Investing Like Buffett: 5 Ways to Achieve Legendary Returns

Investing Like Buffett: 5 Ways to Achieve Legendary Returns
32 comments | by: Follow My Alpha February 22, 2011

People are always interested to hear what Warren Buffett has to say about the current state of the economy, but what everyone actually cares about is how he continues to achieve such amazing returns after all this time. Of course he’s always willing to impart pieces of his wisdom to the public, but sometimes they sound like cryptic messages from the future, while others are crystal clear to understand. Unfortunately, a conceptual understanding of what he says is very different than turning his thoughts into sound investment principles and actions. This is why we have pinpointed five easy Buffett investment principles, which build upon each other, that hopefully will help the everyday investor to achieve better returns.

1. Be a Bear Market Investor

Buffett is, in our opinion, a bear market investor; he has historically made some of his most successful investments and deployed the greatest amount of capital specifically during bear markets. Think for one moment about how well a portfolio would do if a good chunk of its assets were consistently invested only during bear market periods, and that during bull markets capital was deployed much more sparingly. It’s not hard to understand that it would probably do much better over the long term with this general mindset. This is due to the fact that investments would be made more often when stocks are trading at depressed prices. Below is an example of Buffett being a bear market investor:

Investment: PetroChina (PTR)

Investment Date: 2002-2003 (Dot.com crash/recession period)

Total Capital Invested: $488 Million

Holding Period: 6 Years (Sold in 2008)

Capital Received from Sale: $4 Billion

Total Return: 819.67%

Annualized Return on PTR: 136.66%

Most investors were obviously not looking at investing in a Chinese state-owned oil company after the dot.com crash -- or anything else, for that matter. Still, this simple investment principle is no different than if a person only bought clothes when they were on sale at a department store. He bought a great company when it was on “sale” because he realized that the intrinsic value of the company never changed; just the price tag on it. Remember, a great company generally only goes on “sale” during a bear market -- so when there is fear in the streets, it’s time to go shopping.

2. Invest in What the World Needs

During the last recession, investors hated Goldman Sachs (GS), Burlington Santa Fe Rail (BNI), and General Electric (GE) equally. Investors crushed their respective stock prices based on illogical fears, emotional hatred, and very little analysis. Putting personal opinions aside, GE, BNI, and GS are all marble pillars of the U.S. economy. Buffett always invests with objectivity, and that’s why he bought shares in each of these firms. In particular, he bought the remaining shares of Burlington Santa Fe and folded them into Berkshire Hathaway (BRK.A). One man’s “trash” was definitely Buffett’s treasure. The takeaway point here is that Buffett went into heavily distressed industries that were crucial to the U.S. economy recovering and then bought the best in breed.

3. Fundamental Analysis and Due Diligence

The Oracle of Omaha is constantly quoted for saying “I only invest in what I understand.” As simple as this sounds, it actually goes over the heads of about 80% of investors. What he means here is that he spends a good portion of time educating/doing due diligence for himself about industries that he is interested in but potentially unfamiliar with. This includes taking time to understand the industry as a whole, how it fits into the world economy, and the company itself. We doubt he was a chocolate connoisseur before or after he bought See’s Candy, but either way, he knew what he was buying because he did his due diligence.

As an investor, he is probably one of the few who still directly requests the financial statements from firms he has an interest in. Everyone can call Buffett a “value investor” till they’re blue in the face, but he is a fundamental analysis investor at the end of the day. We have little doubt he goes through every number and checks every financial statement ratio in the book to find potential “hidden value.” He is even known to go through the granular footnote details for assumptions and/or additional information about inventory classification.

Doesn’t doing all this due diligence and research take time though? Yes, of course it does. Still, this is what he does in order to beat the market. He realizes and understands that most investors won’t take the time to do this consistently. Imagine how successful anyone could be at anything if they knew exactly how much effort they needed to give in order to outperform the competition. When it comes to investing, Buffett knows exactly how much effort he has to put forward.

This may all sound boring so far, but becoming the third-richest billionaire in the world by investing in names like Coca-Cola (KO) is not. He may like the taste of a Coca-Cola soda, but we doubt he would have invested in the company if it were short on cash, up to the eyeballs in red, and leveraged to the hilt with debt and with no hope of being able to pay it back. When he invests in a company, he knows it and its industry inside out. The time involved with principle three is substantial -- but so is the potential payoff.

