Weekly Update-Feb 13, 2011

We’ve spent the last few weeks dissecting our favorite sectors and analyzing our top picks in each category, so it looks like a good time to shift gears and see how the portfolio is coming together.

When you are talking about building a portfolio, you have two primary options for a deployment strategy. You can take the plunge and buy all your stocks at once, or you can incorporate a more conservative approach and buy into your positions over a set amount of time. There is no right or wrong answer here, each strategy has its benefits.

So even though we were bullish on the market going into 2011, we decided to take the more conservative approach and scale into the portfolio over the course of a few months. That gives us the best of both worlds, an opportunity to participate in a strong market with early picks out the door in our favorite sectors, while also providing protection against weakness in the market with a sizeable cash position.

We Own Eight Stocks

That means we have been buying 2 or 3 stocks per week for about the last month, bringing the total number of stocks in the portfolio to 8. On a longer-term basis we want to own between 25 and 30 stocks, so as it stands, we have deployed about 22% of our accounts into actual stocks while the other 78% remains in cash waiting to be put to work.

In line with our conservative deployment strategy, our first group of picks out the door were defensive, dividend stocks, designed to give the portfolio a nice touch of stability.

Next up was food and energy, two places where I recommend every single investor have exposure all the time because of the very dynamic nature of these markets. Food and energy are probably the two most basic needs of every single human being on the planet, so even though we may see some volatility in the short run, we have a very strong macro-level trend supporting our investments.

Let’s go ahead and take a look at some vital statistics.

Deployed: 22%

Winners/Losers: 5 winners, 3 losers

Average Winner: 4.91%

Average Loser: 3.35%

Largest Holding: Deere & Co. @ 3.87%

Biggest Winner: CF Industries Holdings, Inc. @ +11.73%

Biggest Loser: CPFL Energia @ -3.71%

**we have almost 2X as many winners as losers, and our winners are considerably bigger than our losers, both hallmark signs of a strong portfolio and effective investment strategy**

The Portfolio is Looking Strong

Even though it’s still very early in the game, we’re seeing the portfolio do exactly what it is designed to do. Our conservative picks have been a bit weak because the market has been strong, and when the market is strong investors will shift out of conservative sectors and go for higher growth assets.

That in turn has given us a very nice boost in our food and energy picks, where we have seen some solid gains over the last few weeks. That trend has been fueled by what we are seeing play out in the global political scene, where tension in Tunisia, Egypt and Algeria has put a premium into hard assets like food and energy.

We also seeing some solid news flow on our stocks, so let’s go ahead and take a closer look.

McDonalds (MCD)

McDonalds gave itself a nice little boost this week after reporting strong January same-store sales. The uptick came on the back of a stronger performance in its European operation, where McDonalds had been seeing soft results because of ongoing financial instability in the Euro-zone region. But that situation seems to have stabilized for the time being, giving shares of MCD a nice little pop and moving us into the green on one of our defensive picks.

Transocean Ltd (RIG)

As one of our energy picks, Transocean is in the portfolio to show us gains. So why are we in the red? We saw some consolidation in the drilling industry last week, with Ensco plc (ESV) buying a smaller offshore drilling rival. In the short-run, that M&A (mergers and acquisition) activity weighs on the big boys (like Transocean) and puts a bid into the smaller companies that could be potential takeover target. But here’s the upside. That M&A activity is a very bullish sign from the drilling industry as a whole, meaning strong earnings is giving companies the confidence to spend and invest. So even though it was a short-term drag on Transocean, it is a bullish signal in the long run. Let’s keep our eyes peeled for a rebound as the market continues to appreciate energy companies.

Bunge Ltd (BG)

Bungee stepped up to the plate this week and delivered gang-buster fourth-quarter results, with earnings coming in well ahead of expectations. The strong performance was driven by the company’s Agribusiness, where higher grain and bean prices lifted margins and revenue. On the down side, the company noted that it’s Sugar and Bio Energy division in Brazil was negatively affected by a drought that severely dented its sugar production. It was a bit of a drag on shares in the short run, but we saw a nice rebound by the end of the week as the market took notice of the strong results.

