sources;
3. Though Tesla has yet to be voted a component of each child’s portfolio, discussing the company is teaches them about the role a promising company can play in a well-diversified portfolio.

This month, the kids chose to buy shares of a more mature business, and Tesla shares will have to wait for a subsequent investment period to be selected by our Baby Buffetts. Instead, our children chose their favorite restaurant for hot chocolate and sweet treats, Starbucks (NASDAQ: SBUX). We like Starbucks because:

1. its business is well diversified through its restaurants and consumer products divisions;
2. management has been progressive regarding the incorporation of mobile ordering and their effort to attract and retain quality employees;
3. demand for Starbucks’ products should not vary much across the business cycle because its cost is relatively low compared to a customer’s overall budget and the customer experience is repetitive if not habit-forming;
4. opportunities to expand through international markets are significant.

If you are keeping score at home, the kids own Disney (NYSE: DIS), Carters (NYSE: CRI), and, now, Starbucks in addition to their Vanguard ETF that tracks the S&P 500 Index (VOO). To learn where our children will invest their next $200, follow my social network profiles, linked below. Binge-watched episodes of Star Wars Clone Wars has been a summer indulgence, so my little astromech is likely to vote for Netflix, but his sister has made a couple strong (yet, ultimately, unsuccessful) arguments for Hasbro (NASDAQ: HAS) so it is anyone’s game.

Our Children Bought Every Mom's Favorite Brand

In January I described our approach to raise our children as investors. We aspire to foster an entrepreneurial mindset of ingenuity, courage, and grit. By involving the children in the stock selection process they will learn how businesses earn money at a young age and may be more likely to seek opportunities to start their own businesses.

To teach a consistent investing process, we invest $200 for each child every three months. For their April investment, our children selected Carter’s, Inc. Our children know the main Carter’s brands – they’ve worn clothing from the Carter’s and OshKosh lines their entire lives. When they see a friend wearing OshKosh clothing, they may be reminded they own part of the company that designed and distributed the shirt or pants.

We own Carter’s because it has strong brands that are recognized by parent for their quality. Since parents or family members are usually making purchase decisions for their children, the children’s apparel market is far less fickle than the more fashion-focused teen retail industry. Carter’s maintains a strong wholesale distribution network through established retailers but has also been successful through the more profitable direct-to-consumer distribution (company branded stores and online sales). Moreover, Carter’s has significant opportunities to expand internationally.

Most importantly, Carter’s is the leader in a business that will likely never fall out of fashion. How could the clothing market for young children be fundamentally disrupted? We will continue to monitor the business’ progress, but, hopefully, our children will own Carter’s the company well beyond the time when our future grandchildren are wearing Carter’s brand clothing.

Worse than Watching Paint Dry: Watching a Paint Company Beat the Market After I Sold It

Sherwin Williams (SHW) is the type of company I look for as an investment: strong advantages over competitors and would-be challengers, consistent growth, and a product that will likely be very similar 100 years from today. And I blew it. Perhaps my investing decision was impacted by an uncertain political environment and seemingly overvalued market prices, but I blew it. My inability to execute a rather complex investment strategy hurt our family portfolio. In an effort to reduce capital gains taxes, I liquidated our SHW position to realize a capital loss and offset a taxable capital gain; before I replaced the SHW shares I sold, the stock rallied 30% from our exit price.

The motivation behind sharing this experience is to force myself to analyze the strategy and my execution, but also help others learn from my mistake. You may read this example and decide a more passive approach is better suited to your temperament and time constraints; perhaps the potential benefits from such an approach are not worth the time and effort required to execute it. Maybe you will be able to learn from my mistake and resolve to execute this approach more efficiently – as I will.

In June 2016, I invested roughly 1.5% of our portfolio in Sherwin Williams at $290.30 per share, but, in October, after two ill-received quarterly reports the stock was trading 15% lower and I liquidated the shares for $246.97. Though my intention was to resume our exposure to Sherwin Williams in November, after waiting a month to avoid a wash sale, I have yet re-establish our position.

After Sherwin Williams’ April 20, 2017 earnings release, shares trade north of $324 per share at a new all-time high. For perspective, shares are up over 31% since October and 12% since my initial purchase in June. Instead I saved a few hundred dollars on our tax bill and invested the proceeds to increase our positions Amazon and Berkshire (both stocks are up roughly 15% since October).

