To be honest, this is one of my least favorite assignments every year.In years where I hit it out of the park with a selection that gets hot, I feel like a champ. The e-mails come in and individuals thank me for the pick.
Then there are the years that I pick a real dog. The e-mails still come. Not too many of them are thank-you notes.
The fact is that as traders or even as investors we are never really stagnant, and that's where it hurts. You see, I can usually manage a lousy position in a number of ways. I can trade a portion of the whole for small victories that erode a seemingly larger defeat. I can sell (write) covered calls and/or naked puts (risky) that will manipulate the net basis for me. If all else fails, I can just be disciplined, which for myself means to at least start taking profits at an increase of 20% to 25%, as well as never take a loss greater than 8% in any position unless it happens overnight. This is why I always emphasize both price targets and panic points.
I may call them panic points, but they really are anything but. These prices, in both directions, are designed to take emotion and impulse out of decision-making.
We are here for a reason. Three things we do not need to deal with are fear, overconfidence, and gambling. When we gamble, it might be fun, but we understand that the odds are not in our favor. I like the feel of a casino as much as anyone. I do not pretend to have an edge on those semi-rare occasions that I find myself inside of one. In theory at least, if one takes profits at 24% and losses at 8%, then one only has to be right 25% of the time in order to break even. Sure, this is indeed quite simplified, but acting on these types of price levels is akin to using GPS in your vehicle. It's a lot easier to get where you need to go than figuring out where you are headed by making use of the sun or the stars.
So, I Got To Thinking...
I thought to myself that maybe I would try something a little different this year. There have been two directions that I have gone with this exercise in the past. I could try to ride a name already volatile that would be a market leader should the broader market get hot. I could go with a lower-priced name that I felt could get hot. Limited downside there, but I have had mixed to negative results when taking this approach.
The thing is, this past year was not like any other year in our lifetimes. I don't think the disconnect between the real-life economy and the world of finance has ever been greater. Through the perversions of seemingly permanent ultra-low interest rates and an actual scarcity of available equity, valuations have taken off, Not that equities are overvalued. In this environment, they are not. The decision to be made here is whether you and I believe that this existence carries on as is, exacerbates, or corrects.
What we really are wondering is whether or not economic growth returns with a vengeance in 2021. We know that through the magic of SPACs (special purpose acquisition companies) the scarcity of available equity has started to normalize. I don't know how much the creation of this kind of company relieves the scarcity of operating companies that are actually worth something, but there are close to 500 companies that did go public in 2020 (most of them are simply garbage). Bottom line, there are more places for equity investors (portfolio managers) to go.
What are your feelings on economic recovery or a rebound in corporate earnings, I mean for companies that actually provide goods or services in exchange for revenue? Right now, enough professional economists are looking for the U.S. economy to grow in 2021 from somewhere in the high 4% level to the low 5% range. In other words, a lot of folks who think about these things see the strongest year for U.S. economic growth since the Reagan administration. Then again, this all depends on how soon the nation gets the pandemic under control.
Should economic growth recover beyond the halfway-back point, creating a reverse square root symbol -- which, by the way, we called here and reiterated several times all year -- where it is now, then corporate earnings will recover broadly as well. At the moment, FactSet (you follow who you want, I always rely on FactSet) sees consensus calendar year 2021 expectations for earnings growth for the S&P 500 of 21.8%. This follows a deeply negative year for calendar 2020 where S&P earnings contracted an estimated 13.6%, as we do not have fourth-quarter results just yet. What this means for both the U.S. economy as well as the S&P 500 is easy comparisons year over year.
After taking all that in, we have to study investor sentiment. Right now investors are overwhelmingly bullish, with all of the large-cap indices at or close to all-time highs. That's generally seen as a contrarian indicator. A negative if you will. Margin debt hit new records in late 2020 in dollar terms; however, as a percentage of overall market cap it remains near multiyear lows. Then again, any trajectory-changing correction would impact that percentage, but not nominal margin debt. Know what I mean? That represents a possible $700 billion plus in forced selling at some point.
Then, we'll need to wonder just how forward looking are these equity prices. Vaccine distribution is off schedule? When does a third or fourth vaccine become available? Are we living a more normal life by late spring, or in 2021 at all? Anything that pushes out normal social interaction or pleasantly accelerates such activity will also accelerate the velocity of money, and that, my friends, is the key. Good and/or bad. For velocity of transaction is where demand for credit is created. That is how money created in order to keep interest rates low eventually leaks out of the banking system and into the real economy.
