Compounders And Dividends: January 2023 Watch List Update

Welcome back to my bi-monthly watchlist update. My last watchlist article was in November, and a lot has changed in my portfolio since then.

As a reminder, just because a company is on my watchlist doesn’t mean I like the current price or I’d purchase it today. A company being on my watchlist means one of two things: I love the business and I want to own it one day or this is a very intriguing company and work is needed. I don’t separate the two distinctions below, but I can if that’s something readers are interested in.

As disclosed in my December and 2023 Goals updates, I added FOUR new positions to my dividend growth portfolio, three of which were on my November watchlist update. The one lone exclusion was a company I decided to add in December as its price kept falling.

At the end of 2023, I took a red pen to my watchlist and crossed off a number of companies that I no longer desired to own. In Howard Marks’ December 13, 2022, memo, “Sea Change“, he wrote the following on the shift in psyche from buying high quality assets to purchasing any asset as long as the investor was adequately compensated for the risk:

• In other words, whereas prudent bond investing had previously consisted of buying only presumably safe investment grade bonds, investment managers could now prudently buy bonds of almost any quality as long as they were adequately compensated for the attendant risk. The U.S. high yield bond universe amounted to about $2 billion when I first got involved, and today it stands at roughly $1.2 trillion.

• However, the most important aspect of this change didn’t relate to high yield bonds, or to private equity, but rather to the adoption of a new investor mentality. Now risk wasn’t necessarily avoided, but rather considered relative to return and hopefully borne intelligently. This new risk/return mindset was critical in the development of many new types of investment, such as distressed debt, mortgage backed securities, structured credit, and private lending. It’s no exaggeration to say today’s investment world bears almost no resemblance to that of 50 years ago. Young people joining the industry today would likely be shocked to learn that, back then, investors didn’t think in risk/return terms. Now that’s all we do. Ergo, a sea change.

With the amount of money I’m managing, I’m not looking for lottery tickets and I’m not looking to get rich quick. While many are willing to trade quality for a cheaper price that they believe compensates them for the risk, I’m intensely focused on high quality companies. Because of that, I had to make sure my watchlist reflects that reality, so I removed a number of companies that were added because of a decline in price. An example of such a company is Advance Auto Parts (AAP). I wrote in my November Watchlist article:

• AAP’s recent earnings sell off has added it to my watchlist. I’ve been a long admirer of AZO and ORLY. They’re incredible counter cyclical names that do well when times are tough and have been aggressive purchasers of shares. AZO and ORLY are clearly the superior companies (as I’m typing this, I’m convincing myself to remove AAP from my watchlist) but AAP has decided to return capital to shareholders via dividends as opposed to the share repurchasing method of its peers. While AAP is not as strong as the others in the industry, the 3%+ dividend is quite interesting with two strong dividend raises showcasing management’s commitment to returning capital to shareholders. I’m not sure I’ll buy shares, but it’s worth more research.

I even said, in the paragraph describing why I added AAP to my watchlist, that I shouldn’t purchase AAP shares. I knew it was not as high of a quality a company as AutoZone (AZO) and O’Reilly (ORLY).

I’m still learning, and mistakes like this have no impact on my portfolio since I caught it early before I purchased shares. But a strong process will end up driving results. If I continue to allow lower quality companies to enter my watchlist, some will eventually trickle into my portfolio, thereby lowering the overall quality of my portfolio. Would some of these work out? Absolutely, but I don’t want to be right for the wrong reasons.

Consistent with this thinking, I removed a number of companies on my watchlist that I know are not up to the quality level I demand in my portfolio.

I know there are a few companies in my current portfolio that are not of high enough quality if I were to redo my portfolio today. There are also some companies I’d likely purchase instead of some companies I own now. CVS and UNH come to mind. If I were building my portfolio again a few years ago, I would have purchased UNH over CVS. I won’t make that change now because the reason I purchased CVS was for a turnaround story, and the company has successfully executed on its goal. I am trying to avoid turnaround stories moving forward because they rarely work out. As interesting as INTC or MMM may be, I’ll gladly stay on the sidelines until those companies have shown the ability to turn things around. I don’t mind missing the bottom to avoid a bad situation. Honestly, I thought INTC was sort of interesting in the low $30s, and if I would have pulled the trigger then, I would have been very wrong. The line between a value and trap can sometimes only be viewed in hindsight.