4. Pricing Power beats Sound Management

The pricing power of a firm generally holds more value than does sound management, plain and simple. Further, it reduces the risk that a firm will underperform longterm should key personnel leave. Do you agree? Well, Buffett certainly does; he was quoted saying the following in two separate, recent interviews:

* "The single most important decision in evaluating a business is pricing power …. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.” (For more, see here.)
* “The extraordinary business does not require good management.” (For more, see here.)

His argument here makes sense and we are happy to follow this principle without question.

5. Patience

It’s true that Rome wasn’t built in a day, but sometimes it’s tough to remember that. Buffett understands the power of patience, and that is why he remains bullish over the long term. The rules are no different for anyone else, in that if an investor follows all the other principles then all that is left for him to do is be patient enough to wait and watch hard work pay off.

Conclusion

The Oracle of Omaha will always be bullish long term because he follows these principles without fail, in our opinion. With these five simple principles he has consistently outperformed the market and continues to see the investment landscape differently than almost everyone else.

Road Map for Managing a Dividend Portfolio

Road Map for Managing a Dividend Growth Portfolio
25 comments | by: David Van Knapp February 23, 2011 Font Size: PrintEmail Recommend 8 Share this page
Share0 The article on my real-world Dividend Growth Portfolio earlier this month generated more interest than I expected. So I decided to write about an important part of the portfolio’s construction and maintenance: portfolio management.
I divide stock investing into three phases: stock selection, stock valuation, and portfolio management. I do this whether I am investing for dividends or for capital gains. Portfolio management includes everything that takes place after you have stocks in a portfolio. It covers important areas such as how much of the portfolio is allowed to be in any one stock; when and why to sell; when and how to reinvest dividends; and the like.
Portfolio management is best done, I feel, according to rules that you create before you create the portfolio itself. The rules are embodied in its constitution: the highest-level statement of your vision, goals, strategies, and expected results. Many people call this document their Investment Policy Statement or something like that. It doesn’t matter what you call it. It matters very much that you have it.
I dug back into my corporate consulting career for the following slide, which I have modified to illustrate the strategic planning process in investing (click to enlarge).



