The Ultimate Stock-Picker's Portfolio Makes a Move -- Page 2
We've taken a starter position in a new financial stock.
Stock Strategist
New Position Analysis
In my last article, I indicated that I had winnowed my choices of a new pick for The Ultimate Stock-Picker's portfolio to either eBay (EBAY) or Capital One Financial (COF), but that as of a few weeks ago, these two stocks were essentially in a dead heat based on Morningstar's proprietary valuation metrics.
Over the ensuing weeks, however, eBay's shares have modestly appreciated, while Capital One's have been relatively static.
As a result, we now believe that the valuation for Capital One has modestly improved relative to eBay's, given Capital One's lower price/fair value ratio and higher three-year annual expected return, as shown in the table below.
| eBay vs Capital One | |||||
 | | | | | |
| Name | Price | Fair Value | Cost of Equity | Price/ Fair Value | 3-Year |
| eBay (EBAY) | $33.95 | $49 | 10.0% | 0.69 | 24.3% |
| |||||
| Capital One Financial (COF) | $75.35 | $115 | 11.5% | 0.66 | 28.4% |
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| Data as of 07-13-07. |
As a result, I've decided to take a starter position in Capital One, which is about half of a full position, or around $5,000. I took only a starter position because I like the flexibility that the remaining liquidity provides to the portfolio. For example, if eBay's valuation improves, I'd also like the option of adding that name to the model portfolio. I've also considered adding to our position in Pulte Homes, as this 5-star homebuilder's valuation continues to decline below its stated book value, creating what I believe is an even more compelling risk/reward trade-off. Berkshire Hathaway (BRK.B) is another business whose intrinsic value has continued to grow, while its stock price has remained relatively static, and I'd like the option of potentially adding to that name as well. The key concept I'm getting at here is that by keeping some powder dry, it gives me the option to take advantage of an additional investment opportunity should one suddenly present itself--and that, in my mind, has immense value.
Capital One
In the below table, I've detailed the Tyco International and Capital One transactions I made on July 16.
| Sell: Tyco International (TYC) | ||||||
| | | | | | |
| Shares | Price | Proceeds | Commission | Net Proceeds | Adj Cost Basis* | Realized Gain |
| ||||||
| 95 | $50.43 | $4,790.85 | $12.95 | $4,777.90 | $3,895.82 | 22.64% |
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|
| Buy: Capital One Financial (COF) | ||||||
| | | | | | |
| Shares | Price | Gross Cost | Commission | Net Cost | ||
| ||||||
| 65 | $76.20 | $4,953.00 | $12.95 | $4,965.95 | ||
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| * Adjusted for breakup of Tyco International into Tyco, Tyco Electronics, and Covidien. |
As for Capital One, similar to my colleague Michael Kon, I continue to be impressed by this firm's transformation from a monoline credit-card issuer to a more full-service financial-services firm. In his last Analyst Report, Michael indicated that this transformation will likely lead to more cross-selling opportunities to the firm's existing customer base, which I think should continue to drive high incremental returns on capital for owners for some time to come.
One risk to an investment in Capital One, though, is that because more than 70% of its profits are derived from its consumer lending segment, it is still somewhat sensitive to the health of the U.S. consumer, which many have postulated to be financially stretched right now. Although this is certainly a concern, it is also somewhat mitigated by the high rates that Capital One charges its customers, as the wide spreads earned from these high rates could help to offset the potential for a few bad loans from its riskier customers being charged off. In addition, in the event this scenario did emerge--with the stock price reacting negatively--it could present a compelling opportunity to add to the model portfolio's position in Capital One, potentially bringing it up to a full position size.
Finally, I will also note that Capital One is currently held by the Harbor Large Cap Value Fund (HAVLX), Legg Mason Value Trust (LMVTX), and the Oak Value Fund on my list of investment managers, which gives me an even higher comfort level in the prospects for our new position.
Updated Portfolio
In the table below, I've listed the holdings of the updated Ultimate Stock-Picker's Portfolio, including our new position in Capital One, through Tuesday July 17.
| Current Holdings | ||
| | |
| Shares | Market Value ($) | |
| ||
| Tyco Electronics (TEL) | 95 | 3,691.70 |
| ||
| Covidien | 95 | 4,180.00 |
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| Wal-Mart Stores (WMT) | 219 | 10,588.65 |
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| Dell | 459 | 13,398.21 |
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| Berkshire Hathaway (BRK.B) | 3 | 10,989.00 |
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| Time Warner | 595 | 12,566.40 |
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| Expedia (EXPE) | 599 | 17,730.40 |
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| American Express (AXP) | 174 | 11,264.76 |
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| Anheuser-Busch (BUD) | 211 | 10,617.52 |
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| Johnson & Johnson (JNJ) | 157 | 9,850.18 |
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| Sprint Nextel | 602 | 13,346.34 |
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| Pulte Homes (PHM) | 346 | 7,857.66 |
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| Capital One Financial (COF) | 65 | 4,965.35 |
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| Portfolio Value | 131,046.17 | |
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| Cash | 4,994.06 | |
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| Total Value | 136,040.23 | |
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| As of 07-17-07. |
Please stay tuned for more performance reports, position updates, and manager video interviews in the coming months. And if you haven't already done so, I encourage you to sign up for my free e-mail alerts to be one of the first to hear my thoughts on investment and portfolio strategy.