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By Matthew Coffina, CFA and Jeremy Glaser | 12-09-2015 12:00 AM

Full Valuations Drive 3 Sales for StockInvestor

StockInvestor editor Matt Coffina recently sold out of Charles Schwab and trimmed Visa and Lowe's as current prices offer little margin of safety for the wide-moat names.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Matt Coffina, the editor of our Morningstar StockInvestor newsletter. We're going to look at some recent portfolio moves that he's made.

Matt, thanks for joining me.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: Let's start by looking at Charles Schwab. You recently sold out of this position. How did this perform for you?

Coffina: Schwab was a great investment for us. We first invested a little less than three years ago, in February 2013. At the time, investors were really thinking that interest rates would stay low indefinitely, and Schwab's earnings are probably more leveraged to short-term interest rates than just about any company I know. They've been waiving their fees on money market funds. Their net interest margin is also severely depressed by this low-interest-rate-environment. We think in a normal rate environment, their earnings could more than double.

So the reason the stock has done well for us is that investors have started to anticipate this normalized earnings power. They are looking ahead to the Fed's first rate increase, possibly as soon as December. And they are starting to bake that into Schwab's price.

Glaser: Why did you sell. Was it just the valuation?

Coffina: I think, again, the valuation really incorporates a lot of that benefit coming to earnings. The stock now trades for about 34 times 2015 earnings, 25 or so times forward earnings.

I think investors need to be worried about, first of all, what happens if interest rates don't increase as quickly as they are hoping? Maybe the Fed raises 50 basis points or to a percentage point. Who knows? Two years down the road, maybe we're in another recession, and the Fed starts cutting rates again. Schwab may never see that true normalized earnings power that they need--maybe 2% or 3% short-term rates--to really get the full benefit of that.

Also, Schwab is obviously very leveraged to the overall level of stock prices. They're earning fees on assets under management, which are going to vary depending how the stock market is doing. Trading revenue also is going to be very linked to how the stock market is doing. So there are definitely some risks here, and I just don't see a margin of safety anymore in the current stock price.

Glaser: You also recently trimmed your position in Lowe's and Visa. Is it a similar story there? It's valuation related? Or were there other things at play?

Coffina: These are two more great companies that we've done great with as investments. Visa we've owned for a little over a year, and the stock is up about 50% during that time. Lowe's we've actually owned for about eight years at this point, since before the housing bust, and it's more than tripled in value for us.

I only trimmed these positions. Again, I think they are great companies. They are two of my favorite companies for the long run. But I think the valuation is starting to really incorporate the benefits that they have. In the case of Visa, secular growth in digital payments is a great story that's going to drive double-digit earnings growth for the foreseeable future. But the stock trades at 30 or so times earnings. So it's largely baked in at this point.

Lowe's trades for maybe a low-20s multiple on earnings. The home improvement retailers have really stood out relative to other retailers in a relatively difficult retail environment. Home improvement retailers are still growing same-store sales at a mid-single-digit rate, earnings at a very healthy double-digit rate. But Lowe's would still be vulnerable to any future recession or any future downturn in the housing market or consumers' willingness to spend on their homes. It's certainly not a risk-free investment, and at the current price I don't see nearly the margin of safety that we had when we first invested.

Glaser: These moves have freed up some cash for you. Are you just holding on to this cash right now, or are you finding other values in the market.

Coffina: We had gotten to a point in the Tortoise and Hare where we had very little cash on hand, and these sales have just generated some cash that I am just holding on to for now. We're at about 5% cash in the Tortoise, 7% in the Hare.

I am seeing a handful of opportunities especially in more cyclical areas of the market. Then at the same time, in some cases, more defensive areas of the market--REITs in particular--where investors are very concerned about interest rates. Some healthcare names have fallen out of favor recently.

So I do see a handful of opportunities, and I'm hopeful that we can put the cash to work pretty soon. But I also don't mind holding cash in this kind of environment, where I still see the market as a whole as pretty fully valued.

Glaser: Matt, thanks for sharing your thoughts on these moves today.

Coffina: Thanks for having me, Jeremy.

Glaser: For Morningstar I'm Jeremy Glaser. Thanks for watching.

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