Your vision is your long-term aspiration, where you want to be years from now. My vision is to have a financially secure retirement. Maybe that sounds unimaginative…more on this at the end of the article.
After your vision comes investment goals: What objectives you must achieve in order to make your vision come true. Your goals should be specific, measurable, and attainable. For example, what investment accomplishments do you want to be celebrating 3, 5, or 10 years from now? What difficulties or issues must you eliminate to achieve success? What, if you don’t do it, will cause failure?
Next come your strategies: High-level steps to reach your goals. Strategies state your approach for achieving your objectives. They establish guidelines and boundaries for your investment activities:
How you will identify the best stocks
How many and what variety of stocks you will hold
How you will recognize a good entry point for each stock
Your rules for portfolio makeup (number of stocks, diversification, maximum size of any one holding, etc.)
How you will know when to sell
What you will do with incoming dividends
How you will measure performance
Notice that your strategies do not tell you which stocks to purchase, nor when. Those are tactics, the activities needed to accomplish your strategies. They usually don’t belong in this document.
Here (with a few omissions for brevity) is the constitutional document for my public, real-world, real-money Dividend Growth Portfolio:
Goal:
The goal of the Dividend Growth Portfolio is to generate a steadily increasing stream of dividends paid by excellent, low-risk companies.
Broken down, the goal is to create and maintain a portfolio of dividend stocks:
purchased at favorable prices;
of companies with sound business models and solid financials;
that consistently raise their dividends;
that is reasonably diversified;
that have a combined beginning yield of at least 3 percent;
whose yield on cost steadily grows to 10 percent within 10 years of inception, and then continues to grow beyond that as long as the portfolio exists;
whose dividend growth is accelerated by regularly reinvesting the dividends; and
whose total return beats inflation over long periods of time.
Strategies to Attain the Goal:
Use the current Top 40 Dividend-Growth Stocks as the Shopping List.
Buy only stocks with “Fair” or better valuations. All else equal, favor stocks whose most recent dividend increases have been the healthiest.
Reinvest dividends, but not automatically in the company that issued them. Rather, collect the cash and reinvest when it accumulates to $1000, selecting the best candidate at that time.
When reinvesting dividends, always try to improve the portfolio along some dimension: yield, dividend growth, diversification, and the like.
Limit the number of stocks owned to about 10 to 15, maximum 20.
Aim for well-roundedness in the portfolio. Diversify across sectors, industries, geographies, and different ranges of yields and growth rates.
Hold no more than 20 percent of the portfolio’s value in a single stock. If a position exceeds 20 percent, sell the excess and re-deploy the proceeds. [Note: I recognize that this is a higher percentage than many would tolerate for one stock.]
Make opportunistic switches from one stock to another if such a swap will upgrade the portfolio. The expected frequency of such exchanges is low.
Since the major focus is on dividends and not share prices, the portfolio will usually be 100% invested (except for accumulating dividends). Don’t “sit out” bear markets so long as the dividend stream is intact. Cash does not generate dividends.
Seriously consider selling any stock for these reasons:
(1) It cuts, freezes, or suspends its dividend.
(2) It bubbles or becomes seriously overvalued.
(3) You receive news of significant changes impacting the company.
(4) It is acquired.
(5) Its dividend rises above 9 or 10 percent.
(6) It underperforms the market in total returns (price + dividends) for three years running.
Conduct a thorough Portfolio Review twice per year.
Review this constitution once per year and adjust it for changed circumstances, new knowledge, and the like.
Don’t do the following:
Use margin.
Use options, futures, or other “derivative” investments.
Invest in mutual funds or ETFs.
Use trailing sell-stops.
Refer to your constitution from time to time for guidance, especially if you find yourself in a perplexing or ambiguous market situation. It will remind you of how you analyzed things when you were thinking broadly and clearly.
Once written, your constitution need not be rigid or unchanging. It can be amended. Review it annually. Make adjustments as your life circumstances change, you learn more, and you become a better investor. Review your actual stocks twice a year, and review any individual stock immediately when you hear significant news about it. BP's dividend cut in 2010 should not have caught any serious Dividend Growth Investor by surprise. That dividend was in peril as soon as the rig blew up, and you couldn’t miss the news. Don’t play the victim card when things like that happen, because they do happen. Instead, be proactive. As has often been noted, dividend-growth investing is not buy-and-ignore. It is buy-and-monitor.
I mentioned my unimaginative vision earlier: To have a financially secure retirement. What does that mean? For me, it means not only a secure but an exciting retirement.

An article on MarketWatch on Tuesday by Robert Powell addresses the idea of a bucket list. Powell speaks of a former colleague—who he admired greatly—that died at the age of 63, while another friend posted a notice on Facebook that’s he’s leaving for a three-week trip to Africa. A financially secure retirement is not boring—it’s the ticket to doing exactly what you want to do.
According to the article, almost everything about a bucket list can be boiled down to three questions:
What makes you happy?
What are your interests?
How much do your interests cost and do you have the money and time to pursue the things that you are interested in and that make you happy.
So my “financially secure retirement” vision is critical to exploring my interests and doing what makes me happy.
Art Koff, founder and CEO of RetiredBrains.com, says identifying your passions and interests are the key ingredients of building a bucket list. The items on many bucket lists are somewhat common. The things that make most people happy center on travel, spending time with family and friends, and going back to school.
Spending time with family and friends is among the most common items on bucket lists. Social connections—including family and friends—have been shown to add to longevity. Items like travel, gardening, or playing a musical instrument come up often. But unless you have a plan and the money to pursue your interests, the bucket list is unattainable. Financial independence is one key to being able to accomplish the items on your bucket list.

when the yield curve flattens

In moderation, a little inflation is not all that bad — as the Fed reminded us when it was still worried about deflation. Inflation can boost sales, profits, employment and incomes, thus giving the recovery a needed lift.

Too much inflation can be problematic, for reasons you well know. To keep inflation from getting out of hand, the Fed will start tightening up, boosting short-term rates in the process.

The yield curve will then begin to flatten. Once it inverts — when short rates go above longs — that’s when it’s time to bail out of stocks, and prepare for the next recession

Invest in recovery

Jim Lowell

Feb. 1, 2011, 12:01 a.m. EST
Invest in recovery
Commentary: Buy emerging markets where you can


Finally, while everyone is saying the end of the small-cap run is upon us, I think seeking out emerging-growth stocks here that can grow to go global in five or more years makes sense (now at a slight discount to the most recent high water mark). I like the actively managed Fidelity Stock Selector Small Cap /quotes/comstock/10r!fdscx (FDSCX 19.49, +0.12, +0.62%) .