What I am trying to tell you, in short, is that if there were to be a significant increase in the velocity of money that conditions would be ripe for the economic growth that we all crave, but with it will come higher long-term interest rates (despite the Fed's stated intentions) and more aggressive consumer-level inflation than anyone, except maybe the heavily indebted, is mentally prepared for after all these years of disinflationary activity.
Thanks for the Economics Class, Sarge
All in all, what I am trying to do is to explain why my single stock pick for 2021 is going to be a stock that has underperformed at least in 2020 but would likely excel in a year of renewed growth in economic activity. I have also decided not to name a stock that I already own. I will wait until publication of this article to get myself long the first tranche or one-eighth of my intended position size. I will communicate to readers my intention to change position size or to liquidate. If you read my articles on Real Money or Real Money Pro or follow me on Twitter you will know what's cooking. I will be transparent and walk the walk by your side. On with the announcement.
My stock pick for 2021 is Berkshire Hathaway, the B shares (BRK.B) . I chose the B shares despite their overvaluation versus the A shares because this article is written for retail investors. I figure more of you can spend $23,200 on 100 shares of stock or $2,320 on 10 shares than $347,815 for one share. Just a guess.
No, there's no dividend, but Warren Buffett did get behind the authorization of a $9 billion share repurchase program last year. Berkshire Hathaway has badly underperformed the S&P 500 for two years running. BRK.B closed out 2020 at $231.87, after closing out 2019 at $226.50. That's an increase of less than 2.4% versus the 16% that the S&P 500 returned in aggregate.
Not only does Berkshire sit on a cash position of $145 billion, but cash flow and operating income itself will pop given the way the company is invested, not just in publicly traded companies, but also in privately held businesses. The crown jewel of these companies, in my opinion, would be Burlington Northern Santa Fe Railroad, but you know some of the other names -- Geico, Benjamin Moore, Dairy Queen, Helzberg Diamonds, and Pampered Chef.
Now, Berkshire's holdings.
Berkshire's largest position is still in Apple (AAPL) , which is one of my favorites as well. Berkshire remains long a number of winners that by themselves easily beat the S&P 500 in 2020. Among these would be Amazon (AMZN) , which is my favorite stock for the next 50 years, as well as RH (RH) , StoneCo (STNE) , T-Mobile (TMUS) , DaVita (DVA) and United Parcel Service (UPS) . Buffett has also been adding to a number of pharmaceuticals, including longtime Sarge fave AbbVie (ABBV) .
There are two primary risks that investors must be fully cognizant of. One is that the pandemic may worsen or hang around longer than anyone imagines. The other is Warren Buffet, who has run Berkshire for 55 years, is now 90 years old. His pal, Vice Chairman Charlie Munger, is 97. They both seem to be as sharp as ever, but their age is an issue. There is no doubt that should anything negative happen to either one of them, Buffett in particular, that investors could lose confidence.
In the event that something along those lines unfolds, there is a succession plan in place, which was laid out almost a year ago. Top lieutenants Greg Abel and Ajit Jain have been mentioned as potential leaders, but even if fully able to prove themselves, neither will have the same celebrity appeal (at least at the start) as Buffett and Munger. There will be some liquidation prior to stabilization should something like this (we hope it does not) unfold.
Readers will note that the shares formed a large cup with handle pattern that endured all the way from February until the breakout in November. Note that this pattern created a pivot at $223 that developed into a breakout that, in theory, could have produced a target price of $267. That breakout failed, so why do we not discard it? Answer: Because the pivot showed up again as support for a basing pattern that has been in place for six weeks. For now, my target remains $267. Should the basing pattern produce its own breakout, the pivot moves up to $235 and the target up to $282. My plan of action is as follows (using minimal lots).
- Purchase 100 shares (or one-eighth) of intended position size in BRK.B at or close to $231.87.
- Sell one February 19 BRK.B $245 call for around $2.25.
- Sell one January 15 BRK.B $225 put for roughly $1.25.
Net Basis: $228.37
Note: Selling puts is risky. This part of the trade can commit the investor to purchasing more equity at the strike price upon expiration. The intent here is to price these at levels where the investor would be willing to add another one-eighth or so of the position if forced. The real goal here is to see the put (and the call) expire worthless. Should the position be called away prior to the investor building the position to desirable size, the investment is no longer an investment, but a trade. A very good trade at that.