TX Group

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Sergey Basalyga

​Portfolio Rebalancing: A 11+5 Decision

TX Group: Portfolio description

We’ve constructed our portfolio, choosing the automotive industry. The portfolio is made of 16 stocks, 11 of which are automotive. In addition, we have included 5 companies from such industries as technology, banking, biotechnology, consumer goods, energy with the aim of making the portfolio diversified.

Stock summary

Tata Motors (TTM) (Auto Manufacturers)

Having taken into account Tata’s stable performance, growth potential and decent recovery from the events of August, we issued a buy recommendation on the shares of Tata Motors Limited. As a bonus, Tata hired Messi which offers a good potential for the stock growth.

Current price: 28-31$

Median target price: 41$

Amazon (AMZN) (Technology, Retail)

On the one hand, the company has impossibly high P/E ratio with shares being overpriced according to technical analysis. Total assets are growing at the expense of respectively growing liabilities. On the other hand, Amazon is a best practice of this industry with business processes constantly improving: it’s proved by ever growing revenues and net income in AWS as well as intent of changing the whole industry by introducing drones and big investments into various projects. We think that Amazon is a leader in monetizing its innovations.

Current price: 672-675$

Median target price: 800$

Master Card (MA) (Credit Services)

MasterCard is the company that will experience a subsequent growth causing the share price go up. We believe that the company has a good potential in the foreign markets (especially China) and new technologies (such as payment via mobile phone).

Current price: 98-100$

Median target price: 120$

Gilead (GILD) (Biotechnology)

Gilead Sciences as it’s highly undervalued. The revenue and net income growth bewilder. We see these company as a market leader due to the pace of expansion and high quality of the products. Moreover, not only it can produce a hit, but also receive an approval and sell it. It’s a good pick for a long investor.

Current price: 104-106$

Median target price: 130$

Lear (LEA) (Auto parts)

We see Lear Corp. as a buy company due to the fact that the company is steadily growing, having a unique product line. Moreover, the product line is improving as well as its marginality. Lear constantly surpasses investors’ expectations, smoothing negative impacts on the share price. All these facts in total makes the investment enticing. Also, we believe that the takeover bid, which has already been included in the price, yet it may influence the following growth.

Current price: 125-127$

Median target price: 133$

Diageo (DEO) (Beverages)

Diageo may be of interest for long term and short term investors due to its stable performance, strong brands, highly diversified product portfolio, focus on emerging markets and undervaluation of the P/E ratio. As a bonus, the price is expected to rise due to forthcoming Christmas Day.

Current price: 1891-1892£

Median target price: 2100£

Paccar (PCAR) (Truck Manufacturers)

Facts say in favour of PACCAR’s growth. Among the main drivers are the company’s success in the European market. Additionally, one should pay attention to the insider buying which is an indicator of the possible share price growth. However, short-term investors should keep more detailed track on the market moves.

Current price: 48-50$

Median target price: 56$

Plum Creek Timber (PCL) (Real Estate, Energy, Lumber and Wood Production)

The company shows good margins and a clear commitment to the strategy by getting rid of the assets that are not a part of the strategy. Other growth drivers are condition of the lumber market and merger deal with Weyerhaeuser, which should take place at the beginning of 2016 and which positive effect on growth of stock company price.

Current price: 50-52$

Median target price: 60$

Tenneco (TEN) (Auto Parts)

According to our estimations, the share price price will increase. Though the company faces operating difficulties, there are reasons to believe in it (management, innovations, clientele diversification, price rebound).

Current price: 52-53$

Median target price: 61$

Harley-Davidson (HOG) (Recreational Vehicles)

The shares are underpriced, considering the P/E ratio. Additionally, the company’s shares are very dependent upon the quarterly report, so we expect revenue and net income growth in the Q4, as well as share price. Currently, the price fell more sharply than the operating results, while dividends have been raised which is very important to the investors. This all is added to the planned investment and job cuts which will only benefit them.

Current price: 47-48$

Median target price: 54$

Johnson Control (JCI) (Auto Parts)

The main investment decision ratios show that the shares are underpriced. Additionally, it´s highly probable that the price will increase significantly right before October 1, 2016.

Current price: 43-44$

Median target price: 60$

Magna (MGA) (Auto Parts)

The company had an impressive run and its shares have doubled in just three years time. This isn't a sign of an overly optimistic market as it looks like Magna is still priced relatively attractive. It has pretty stable business model which allows to pay almost ever-growing dividends while share price being relatively low (judging by the multiple and technical analyses).