While this fund has been around since 1993, it has undergone not only numerous manager changes, but a few key management, objective and strategy changes, too. Currently, its team-managed crew looks for Russell 2000-like capitalization ranges domestically and globally for their best picks. With under 200 issues, it’s concentrated and, perhaps because of the various changes the fund has seen over the years, it’s off the grid of most investors. It’s a $1.4 billion fund with 20% in tech, 20% in financials, 14% in consumer discretionary and industrials, and 12% health care. As I have written here before, thanks to the emergence of the global consumer, I think health care is the emerging growth and emerging market play of the decade. That thread and theme runs through all the picks above.

The best laid plans...

The best laid plans...
Commentary: Don’t bet all or nothing on any adviser or system
By Mark Hulbert, MarketWatch

CHAPEL HILL, N.C. (MarketWatch)

Rchard Russell made a remarkable confession earlier this week.

He said that he finds the financial markets to be so inscrutable that trying to time them is close to futile. He says that he’s therefore decided to invest a good chunk of the accounts he manages in a mutual fund that has a static allocation to several uncorrelated asset classes.

Russell, of course, is the grandaddy of the investment advisory industry, having continuously published his Dow Theory Letters advisory service since 1958, more than 50 years ago. He has seen more bull and bear markets than almost any of the rest of us, and he has the cynicism that is borne of witnessing innumerable new strategies and approaches that have come onto the investment scene to great fanfare and then ultimately failed.

As an illustration of the mixed and divergent signals the market is sending, Russell writes: “I recently read the works of A. Gary Shilling and Bob Prechter’s Elliott Wave Forecast, and they provide really convincing reasons as to why we’re going into deflation. I read Larry Edelson and a dozen other advisors and they provide excellent reasons why we’re heading into hyperinflation.”

I sympathize with Russell’s argument. As fate would have it, I read his comments while at the World Money Show in Orlando, where I will be giving a couple of workshops. After listening to some of the other workshops at this conference, I was convinced that I’d be a fool to have any exposure whatsoever to the equity markets. Upon listening to other workshops, in contrast, I concluded that I should mortgage the house to put everything into the stock market.

Unfortunately, examining these advisers’ track records goes only so far in helping us decide which of these viewpoints is correct. Even among the advisers with the very best long-term performances, there still is widespread disagreement.

The first step towards wisdom in this business is to recognize that your chosen adviser might get it all wrong — no matter how good his track record and how cogent his reasoning. This seems like an utterly banal thing to say, and yet if we are willing to follow its logic, you reach a very provocative conclusion.

The late Harry Browne, the one-time investment newsletter editor who became the Libertarian Party’s candidate for president in the 1990s, was one adviser who was willing. In his book “Why The Best-Laid Investment Plans Usually Go Wrong,” Browne pleaded with readers not to bet all or nothing on any one adviser, no matter how good his or her record, or any sure-fire market timing system that allegedly “can’t” go wrong.

Browne continued: “Almost nothing turns out as expected. Forecasts rarely come true, trading systems never produce the results advertised for them, investment advisers with records of phenomenal success fail to deliver when your money is on the line, the best investment analysis is contradicted by reality. In short, the best-laid investment plans usually go wrong. Not sometimes, not occasionally — but usually.”

Browne’s idea was to invest in a basket of asset classes, each one of which has a low correlation with the others. As a result, when any one of the asset classes is performing poorly, there is a good chance that the others will at least be holding their own — if not actually appreciating in value. Brown coined the name “permanent portfolio” to describe this approach, since it makes no changes other than periodic rebalancing.

Brown’s idea eventually manifested itself in a mutual fund, the Permanent Portfolio Fund /quotes/comstock/10r!prpfx (PRPFX 45.94, +0.05, +0.11%) . It is into this fund that Russell says he’s putting a good deal of the accounts he manages.



