The 2019 performance of the CFALLC 187 Portfolio showed a composite price gain of 32.57%
Connolly Financial Advisors, LLC
December 10, 2019
The 187 companies I track each year are varied in terms of industry and market cap. From a market cap perspective, the dollar range of the portfolio reflects mkt caps of $1 trillion to $159 million. Each company is weighted against the overall portfolio based on:
• Operating Margin
• Price to Cash Flow multiple
• Cash Flow growth rate
• Enterprise value to EBITDA
This weighting is used to identify potential undervalued or overvalued stocks.
From an overall market perspective, I compute the cumulative portfolio metrics that exist now and contrast them to the same metrics of the portfolio for prior periods covering more than ten years of data. This yields a perspective on the market’s overall state of value.
The data as of December 2019 reveal operating results that are underperforming history. This operating under-performance is contrasted with stock prices that are over-performing history. The key observations are as follows:
• The Price to Cashflow multiple of 25.14 times at December 9, 2019 compares to the historic average of 18.34 times. The current prices to cash flows are very close to historic highs that have typically preceded market sell-offs.
• 45 of the companies in the portfolio have lower levered cash flow in 2019 vs 2018, yet have higher stock prices than what existed at December 31, 2018.
• The forecasted cash flow growth rate beyond 2019 is at 9.42%, which is historically low and below the average growth over the past ten years of 10.55%
• 31% of the companies have lower cashflow in 2019 than 2018
• The portfolio value on a discounted cash flow basis is below the current price of the portfolio
• The median cash flow growth of the companies in the portfolio for 2019 is 6.58%, which is lower than each year since and including 2016 vs 2015.
• At the end of 2018, analysts forecasted cash flow growth of 15.15% for the portfolio. The actual growth is coming in at 9.20%
• The average share price is up by 31.8% yet the average cash flow growth is only 9.20%
• On a DCF basis, approximately 50% of the companies have stock prices that are above the DCF value vs the historic average of 33%
• The Dividend yield is under 1%
• Operating margin in 2019 for the portfolio is 13.15%. The historic average operating margin is 14.13%.
• The Enterprise Value to EBITDA multiple is 17.92 times. The historic average of EV/EBITDA multiple is 12.07 times.
• The discount rate needed to value the portfolio’s cash flow at current stock prices is 8.69%. The historic average is 12.11%. This is the rate needed to equate values and provides no future investment return from price appreciation. To realize a positive return, the discount rate needs to be below the 8.69%.
• The required return on equity vs debt in the market at December 2019 is 8.93%, which is significantly below the historic average of 12.25%. The market’s risk profile for equity is very low, below historic levels, in an environment where operating metrics are relatively weak and declining. There appears to be a disconnect between risk and reward.
• Since 2011, the debt of the companies in the 187 portfolio have risen by an annual compound rate of 12.5%, whereas the market cap has risen by an annual compound rate of 15.5%. For 2019 alone compared to 2018, debt increased by 14.19%, whereas market cap increased by 15.52%. Growth in debt in 2019 above the CAGR since 2011 vs the growth in market cap for 2019 that equals the CAGR is a concern, as debt in 2019 grew at an accelerating rate.
The data presented above will be presented within the next week in chart format to provide context of current values versus historic values.
Finally, the assessment of current prices vs the discounted cash flow values reveals that 98 companies have future positive return potential and 89 companies have future negative return potential. At December 31, 2018, there were 109 companies with positive return potential and 78 companies with negative return potential. The forecast at December 31, 2018 of 109 companies with positive return potential compares to the actual of 155 companies out of the 187 that had actual positive returns in 2019, yet cashflow for 2019 underperformed as noted above, and operating margins stayed constant. This makes one wonder if the positive stock price performance overall is more aligned with the growth in debt of 14.19%, and the funding of stock buybacks. Something to think about.
Please feel free to send me any questions or comments you may have.
All the best and Happy Holidays,