Many hours of research and analysis were devoted to establishing and liquidated our Sherwin Williams stake; I could have shared that time with my family. Do I regret decisions that lost money for my family? Absolutely.  Do I regret forgoing family time to manage our portfolio? No. These are among the trade-offs every investor needs to consider when developing an investment strategy.

Going forward, I will continue to liquidate positions to offset taxable gains, but this experience with SHW is a valuable lesson. My transactions need to be more systematic. Perhaps our portfolio has too many positions, and my strategy execution needs to be more systematic, but I will evolve and improve as an investor through reflection and self-awareness.

Investing in individual companies requires more time and energy than more passive strategies. If you want your portfolio on autopilot, Buffett’s 90-10, S&P 500-cash portfolio may be more appropriate for you. The key to financial independence is maintaining a sound investing strategy.

As this earnings season progresses and the companies we own report their financial results, I will update this blog to document the successes and challenges I encountered. Any questions or comments are welcome. Follow the below links to connect.

Transactions on December 7th, 2016 and Portfolio Guidance

Earlier this week I purchased shares of five separate companies: Match Group (MTCH) and 3M (MMM) were new additions to the family portfolio; Under Armour (UA) and Novo Nordisk (NVO) are positions that were reinitiated after waiting for a month to pass and avoid wash sale status (I harvested short-term capital losses); Proctor and Gamble (PG) is a position to which I added new capital.

Match Group is a small position in our portfolio (roughly 0.38% of total assets), but as a leader in an industry poised for growth I expect the position to grow as a percentage total assets. The company was recommended by the Motley Fool and I am intrigued by the company’s impressive margins.

The capital committed to 3M was just under one percent of the portfolio and provides reliable dividend income and the opportunity for capital gains. An industrial conglomerate best known for making Post-it Notes and Scotch tape, 3M is a dividend aristocrat that I intend to hold in our portfolio for many generations.

Under Armour is an exciting company which I am glad to bring back to our portfolio. Kevin Plank is a leader I am happy to rally around, and, after reading “Shoe Dogs” by Phil Knight, it is easy to compare him to the founder of Under Armour’s top rival, Nike. The new position in UA is a smaller position (1% of assets compared to almost 2% before we sold the initial stake) to allow our portfolio to be more diverse across industries.

Novo Nordisk is another position that has rejoined our portfolio after a month away. The leader in treating diabetes, I like NVO’s future prospects and, while out of the position, we were fortunately not hurt by the poor reception to the company’s most recent earnings report and guidance. Though more volatile than 3M, NVO is another company that helps me sleep well at night.

Adding to the position in Proctor and Gamble allows me to increase the portfolio’s exposure to the consumer defensive sector without the burden of owning another company. I appreciate PG’s renewed focus on its core brand through sales of ancillary businesses, and like its dividend aristocrat counterpart, 3M, I plan this position to be a cornerstone of our portfolio for many generations.

Portfolio Overview and Direction Moving Forward

With the new commitments of capital the portfolio’s cash position has approached my target of 15% of total assets; see the chart below. I have broken out Berkshire Hathaway into its own sector because Burlington Northern, Berkshire Energy, and other non-financial subsidiaries have become such large portions of the business I find it more informative to separate Berkshire from the financial services companies.

A more thorough analysis of the portfolio is forthcoming, but large legacy positions in Wells Fargo, JP Morgan Chase, and U.S. Bancorp remain 18.5% of the portfolio. Despite a recent resurgence in its stock price, I still plan to trim our position in Wells Fargo (currently 10.7% of assets). More capital should be available within the next four months as a few fixed income positions are due to be called; I plan to initiate new positions in companies in the Consumer Defensive and Healthcare sectors; to provide more upside potential, I am also interested in small positions in high growth companies new to the portfolio.

Be Open to Change

I am a buy-and-hold investor. Every stock I purchase with the intent to hold forever. With that disclaimer out of the way, I need disclose I recently liquidated five positions in our family portfolio and further trimmed our position in Wells Fargo. Many of the positions I have initiated since June have depreciated significantly. Some of these under-performing stocks were priced for perfection at time of purchase and have since fallen out of favor with the market; other stocks have experienced significant changes to their business prospects. All of these losses were realized to mitigate taxes as I further reduce the portfolio's exposure to Wells Fargo. In December, when wash-sale rules no longer apply, I plan to initiate new positions in a few of these businesses.