Seven best funds for 2011
Commentary: Consider these standouts when freshening your 401(k
By Jeff Reeves

Best conservative fund

What if you are one of the many investors who doesn’t want to take more risk than necessary with their retirement cash, settling for a little less profit in the boom times to keep you safe when things go south? If that’s the case, consider a mutual fund with a name that says it all: the flagship Permanent Portfolio Fund /quotes/comstock/10r!prpfx (PRPFX 45.94, +0.05, +0.11%)

Permanent Portfolio is a family of funds, but the PRPFX fund is their most conservative offering. The investment seeks to preserve your retirement funds in tough times while cashing in on hard assets and income investments. The portfolio’s top holdings include gold, silver, Swiss francs and bonds, foreign real estate and natural resource stocks. As you can see, your money isn’t going to evaporate in these picks — unless some disaster wipes away nearly every investment option out there, and then we all will have much bigger problems.

In fact, if you want to know how stable this fund is, look at its worst three-month return on record — an 18% decline recorded as the U.S. economy cratered, while index funds like Vanguard Total Stock Market /quotes/comstock/10r!vtsmx (VTSMX 33.23, +0.05, +0.15%) tallied losses of more than 30%.

The Permanent Portfolio Fund is open to new investors with a mere $1,000 buy-in and boasts Morningstar’s top five-star rating. Its expense ratio is a reasonable 0.82%.

EMC & HPQ

High Tech + Large Cap + Strong Momentum = Buy Pullbacks on These 5 Stocks
MC Corporation (EMC): 25.69



Accelerated technology spending by companies eager to jumpstart growth has boded well for the largest maker of data storage computers. EMC saw its 4th quarter jump 61% as it beat Wall Street’s expectations on both revenue and earnings.

The future looks promising for EMC as companies continue to upgrade current technology and also invest in data-storage technology as they understand cost savings realized by embracing cloud computing, Management expects EMC to gain share in the data storage marketplace.

Analysts have raised their 2011 earnings estimates following the company’s earnings call. Consistent earnings with high profit margins contribute to a strong ROE. Positive money flow activity and a strong price trend vs. the broader market contribute to a bullish price/volume activity.

The stock is back to its high before the 2008 collapse which could provide short-term resistance. However, given its position in one of the most critical technology areas and the momentum it has gathered, we believe such resistance will be short lived and should be viewed as an opportunity to buy on the dip.

Hewlett-Packard Company (HPQ): 47.43



HP, like a troubled superstar player on a championship team, does everything (well, mostly everything) right on the field and wrong off it. While memories of ex-CEO Carly Fiorina and her ouster are still in the present, we now have to digest the ouster of another ex-CEO Mark Hurd.

However, despite all the noise, HP continues to execute much better than many of its peers and competitors on the field. Whether it is gaining market share in the waning PC market, teaming up with Verizon to introduce a 4G LTE notebook, or flexing its muscles in the cloud computing marketplace, it continues to “invent” and grow.

Despite posting consistent earnings with high profit margins and generating strong ROE, HPQ lost 30% in less than 3 months from its 52 week high in May to its 52 week low in August amid the Mark Hurd scandal, losing 20% in August alone following the CEO’s resignation. Since then, the stock has recovered 25% and is back to Mr. Hurd’s preresignation days but still 10% off its 52-week high. The current board is completely revamped following the replacement of many of Hurd’s directors.

The fundamentals of the company seem to be intact. A low projected P/E ratio on 2011 earnings suggests that shares are undervalued at current levels. Analysts are bullish on the company’s 2011 prospects and have raised their estimates. All these factors result in a very bullish rating. We believe that with new management team now in place and the Mark Hurd scandal a story of the past, HPQ will resume focus on business opportunities and growth rather than personalities.

About the author: Marc Chaikin Inventor of the Chaikin Oscillator & Managing Partner at Chaikin Stock Research LLC. To learn more about Marc Chaikin and his actionable decision making tools for self-directed investors called "Chaikin Power Tools" visit: www.ChaikinPowerTools.com. Marc utilizes the...

Buffett's tips for new investors

The world's most famous investor lays out his basic principles in this year's annual letter to Berkshire Hathaway shareholders.
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Related topics: investing strategy, Warren Buffett, General Electric, value stocks, stock market

Every few years, critics say Warren Buffett has lost his touch. He's too old and too old-fashioned, they claim. He doesn't get it anymore. This time he's wrong.

