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Investing Specialists

The Ultimate Stock-Pickers' Top Purchases and Sales

We're sorting through the transactions of top managers to find higher-conviction opportunities.

By Greggory Warren, CFA | Stock Analyst

The fourth quarter of 2008 and the first couple of months of this year posed a significant challenge to most investors--including the top managers we monitor at Ultimate Stock-Pickers. While the market (as represented by the S&P 500 Index (SPX)) was already down some 20% during the first three quarters of 2008, it did little to prepare investors for the carnage that was about to come. With the credit markets in complete disarray, following the collapse of Lehman Brothers,  AIG (AIG), and a host of other financial bellwethers, and concerns growing about global economic growth, equities went into a broad-based decline in October and November, with the index losing another 25% of its value. While the market did settle down some in December, it was not enough to overturn the nearly 40% decline the S&P 500 since the beginning of the year. And, unfortunately, things did not improve much during the first few months of 2009, with the market declining another 20% in value.

Against this backdrop, our top managers were not just sitting idly by. Many were actively buying and selling securities, either adding to (or subtracting from) existing positions or taking advantage of the market weakness to build positions in new names. With the Ultimate Stock-Pickers' concept, we're looking to uncover the level of conviction these managers had in the securities they were buying and selling. We do this in a two step process that first assesses the relative attractiveness of individual securities by noting how many funds actually hold it and whether or not they've been adding to (or subtracting from) their position. We also look at the percentage that each individual security makes up of the equity portfolios of the managers on our list, determining the level of conviction the managers have in a particular name by the amount they have committed to it.

A good example of this would be  Microsoft (MSFT), which was held by 13 different managers, with an average position size of around 3% in the portfolios holding it. We found that eight different managers were adding to their holdings in Microsoft during the period, with almost all of them increasing their last reported position by 10% or more. Contrast this with  PepsiCo (PEP), which was purchased by four different managers during the period and had an average position size of around 2% in the seven portfolios holding the name. While the average position size also increased by around 10% during the period, PepsiCo did not make our list of top purchases because the combination of each of these factors left it sitting outside of the 10 stocks that ultimately made the list. It should be noted, though, that we have left ourselves some flexibility when determining what qualifies as a top purchase or sale, recognizing that this process is always going to be more of an art than a science.

Ultimate Stock-Pickers' Top Purchases
With that in mind, the current list of Ultimate Stock-Pickers' Top Purchases includes four energy stocks, two media names, two consumer goods firms, Microsoft and  Emerson Electric (EMR). All 10 of these stocks were rated 5 stars by our stock analysts at one point or another during the period in which these purchases took place, with seven of them holding a 5-star rating throughout the fourth quarter of 2008 and the first couple of months of 2009. Interestingly, only  Occidental Petroleum (OXY) and Emerson Electric have rallied to the point where our analysts believe that they are no longer considered buys. That leaves seven other names priced below our Consider Buy prices, with  Cadbury PLC (CBY) (at 4-stars) sitting somewhere above an initial entry point.

One name that sticks out is  Avon Products (AVP), which our analyst Erin Swanson believes was oversold during the fourth quarter. She said as much in a stock analyst note published after she had a chance to dig through the company's third-quarter results, and reiterated it in an industry report published near the end of the fourth quarter. While she recently lowered her fair value estimate--to recognize the impact a slowing global economy and unfavorable currency exchange rates could have on Avon's sales and profitability--she still believes that "the firm's long history of managing through global economic disruptions, and the fact that it is more focused than ever on controlling costs and empowering its sales representatives around the world" will allow it to "successfully navigate its way through the current crisis."

Ultimate Stock-Pickers Scoop Up Energy Stocks
It was also interesting to note that the four energy stocks on the list--  ExxonMobil (XOM),  ConocoPhillips (COP), Occidental Petroleum, and  Devon Energy (DVN)--were each purchased by at least five managers, with one of them, Susan Byrne at  WHG Large Cap Value (WHGLX), actually buying shares in all four names. While, in hindsight, these purchases look to have been a little premature (given that oil prices have been cut nearly in half since the beginning of the fourth quarter of 2008), these managers were operating in an environment where oil had just dropped from an all-time high of nearly $150 per barrel during July 2008 to less than $100 per barrel at the end of the third quarter.

With three of these energy names still trading at Consider Buying prices, we recently asked one of our energy analysts, Allen Good, to walk us through some of the reasons why managers have been building stakes in these particular stocks, as opposed to others in the energy sector. He noted that "a large accumulation of ConocoPhillips' stock by Warren Buffett probably initially drew managers' attention." That said, the stock continues to trade at 50% of our fair value estimate, as well as at a steep discount to its peers. ExxonMobil, on the other hand, is trading at about 75% of our fair value estimate--a premium that is well-deserved.

According to Allen, ExxonMobil "generally avoids the volatility smaller E&P companies see during oil price fluctuations and the financial distress that low prices bring. Its balance sheet is a fortress that protects it from commodity price movements and provides management the ability to pick their spots to invest wisely. A large cash pile, little debt, and a strong credit rating give management the ammunition necessary to invest in projects at opportune times when others may be selling just to survive." From our perspective, it looks like a clear cut case of the greater risk, in this case ConocoPhillips, requiring a much greater reward.

Ultimate Stock-Pickers' Top Sales
As for the top sales by our managers, the findings were much less clear cut. Although we noticed managers selling shares of consumer services firms, such as  Home Depot (HD),  Staples (SPLS), and  Target (TGT), they were also trimming positions in what we consider to be solid, stable cash-flow generators, like  Johnson & Johnson (JNJ) and  Procter & Gamble (PG). With the economy in the throes of a consumer-led recession, it was not too surprising to see managers unloading shares of retailers, but we were somewhat perplexed by the sales of the two consumer goods firms, which continue to be among the top 10 holdings of the managers on our list (with Johnson & Johnson in 15 portfolios and Procter & Gamble in 12).

Some of this could be attributed to mutual funds trimming positions in order to raise cash to meet redemption requests from investors, which makes sense given that nearly $180 billion was withdrawn from mutual funds in the fourth quarter (according to recent data from Morningstar FundFlow). But the reality is a bit more nuanced. Looking back Bill Bergman's recent Stock Strategist article about  Berkshire Hathaway's (BRK.A) (BRK.B) 13-F filing for the fourth quarter of 2008, we noted that among the company's largest position changes during the period were sales of what had been two of its better-performing holdings. So, in all likelihood, this could have been a case of Warren Buffett selling off positions in these firms, which are still major holdings of Berkshire Hathaway, in order to take advantage of better relative opportunities.

Berkshire sold half its stake in Johnson & Johnson and shaved about 10% of its position in Procter & Gamble, which ultimately had a larger impact on the conviction levels for these names than the sales done by the other managers in the Investment Manager Roster. Despite the heavier influence Berkshire's transactions had on these two names, we decided to keep them on the list because they were, in the end, higher conviction sales.

It is also interesting to note that both of these names are the only ones on the list of Ultimate Stock-Investors' Top Sales that continue to garner 5-star ratings from our analysts. This may be one of those rare instances when stocks showing up on the list of top sales turn out to be ones we should consider purchasing, but we wouldn't have known that had we not dug deeper into the details and found out what was behind the high level of conviction in these sales. 

Disclosure: Greggory Warren, CFA, has a position in the following securities mentioned above: Avon Products AVP, Johnson & Johnson JNJ, and Procter & Gamble PG.