It would be easy to blindly hold Wells Fargo (and the other positions in peril) and hope for the best - this strategy has worked well for 30 years - but before trimming of our stake in Wells its value was over 20% of the portfolio. Investors must be able to trust the managers of the businesses they own. Wells' management created a hostile work environment that drove employees to commit fraud. Tumultuous cultures were also present in two of the liquidated businesses which will not likely return to the portfolio.

To employ excess cash generated by these liquidations I added to our positions in Berkshire Hathaway and Amazon.com. Our stake in Wells remains the portfolio's largest holding, but our Berkshire position is now 15% less than our stake in Wells. Wall Street turned a cold shoulder to Amazon's latest earning report and I seized the opportunity to increase our exposure to one of the world's most intriguing businesses.

Investing is not easy, but through reflection and self-criticism I will learn from the mistakes I have made and will make in the future. I will hone my skills and through patience and experience the investing decisions I make will enable my family's financial security.

Don't Tell Grandma: We Sold Wells Fargo

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If Grandma knew we sold her darling Wells Fargo (though it is was only 1/8 of the position) she might disown me. Since the mid-1980's when Grandma bought a small Minnesota bank that was subsequently purchased by Wells Fargo (WFC), our family position in the bank has appreciated over 3,000%. For perspective, the annual amount in dividends received from our Wells Fargo position is greater the total cost basis.

WFC has been known for its efficient business model built on cross-selling products to existing customers; if a customer used WFC for one banking service, WFC would not be satisfied until that customer used eight WFC banking services. Unfortunately, WFC was not just a great operator, they were a ruthless employer whose employees felt compelled to create fraudulent accounts for customers to meet sales goals. Ultimately WFC fired over 5,000 employees related to this issue - roughly 5% of their branch-based workforce. This throws a wrench in our investing thesis. 

Banking may be a very sticky business, and WFC may be able to retain most of its customers, but if WFC has been systematically committing fraud it can no longer be the cornerstone of our portfolio. WFC was roughly 10% of our family portfolio, by far our largest position. Due to tax implications I have been reluctant to liquidate more of the position, but we have reduced our position by 12.5% and it will further reduced in the near future. 

I never thought I would feel so compelled to dispose of WFC: it was the bank of Buffett, his largest holding; WFC was solid through the financial downturn, and actually grew substantially through its Wachovia acquisition; WFC even begged Uncle Sam to repay its TARP loan in 2009. This was a valuable lesson to learn. Though skilled investors brag about their ability to maintain a concentrated portfolio, never again will I allow one company to become such a large portion of our portfolio. Grandma may have always been a buy-and-hold investor, but it is time to sell WFC.

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Cintas Grows Through Acquisition of G&K Services

This morning Cintas Corporation (CTAS) announced it agreed to purchase G&K Services, Inc. for $2.2 billion in cash. 

Hain Celestial Group, Inc. Delays Reporting and Announces Review of Financial Reporting

Photo Courtesy of The Hain Celestial Group Inc.

Here is an argument for diversification. Hain Celestial Group, Inc. (NASDAQ:HAIN) is being punished by the market today after it issued a press release to announce it would delay the release of its results for the fourth quarter and fiscal year 2016. The company acknowledged concessions were made to certain U.S. distributors in the fiscal fourth quarter of 2016, and HAIN is currently evaluating whether the revenue associated with those concessions were accounted for in the correct period. HAIN is also evaluating the internal control over financial reporting. HAIN's board of directors will also conduct an independent review. 

What does this mean?

Revenue recognition is a topic many of us slept through in our introductory accounting class in college and is easily confused. Consumer packaged goods (CPG) manufacturers like HAIN contract with resellers to distribute their products to consumers. Depending on the contact, HAIN may be able to recognize revenue when its product is shipped to the retailer, or may be required to recognize revenue only when its product is purchased by the final consumer. See this meticulous explanation by Ernst and Young. Concessions may have been slotting fees, discounts or free products, but are usually treated as a reduction of the transaction price. If HAIN recognized revenue related to these concessions in a period prior to F16Q4, their revenue reported for a prior was likely inflated. 