It happened during the dot-com bubble, when Buffett was mocked for refusing to join the party. And it happened again during the recent financial crisis. As the Dow Jones Industrial Average ($INDU) tumbled below 7,000, Buffett came under fire for having jumped into the crisis too early and too boldly, making big bets on Goldman Sachs Group (GS, news) and General Electric (GE, news) during the fall of 2008, and urging the public to plunge into shares.

Now it's time for those critics to sit down for their traditional three-course meal: humble pie, their own words and crow.



Diversify your portfolio

Class A shares of Buffett's investment vehicle, Berkshire Hathaway (BRK.A, news), slumped to nearly $70,000 in early 2009 but have since rebounded to above $12,000, as those bets on GE and Goldman have paid off.

Anyone who took Buffett's advice and invested in the stock market in October 2008, even through a simple index fund, would have been up about 30% two years later.

This is nothing new, of course. Anyone who held a $10,000 stake in Berkshire Hathaway at the start of 1965 has about $80 million today.

Inside the Berkshire Empire

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How does he do it? Buffett explained his beliefs to new investors in a recent annual letter to stockholders:

Stay liquid. "We will never become dependent on the kindness of strangers," he wrote. "We will always arrange our affairs so that any requirements for cash we may conceivably have will be dwarfed by our own liquidity. Moreover, that liquidity will be constantly refreshed by a gusher of earnings from our many and diverse businesses."

Buy when everyone else is selling. "We've put a lot of money to work during the chaos of the last two years. It's been an ideal period for investors: A climate of fear is their best friend. . . . Big opportunities come infrequently. When it's raining gold, reach for a bucket, not a thimble."

Don't buy when everyone else is buying. "Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance," Buffett wrote. The obvious corollary is to be patient. You can only buy when everyone else is selling if you have held your fire when everyone was buying.

Value, value, value. "In the end, what counts in investing is what you pay for a business -- through the purchase of a small piece of it in the stock market -- and what that business earns in the succeeding decade or two."

Don't get suckered by big growth stories. Buffett reminded investors that he and Berkshire Vice Chairman Charlie Munger "avoid businesses whose futures we can't evaluate, no matter how exciting their products may be."

Most investors who bet on the auto industry in 1910, planes in 1930 or TV makers in 1950 ended up losing their shirts, even though the products really did change the world. "Dramatic growth" doesn't always lead to high profit margins and returns on capital. China, anyone?

Understand what you own. "Investors who buy and sell based upon media or analyst commentary are not for us," Buffett wrote.

"We want partners who join us at Berkshire because they wish to make a long-term investment in a business they themselves understand and because it's one that follows policies with which they concur."

Defense beats offense. "Though we have lagged the S & P in some years that were positive for the market, we have consistently done better than the S & P in the 11 years during which it delivered negative results. In other words, our defense has been better than our offense, and that's likely to continue."

Timely advice from Buffett for turbulent times.

This article was reported by Brett Arends for The Wall Street Journal.


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Citrix: Strategic Issues Overshadow Upbeat

Citrix: Strategic Issues Overshadow Upbeat Earnings ReportAfter investigating the networking sector a couple weeks ago, I was intruiged by Citrix (CTXS). Let me start off by saying that Citrix Systems Inc. is a great company. They have been a leader in their sphere for years, and their growth has been phenomenal. Couple that with the fact that they just had a great Q4, and one might call me crazy for issuing a sell recommendation on this company.

However, I am firm in my beliefs that no matter the story behind a company, you have to combine that with the right price to call it a good investment. Some highly priced companies do this with explosive growth, competitive edge and proprietary technologies. Some companies individually break this rule and sometimes the market disproves this rule over the short to medium term, but I think it in the long run value prevails.

Citrix Systems has had a competitive advantage in terms of application virtualization for some time now. They have been the best option for companies hoping to run an application from a central server with XenApp, and also from remote locations using Access Essentials. Their technologies are applicable across a wide variety of operating systems, including Windows, which made them unique in this sphere; many competitors bundle desktop and application virtualization into one package.

Because of this flexibility, CTXS has a strong relationship with Microsoft (MSFT), which it relies upon to avoid direct competition with companies like VMware (VMW), who focus on more complicated holistic server infrastructures. Recently, VMW released their earnings, which beat but were tempered by soft guidance on margin outlook. Their CFO, Mark Peek said (see conference call transcript here):

The IT spending environment improved dramatically compared to 2009, and we were able to capitalize.
However, the caveat with their earnings call was a flat margin for 2011. Could CTXS be caught in the same boat? Let’s take a look at their earnings and see.

