2018 Q4 Review
Review of the quarter including results, market commentary, portfolio commentary, and insights.
The 4th quarter ended on December 31st, 2018. The end of the year is a great time for reflection. While 2017 was an investors dream, 2018 painted a much different picture. The S&P500 ended 2017 with a 19.42% return with a maximum drawdown of only 3% from all-time highs. In stark contrast, volatility came roaring back in 2018. The market experienced 2 corrections — a quick drawdown of more than 10% at the end of January and the current one starting in August declining 19.8% by December 24th. The stock market performance on December 2018 was the worst since the Great Depression, 1931. To top it off, the markets ended the year with their worst performance since 2008.
While the price action may signal a bear market, the economy continues to look sound and intact. Unemployment rates are low, wages are rising, and, regarding future rate hikes, the fed has stated their willingness to cooperate. Many of our portfolio companies have shown strong earnings and have given optimistic outlooks in their most recent earnings. With our business-owner mentality, that is what we focus on. Given that backdrop, there is no need to make any drastic changes to our strategy. We will continue to invest in the highest quality companies, which continue to grow revenue and earnings, as we patiently wait for the market to reprice.
Portfolio
Broadcom (AVGO) reported 4th quarter earnings on December 6th, 2018. Broadcom beat estimates on revenue and earnings, continues their strong share repurchase program, and increased the dividend by 51%. The press release makes some optimistic remarks.
Hock Tan, President and CEO of Broadcom Inc:
“Strong operating performance in the fiscal fourth quarter caps a year of solid results that continues to reinforce the sustainability of our business model. Revenues grew 18% to nearly $21 billion on the back of strong demand for our networking, enterprise storage, wireless and industrial products while operating margin continued to progressively expand to 50%. Looking forward to fiscal year 2019, we expect another year of double digit revenue growth. Sustained demand within our semiconductor segment will be augmented by the newly acquired mainframe and enterprise software businesses to our infrastructure software segment. We also expect operating margin to hit another record in fiscal year 2019 driven by improved operating leverage.”
Tom Krause, CFO of Broadcom Inc:
“Free cash flow from operations grew 50% in fiscal year 2018 to $8.2 billion. As a result, we are raising our target dividend by 51 percent to $2.65 per share per quarter for fiscal year 2019. Looking ahead for the year, we expect sustained revenue growth and improving operating leverage to accelerate cash generation from operations. Our capital allocation strategy remains unchanged for fiscal year 2019. We plan to return 50% of our prior fiscal year free cash flows to stockholders in the form of dividends and use the balance of our free cash flows to buy back stock and support additional acquisitions, while remaining focused on maintaining our investment grade credit rating.”
This outlook presented above hardly looks like an industry in decline. With top and bottom line growth, a positive outlook, low valuation, and a dividend yielding over 4.5%, AVGO is a buy in our book.
Celgene (CELG), our biotechnology company and owner of one of the world’s best-selling medicine, Revlimid, has entered into a agreement to be acquired by Bristol-Meyer Squibb for 74B. Celgene, in deep value territory, continues to grow revenue and earnings by over 20% year-over-year. A looming patent expiration on Revlimid, one of its largest revenue generators, has been holding Celgene back. Joining forces with Bristol-Meyer Squibb will result in better diversified revenue sources. Bristol-Meyer also pays out a hefty dividend. We’re optimistic about the deal, which pays out $50 in cash plus 1 share of BMY for every share of CELG, and plan to hold onto BMY.
Our oil producers in the Permian had a rough 4th quarter. With the price of crude oil dropping over 30%, the market aggressively repriced the entire industry. Diamondback Energy (FANG), one of our portfolio companies, announced their plans to scale back production growth. Even so, the company plans on continuing to grow at 30%. Their prudent approach ensures that any capital deployment is covered with operating cash flow. Diamondback also announced they are increasing their dividend by 50%.
Insights
“Of the top-decile portfolio managers for any measurable 10-year time period, at least 41% of those managers spent at least three years in the bottom decile of performance rankings. The point being top flight portfolio managers can go long periods with poor relative performance and not looking so smart.”
Tax Forms
With the end of the year, tax season is upon us once again. Interactive Brokers will make all of your tax forms available to you. If you have any trouble gathering them, feel free to reach out to Federico Torre or the IB customer support team. Also worth noting: some of our investments, namely Master Limited Partnerships (MLPs) have special tax treatment. These holdings are tax-efficient when held in a taxable account, but have extra paperwork. Look out for K-1 forms mailed to your address if you have any of the following investments in your portfolio: VNOM, AM, EQM, OMP.
Note: VNOM and AM are, or have been converted to a C-Corp and will no longer need to issue K-1s in the near future.