Saturday, January 1, 2011

Annual Report: Looking Back at 2010


This article is an update on 2010 performance of my investment portfolio. If you curious about why I update this on a public forum, you can read my reasoning in the Sept 2010 semi-annual report.

The equity portion of the portfolio was up by 22.58% relative to beginning of 2010. Accounting for cash & cash equivalents, portfolio was up by 20.37%. These numbers are net of all broker commissions and expenses. In comparison, in the same time-frame, S&P500 was up by 12.78% , Gold was up by 31.41%, and BSE Sensex was up by 17.43% (excludes costs of investing in the asset class). Really the closest comparison is S&P500, but I picked others simply because the masses are excited about these classes today. I believe that the portfolio’s performance was achieved with lower overall risk compared to any of these other asset classes, since the positions in the portfolio were purchased at an average discount of 30-60% of its intrinsic value and the portfolio maintained 10-20% cash through the entire year. I am not sure if one could say the same about the other asset classes. At the end of the year, cash dropped to 10% as a portion of cash was put to work in two new ideas in Nov & Dec.

Kirklands was purchased at an average cost of $12.10 at a surprisingly low valuation of Enterprise Value to EBITDA (EV/EBITDA) ratio of 2x. Kirklands fell from a high of $25 to $10 due to undue concerns about rising shipping costs and fall in margins. Its closest competitor Pier 1 Imports traded at EV/EBITDA of 6x at the time of purchase. Kirklands has one of highest inventory turnover in the industry and is one of the lowest cost provider.

MasterCard was purchased at $225. You can read the extensive analysis of MasterCard that was conducted before putting the cash to work in this position. This is typical of the process that I follow before investing in a specific idea. 


Frankly, I have mixed feelings despite the ‘market-beating’ performance of the portfolio. I am happy that it did so well, but I am surprised it happened so soon. When these positions were established in the earlier part of 2010, I had prepared myself to be patient for 1-3 years for 15-20% performance. Now with the price for many of these positions hovering around fair value (Leucadia, Ensco, Accor, Edenred), the margin of safety of holding them is much lower. This situation creates a bit of a challenge in terms of portfolio management. Since its been less than a year, selling them now would force the portfolio to part away with 30% of the gains to Uncle Sam. Giving away 30% of the gains would reduce the net gain of the portfolio from 20% to 15%. There are two ways to address this issue – either wait for the one year anniversary to sell out the fairly valued positions or add new assets to the portfolio to reduce the impact of these fairly valued positions to the portfolio. I am not sure which of these options should be chosen yet, but both aren’t too appealing. Holding fairly valued positions is not fun, since the margin of safety is smaller (higher risk lower reward). Adding new assets is not easy, because saving takes time. I really would have preferred a more slower recognition of value over a time frame of one year or more.

Lastly, I don’t think its going to easy to repeat the 20% performance again in 2011. In fact, I do not like to set goals for performance returns. Such goals force one to take unjustified risks. The only goal I have is to do better than inflation by about 10% on a long-term basis of 5-10 years. With the market run up, value has become really hard to find. I spend a lot of time looking at different ideas, but nothing so far meets the strict criteria of value. Since my primary goal is not beating the market, but to do well on an absolute basis (10% + inflation), I have no compelling reason to act. I would rather sit around waiting for a ‘fat pitch’. A ‘fat pitch’ is a term from baseball where the ball is pitched perfectly in the middle of the strike zone that a batter is completely confident in swinging at. Fortunately in the game of investing, any ball that is not a ‘fat pitch’ can be easily passed without being called out a strike. I do not mind twiddling my thumb until then. (I am not really twiddling my thumbs, but turning a lot of pages of 10Ks).

I will write again the status of the portfolio at the end of the half year on Jul 1 2011. Happy New Year !

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