Earnings
See the earnings press release here.

Q4 Financial Summary: In reviewing the fourth quarter results of 2010, compared to the fourth quarter of 2009:

•Product license revenue increased 17 percent;
•Revenue from license updates grew 13 percent;
•Online services revenue grew 16 percent;
•Technical services revenue, which is comprised of consulting, education and technical support, grew 40 percent;
•Revenue increased in the Americas region by 27 percent, the EMEA region by 7 percent and the Pacific region by 15 percent;
•Deferred revenue totaled $779 million, compared to $619 million on December 31, 2009;
•GAAP operating margin was 21 percent for the quarter, and non-GAAP operating margin was 28 percent for the quarter, excluding the effects of amortization of intangible assets primarily related to business combinations, stock-based compensation expense and costs associated with the 2009 restructuring program;
•Cash flow from operations was $179 million, compared with $178 million in the fourth quarter of 2009; and
•The company repurchased 1.9 million shares at an average price of $65.90.
Annual Financial Summary: In reviewing 2010 results compared to 2009 results:

•Product license revenue grew 15 percent;
•License updates revenue grew 13 percent;
•Online services revenue grew 17 percent;
•Technical services revenue, which is comprised of consulting, education and technical support, grew 31 percent;
•Revenue increased in the Americas region by 20 percent, the EMEA region by 8 percent, and the Pacific region by 21 percent;
•GAAP operating margin was 17 percent for fiscal 2010, and non-GAAP operating margin was 26 percent, excluding the effects of amortization of intangible assets primarily related to business combinations, stock-based compensation expense and costs associated with the 2009 restructuring program.
•Cash flow from operations was $616 million for fiscal 2010 compared with $484 million last year; and
•During fiscal 2010, the company repurchased 8.3 million shares at an average price of $53.14.
Financial Outlook for Fiscal Year 2011: Citrix management expects to achieve the following results during its fiscal year 2011 ending December 31, 2011:

•Net revenue is expected to be in the range of $2.10 billion to $2.14 billion;
•GAAP diluted earnings per share is expected to be in the range of $1.78 to $1.84. Non-GAAP diluted earnings per share is expected to be in the range of $2.29 to $2.33, excluding $0.34 related to the effects of amortization of intangible assets primarily related to business combinations, $0.45 related to the effects of stock-based compensation expenses, charges recorded in conjunction with the company’s 2009 restructuring program, if any, and $(0.24) to $(0.34) for the effect of the differential between the GAAP and non-GAAP tax rates and tax effects related to these items.
By all estimates, a solid quarter. Revenue growth was solid all across the board, and their per share earnings guidance of $2.29-2.33 beat the street's estimate of $2.28. The other strategic issues surrounding Citrix are what I feel overshadow this upbeat earnings report.

Noteworthy Strategic Items
Microsoft - The Elephant in the Room: I find issue with CTXS’s strategic positioning in the market right now. They have positioned themselves as a technology leader in application services, especially in Windows based virtualization efforts. However, very soon they may come head to head with MSFT as a potential rival. Microsoft has made not made it a secret that their entrance into the cloud would include application virtualization. Combine this with the fact that CTXS relies on Windows for a competitive edge, and I am not convinced this relationship can hold up in the long term. Right now it is working but five - or even three - years from now I wouldn’t be so sure.

Acquisition Target: It has been whispered that Citrix could make a good acquisition target for a variety of firms with piles of cash that want to play in the cloud. Their technology would provide any larger company with the foundation to compete immediately with anyone in this market, and could also create synergies if combined with the right partner.

Insider Selling, CTXS 10b5-1 Plan Sales: Insider trading is generally not a leading indicator for stock performance. Executives need to sell stock for anything from liquidity to diversification, and since options make up a large portion of salaries for these employees, turning those into cash is a natural progression.

However, there is one type of insider selling that is generally considered a negative sign in the eyes of the market. That is the 10b5-1 plan. With this type of sale, you can enter into a transaction agreement, but then rescind that agreement even if you come across insider information. The SEC says that insider trading must involve an actual transaction of shares. According to InsiderMonkey, companies with large 10b5-1 filings have experienced abnormal negative returns of 70 basis points a month.