The Big Picture

In terms of the macro picture, the market continues to look strong, supported by another awesome quarter of earnings and the Fed’s ongoing commitment to fuel liquidity.

One of the things we talked about early in the year that we needed to be on the lookout for was China raising interest rates. Higher interest rates are bad for the economy and bad for the stock market. But guess what? China has raised interest rates twice this year and the market doesn’t seem to be particularly concerned about it. That’s great news, so let’s look for more of the same down the line.

Another wildcard going into the year was the European Union, struggling with massive budget deficits and a loss of confidence. That story has cooled over the last few months as the EU Central Bank and International Monetary Fund (IMF) have pledged unwavering support for distressed countries. But just last week, we saw Portuguese bond yields spike to a new all-time high. For those living outside the doldrums of bond trading, that is not a good thing. But once again, the market seems to be shrugging it off for now, focused on strong corporate earnings and the river of liquidity flowing out of the Central Banks of the world.

So as its stands, the strong market of 2010 appears to be spilling over into 2011. But make no doubt about it, a strong market presents its own set of unique challenges. In this case, it means buying stocks that are trading at multi-year highs on the back of a very bullish 2-year run. That can be a little bit scary at times, but the path of least resistance is most definitely higher, and as we used to say on the old trading floor, “the trend is your friend.” So for the time being we are going to stay aggressive and look to benefit from the solid upward momentum.

This week’s picks don’t really have a central theme, with two technology stocks and a rail shipper at the top of our list for potential additions to the portfolio.

Checkpoint Systems, Inc. (CHKP)

Security is a very big issue in the world of technology, which is why Checkpoint looks like a great pick in the category. The company specializes in enterprise and Internet security solutions and works with some of the biggest vendors in the industry like Dell, IBM and Microsoft. With a market cap of $10 billion, Checkpoint is on the small end of the large cap scale.

Although shares have been strong lately after the company reported a great quarter in the end of January, the valuation picture still looks solid. Checkpoint has a forward P/E 19, which is a premium to the S&P500 but a discount to its peer average of 23X.

VeriFone Systems, Inc. (PAY)

You know those little machines at the grocery store that you use to swipe your debt and credit card? VeriFone makes those. The company also has a strong presence on the software side of the business, developing processing and security systems that offer higher margins. That makes this a great play on the global trend of consumers relying on electronic financial transactions as opposed to paper currencies.

VeriFone is both domestic and international, so it provides strong regional diversification and exposure to emerging markets like Brazil. Much like most of the stocks we are looking at, PAY has seen some nice gains over the last few months. That has made the valuation picture a bit rich, but its forward P/E of 30X is only slightly above its historical average of 26X.

Kansas City Southern (KSU)

Rail shippers are a great way to play strong corporate earnings, which is exactly what we have right now. The assumption goes that as business activity increases, so does demand for shipping services. That has been on display for the last two years, with the rebound in the global economy supporting KSU’s earnings profile and share price. In the world of rail shippers, KSU is actually on the small side with a market cap of $5.6 billion.

The company has a very strong presence in the gulf of Mexico and Midwest, which means it stands to benefit from growth in Latin America and strong agricultural production from the heartland. And even though shares just hit a new 52-week high on strong Q4 results, the valuation picture is in check, with a PEG Ratio (PE/Growth) just a pinch below 1, the typical benchmark for value.

Until Next Week

That’s all for this week. In the meantime, here are two good articles everyone should check out.

The first talks about shortages in the corn market that are giving our agriculture investments a boost. The second discusses how “regular” investors who have been on the sidelines for the last two years are starting to move back into equities. If that trend holds it could provide a tremendous amount of support for the market.

Higher Food Prices on Weak Corn Supply

Investors Return to US Stock Funds in January

Your Investment Partner,

Mike

ABOUT THE AUTHOR

Michael Vodicka

Michael Vodicka is the president and founder of the Vodicka Group Inc., a licensed investment advisor (Series 65) and a financial journalist.