Current price: 44-45$

Target price: 65$

GoodYears (GT) (Rubber&Plastics)

There are no premises for the price decrease in the long term. The company is good at smoothing market volatility. Goodyear is expected to be at the wheel of the US market during following the following 4 years through innovating and preserving market share.

Current price: 34-35$

Median target price: 40$

Gentex (GNTX) (Auto Parts)

Gentex shares are trading at historically low P/E value. Moreover, it’s a dominant player in the market, having 90% of the market shares. It also one of the most financially healthy companies in the industry with almost all ratios better performing than the industry average. It means a stable growth, including by merging and acquiring other companies.

Current price: 16-17$

Median target price: 19,5$

Nissan (NSANY) (Auto Manufacturers)

We see Nissan as an enticing investment, though it must be acknowledged that these shares are sweet only for the risk takers due to uncertainty concerning the whole electric vehicle industry.

Current price: 20-21$

Median target price: 23$

Cummins (CMI) (Auto Parts)

Company are definitely underpriced, while the company’s growing at a faster pace. The growth due to the innovative technologies, coupled with an ending business cycle and strong balance sheet speak for itself.

Current price: 92-93$

Median target price: 120$

SPDR S&P 500 ETF (SPY)

Historical portfolio performance

The analysis of our portfolio should be started by considering 11 stocks of the automotive industry. This year the whole industry suffered major problems connected to the Chinese demand, diesel scandal and many other factors. Additionally, it’s worth noting that the automotive industry is very cyclical and only embarks on a path to get out of the depression. Many investors, underestimating the performance of each stock, got rid of them. That being said, if our portfolio had only been comprised of automotive stocks, it would have terribly underperformed the benchmark S&P500, showing higher volatility and drawdown.

12-month performance - 11 stocks

As a result, we decided to diversify our portfolio by picking Amazon, MasterCard, Gilead, Diageo and Plum Creek Timber, what allowed us to get 12-month total returns much closer to the performance of S&P500.

12-month performance - 16 stocks

Also, that allowed us to diminish correlation of our portfolio because, among newcomers, only MasterCard has strong correlation with the automotive industry.

Intra-portfolio correlation: 0,42.

In order to understand if there were problems with returns for a big amount of time, we analyzed its 5-year performance. In the beginning, we included the automotive stocks. Considering a 5-year period, this portfolio also underperformed the S&P500, which might be related to the events of the previous year and the cyclical nature of the industry. Over a 3-year period, only 3 automotive stocks could outperform the S&P500: Lear, Magna and GoodYears. However, we believe that the rest of the stocks will outperform the benchmark index during the next 5 years.

5-year performance - 11 stocks

But our full portfolio, which comprises additional 5 stocks from other industries, allowed us to outperform the index over the last 5 years. Meanwhile, we agreed to take risks and volatility of the stocks was higher than one of the index. The main portfolio drivers were Amazon, MasterCard, Gilead (best performance due to biotechnological innovations), Lear and GoodYears.

5-year performance - 16 stocks

The correlation of 5 other stocks over a 5-year period with the automotive industry is also not strong, as it was in the 12-month analysis (with the exception of MasterCard).

Also, the intra-portfolio correlation over the last 5 year had beenс 0.48, with 0.42 during the last year. It can be concluded that intra-portfolio correlation is still strong (as the majority of the stocks are automotive), but the interconnection is diminishing, what in its turn offers better opportunities to analyze stocks independently.

Best choice, in hindsight

The best choice for an investor 5 years ago was to get rid of the 6 worst performing stocks and have a portfolio of 10 stocks. This 10 stocks would have included 5 automotive stocks and 5 stocks from other industries, which would have allowed to have double S&P performance. Meanwhile, the volatility of the portfolio would have been very close to one of the S&P500 (with Beta 1,17 against S&P’s 1).

5-year performance - best 10 stocks

Expected portfolio return

Forming a portfolio of 16 suggested stocks, we expect a 22% return in a year. It’s substantially higher than last year’s return. Meanwhile, we believe that the selected companies will make use of the innovations with a clear commitment to the approved strategies, which will drive the stock prices up.

Performance of the next 12 months - 16 stocks

Conclusion

However, for conservative investors we would recommend to compose a 10 stock portfolio. including 5 stocks from the automotive industry and the rest from other industries as this strategy has already proved to be effective and able to significantly outperform the S&P500.