Implications for Investors

While the market is punishing HAIN today it is difficult for an investor to know exactly what happened with HAIN’s revenue recognition. The company included this comment in its release:

The Company expects that any potential changes in the timing of the recognition of revenue with respect to these transactions should not impact the total amount of revenue ultimately recognized by the Company with respect to such distributors and does not reflect on the validity of the underlying transactions with respect to such distributors.

From HAIN’s release, the company would have investors believe this is a cosmetic change in accounting practices, but the fact that an independent review is has been initiated is concerning.  Until further information is provided we do not know the impact this incident will have on the business.

We own a small stake in HAIN which is now down 23% as of 3 PM ET today from when I purchased it in mid-late June. Though I could liquidate the position and realize a capital loss, the position is now less than one third of one percent of the entire portfolio and I would rather maintain exposure to HAIN until we learn more about this incident.

Four years ago we held a position in New Oriental Education (EDU) – a private educator in China. Highly skeptical of governance in China (corporate or otherwise), I quickly sold our shares of EDU when they lost half their value after announcing a similar review of revenue recognition.  Sixteen months later the market had forgiven EDU for it accounting mishap – the stock price recovered to previous highs – and today, after more stock price volatility and impressive sales and earnings growth EDU trades for four times the price at which I sold it.

Ultimately this new incident will not likely be material to HAIN’s business in five years. I will not add to our position in HAIN, but we will hold these shares through this volatile point in the company’s history. I still like the company’s brands and prospects and unless we determine HAIN was trying to maliciously misrepresent revenue or earnings I want to be part of their future.

August 15, 2016 Gilead, Shopify, and Cognizant, Oh My!

Yesterday I purchased Gilead Sciences, Shopify, and Cognizant Technologies. Though I believe in all three companies I elected to assume exposure to only half of the target allocation for each company. Two reasons led me to be more cautious with these investments: first our portfolio still contains several legacy positions that are soon due to mature and a two step approach to assuming our target allocation enables exposure to these companies with less strain on liquidity; second, the equity markets are near record levels, the U.S. labor market is near full employment, and these companies may be more attractively valued in six months if investors become more pessimistic. 

Invest Now, Time the Market Systematically, and Put Money to Work

Today I invested new capital in ten new holdings and moved our portfolio closer to its target allocation. With broad market indexes near record-high levels I struggled to overcome my cognitive bias to buy low and sell high. After acknowledging my bias I made compromise which allowed me to put new money to work without reservations. If you ever find your portfolio seriously unbalanced, this helpful trick may be helpful.

First, context: two months ago, I assumed control of our sprawling family portfolio that generated far more income than necessary and presented several opportunities to offset capital gains and losses. Though much progress has been made, when the day began, our cash position represented more than 25% of the portfolio’s assets. 

Today, as I worked to achieve our target cash position (15% of investable assets), I faced a conflicting, and potentially detrimental, urge to time the market (employ capital at the most opportune time). The next market crash may begin tomorrow- in this scenario my family would benefit by waiting to invest after the next market downturn. But the market is just as likely to rise beyond current records and never again, even after subsequent declines, present an entry point this attractive – in this case we would forgo significant returns while waiting for stocks to fall.

I cannot predict future market performance, and I do not have much confidence in the predictions of others. Were the market less richly-valued I would not hesitate to invest all excess cash, but today I decided to split the difference. While current market levels give me pause, I have no reservations about investing half of our excess cash today and holding the residual to invest six months from now (an admittedly arbitrary timeframe, but no worse than any alternative).

The businesses in which I have invested today are exceptionally well-run organizations, and my intention is to own these companies forever. In six months when I add to these positions and assume exposure to their full target weight. See the below chart. For example, to diversify our cost basis in Carter's, Inc. I invested 62.5 basis points (.625%) of the portfolio's assets in CRI today, and I plan to add to the position in six months.

Some of the above stocks may decline 10%, or more, over the next six months and others may appreciate 10%; by assuming a half-position in each holding today, systematically timed the market and diversified our cost basis. Thus my reservations about rebalancing the portfolio to new target weights while the market nears record levels were mitigated. Ultimately, I know compounding returns will be responsible for our portfolio's performance and I cannot predict future market fluctuations; therefore our success as investors will be directly related to the length of time our assets are exposed to the market.

You may experience similar reservations when rebalancing a portfolio during similar market conditions. Or, you may have a stock on your watchlist that seems perpetually overvalued. Split the difference and diversify your cost basis. You will feel less anxiety about your decision and reduce the impact emotions have on your investments.