We all love to read annual reports, right? Before making an investment, I always like to read a few annual reports in order to get a sense of the business. Warren Buffet is famous for, among many other things, writing some brilliantly entertaining and enlightening letters at the beginning of the Berkshire Hathaway annual report. In fact, his letters over the years have been combined into a book. They are well worth reading.
Most asset management firms also produce an annual letter to their clients/shareholders. This is a useful tool for communicating about the year’s performance, but also a way to crystallize thought and explain certain moves that the firm made during the year.
Have you considered writing an annual letter for your own investment performance? I thought I would give it a try. Here’s my first attempt:
Dear Investment Partner,
For the full year 2016, the Croce Capital Management portfolio returned 15.82% net of commissions and fees, including dividends. The S&P 500 returned approximately 12.25% including dividends in 2016.
Regarding performance for the past year, I find it’s always helpful to remember that, while it is nice to beat the market, no single year’s performance should be taken as a proxy for a manager’s intelligence or skill — or lack thereof. I would anticipate having years where we are able to handily outpace the general market, and I also anticipate other years of getting beat by the market. It’s the repeated work of reading, listening, analyzing, and intelligently allocating capital that leads to outsized returns over time. We are happy to have had a good year, but also recognize that a longer time horizon presents a more accurate view of performance.
Our investment approach is to minimize risk while also maximizing our opportunities to capture reasonably aggressive growth where it can be accretive to our long-term results without unnecessarily exposing us to risk. If you re-read that sentence, you’ll notice that there’s really nothing special about this approach — everyone wants to minimize loss and maximize gains. Our method of implementing this approach is to maintain our largest positions in companies that we feel minimize downside risk. This means that we have the majority of our capital invested in solid, dividend-paying, blue chip companies that have proven track records of consistent, if unspectacular, growth in both earnings and dividend payouts. These companies also tend to have rock-solid balance sheets and reassuring cash flows. Some companies may try, but it’s really quite difficult to fake cash flows and it’s impossible to fake the dividends that end up in our coffers each quarter.
So if our investment approach is not particularly unique, what is our particular advantage? From where we sit, there are two main advantages that we hold:
- We have a long-term time horizon.
- We have the luxury of being to act on only our best ideas.
What do these mean? Since we are not beholden to quarterly reports or other silly metrics, we have the ability to make investments that we think might not pay off for a few years. Additionally, we have the ability to hold investments for years — decades, even — and sit back and watch the capital gains pile up. In that same vein, we are encouraged to take action only when we feel like we are acting on our very best ideas. There are no outside shareholders to please, no activists to ward off. We act only on ideas that we believe will add to the long term wealth of our primary constituents — you.
It might be a good time now to remind you that not only are we acting with your best interests in mind, but we have aligned our interests with yours. Every time we make an investment on your behalf, we put our own money into the same investment. If an idea is not good enough for our money, it’s not good enough for yours.
As a quick recap on the 2016 portfolio performance, here are two items we would like to highlight:
- Johnson & Johnson (JNJ – 28.81%), The Hershey Company (HSY – 24.42%), Unilever PLC (UL – 11.92%), and Nike Inc. (NKE – 11.65%), together make up 76.8% of our current holdings. This portfolio composition is a little more conservative than we would like — look for this to change over the coming years. Even though it’s conservative, we have no complaints about the performance of these companies that we own. Nike did have a negative annualized return for 2016, but we believe this company represents a real value at the moment – we may increase this position over time. See the below chart for 2016 returns of these rock-solid, foundational holdings:
Company 2016 Return JNJ 12.75% HSY 19.82% UL 19.37% NKE -5.45%
- We sold out of our position in Piedmont Natural Gas (PNY). We first opened a position in this company in March 2014, and over time added to that position at an average cost basis of $35.28/share. When we sold in January 2016, the price had appreciated to $57.00/share, representing an increase of 61.56% over our cost basis. Beyond that, we were able to recover 5.63% of our invested capital via dividends paid out by the corporation. At the time of our sale, Duke Energy had announced intentions to purchase PNY. When we exited, we were able to record annualized gains of 42.08%.
Certainly not all of our investment in 2016 were winners (see Nike), but the ones above are mentioned to reinforce the advantage that we have. PNY would have been a nice little company to hold; we would have been more than happy to keep it and collect dividends over the next several years. We thought it was slightly undervalued, but the share price wasn’t really going anywhere during our holding period. When you identify a value, though, you’re not usually the only one. In this case, Duke Energy thought PNY looked good and bought the company. That was a real boon to use as shareholders. We certainly don’t count on these types of corporate events to boost our results, but we’ll take them when they happen.
As we move into 2017, we are looking to expand our portfolio of deep value investments. This will likely introduce a little more volatility to the overall portfolio, but this is the price we pay for excess returns. We will do our level best to ensure that the investments we make align with our values and beliefs and we believe that in the long run these investments will add to our collective wealth. Always keep in mind that our top goal is this: do not lose money. In fact, we follow Warrent Buffet’s two investing rules pretty stringently:
- Rule No. 1: Never lose money.
- Rule No. 2: Never forget rule No. 1.
With that in mind, we will always maintain (and likely grow) our fortress investments. These are companies such as JNJ, UL, HSY, NKE, etc. Look for this list of foundational companies to grow, even as we expand our portfolio and act on our very best ideas.
Thanks for your trust and your partnership.
Many happy returns.