Buy/Sell Analysis
Valuation: Given the advantages Citrix still claims and their history of strong results, I have to be careful about handicapping them too much for strategic reasons that could change. Nonetheless, even using appropriate growth assumptions without any penalty for a failing relationship with Microsoft, I still can only justify a price floor of $34 and a ceiling of $55 for Citrix. This is around where they were trading in mid October 2010.

However, their abnormal returns over the S&P for 2010 were incredible. They have also recently been trading near their five year high (which is not a sell indicator, just a fact). Citrix’s growth in the coming years will be high simply because of the expansion of the cloud. However, I feel their technological moat is no longer significant enough to warrant such a premium. The erosion of technological superiority will allow competitors to leverage their solutions in a way that will eat at Citrix’s market share. The thought of an acquisition could be appealing, but that is only a whisper in the wind at this point in time.

Ratios: Their ratios are a mixed bag. From a liquidity standpoint, they look perfectly healthy. Their current ratio has been constant for the last five years and they hold no long term debt. They generate free cash flows in excess of five hundred million, and should be able to cover any short term obligations. Their margins and return ratios had been decreasing since 2005, but recovered slightly in 2010. Their profit margin was the most notable increase, moving from 11.83% in 2009 to 14.78% in 2010. I believe this is due in part to the growth of their technical services (40% in Q4 and 31% in all of 2010) which include consulting and technical support, traditionally high margin items.

From a relative perspective, their price to earnings is almost double what it was in 2008/2006 (~46 currently versus 24.2 in 2008 and 26.78 in 2008). However, their price to book and price to sales have increased at a less alarming rate.

Conclusions
Citrix is a great company. They have been aggressively repurchasing shares. They have growth potential, but that is coupled with some potential strategic roadblocks. I feel that investors have already cooked in phenomenal growth for the next five years into the price of this stock, and I cannot justify that price with my assumptions.

If there were to be a run on the stock, and it returned to October 2010 levels, then I’d be more comfortable making an investment. However, at the $67 price level, I think Citrix is too expensive.





PIMCO Corporate Opportunity Fund: One Stellar, Sustainable Yield
by Frank Constantino
I came across the fund in Barron's 2011 Roundtable (part 2); All Over The Map, January 22nd. The Pimco Corporate Opportunity Fund (PTY) is managed by Bill Gross, Founder and Co-Chief Investment Officer of Pimco. PTY was listed as one of two picks from Bill Gross in the article. Let's look at the details of the fund.

Pimco Corporate Opportunity Fund

PTY seeks current income and capital appreciation. The fund invests in US dollar-denominated corporate debt obligations and other corporate income producing securities. Normally, the fund will have an average credit quality that is investment grade. PTY currently yields 7.3%.

PTY currently has a Morningstar Rating of five stars for three years, five years, and overall performance. Morningstar rates the fund as having average historic risk with high historic performance. PTY is up 24% over the last twelve months.

PTY currently holds $1.1 billion in assets and is actively managed by Bill Gross.

Top Ten Holdings


Name Maturity Date Percent of Holdings
Amer Intl Grp FRN 05/15/68 2.60%
Bay Area Toll Auth 7.043% 04/01/50 2.30%
Riverside Calif Elec Rev Rev Bds 7.605% 10/01/40 2.30%
Amer Intl Grp 8.25% 08/15/18 2.00%
Cobank Acb Pfd 144A -- 1.80%
Citigroup Cap Xxi FRN 12/21/77 1.50%
Gsr Mtg Tr 2006-1f CMO 6% 02/25/36 1.50%
Rabobank Nederland 144A FRN 06/30/19 1.30%
Panamsat Corp New 6.875% 01/15/28 1.30%
Ppl Pfd -- 1.30%

Portfolio Assets
Domestic Bonds 64.70%
Cash 20.96%
Foreign Bonds 9.95%
Preferred Stock 4.20%
Foreign Stock 0.12%
Other 0.06%

It is important to note that PTY uses leverage, currently at about 37%. This means that because the fund borrows at low short-term rates to purchase longer dated assets, a spike in short-term rates could hurt performance. I don't see short-term interest rates rising substantially in 2011.