That’s the beauty of constantly learning and challenging one’s view. I think my portfolio has some of the best companies in the United States and world concentrated in my top 10 positions, but there are a few that I think I could replace with a better company. I’m constantly reviewing my portfolio and will make changes as I see fit. Someone far smarter than me once said every day you choose not to sell a company, you are choosing to buy it.

Watchlist Removals

With all of that said, I significantly pruned my watchlist at the end of 2023. Below are the companies that were removed. While I removed these companies for a number of reasons, that does not mean they may not be the right investment for you. Every portfolio is different, and I wish you luck with all of your investments. This also does not mean I’d sell the company if I owned it already (instead, I’d likely continue to hold).

• • Advance Auto Parts (AAP)

  • Aon (AON)

  • Bristol-Myers Squibb (BMY)

  • Charter Communications (CHTR) (called up to the big leagues)

  • Digital Realty Trust (DLR)

  • Dominion Energy (D)

  • Enterprise Products Partners (EPD) (called up to the big leagues)

  • Marsh & McLennan Companies (MMC)

  • Medtronic plc (MDT) (called up to the big leagues)

  • Merck & Co. (MRK)

  • Micron (MU)

  • Novo Nordisk (NVO)

  • Pershing Square Holdings (OTCPK:PSHZF)

  • Pinnacle West Capital Corporation (PNW)

  • Prologis (PLD)

  • Regeneron (REGN)

  • Salesforce (CRM)

  • ServiceNow (NOW)

  • Simon Property Group (SPG)

  • United Parcel Service (UPS)

  • Westinghouse Air Brake (WAB)

  • Whirlpool Corporation (WHR)

  • W. P. Carey (WPC)

  • Zoetis Inc. (ZTS)

I’ll discuss my reasoning for a few companies below.

Healthcare

I removed BMY, MRK, and ZTS from my watchlist due to a decreased appetite for pharma companies in my portfolio. I currently own one pharma name, ABBV, and added one to my watchlist you’ll see below (JNJ). The reasoning for this is JNJ’s other business areas, including consumer healthcare and medical devices reduce its R&D risk as they provide more stable income. I’m closely monitoring the spin-off situation there to determine if it’s something I want to own. JNJ is more attractive to me as a total enterprise, so losing the consumer health segment is a negative in my opinion. Either way, I’ll monitor. MRK, BMY, and ZTS are very good companies, but I don’t believe they fit my appetite since pharma companies require blockbuster drugs/successful M&A to remain behemoths. It’s really just personal preference. There’s a chance if I were re-doing my portfolio that I’d either not purchase ABBV or do a “pair” trade and buy ABT shares as well to balance the position. I have some thinking to do on that aspect, but for now I’m happy with the one pharma company I own.

REITs

I removed PLD, WPC, SPG, and DLR from my watchlist because I’m not interested in adding more REITs at this time. PLD was trading at attractive levels recently and I didn’t pull the trigger. Reflecting on that, I realized it was a desire to not own more REITs in my portfolio. The recent REIT purchase (MAA) was done to balance the large ESS position I own. If ESS would have been MAA, I wouldn’t have purchased ESS to balance that position. Given that direction, I decided to remove all REITs from my watchlist for the time being. If I wasn’t willing to buy PLD at the lows, I’m not sure I’d ever want to buy it (and PLD is likely the only other REIT I’d own). I’ll likely purchase REITs at some point in the future to increase the portfolio’s yield, but it’s not something I foresee myself doing in the next few years.

There were a lot of removals, so it is difficult for me to discuss all of them in depth. For some companies (like AON and MMC) I decided I didn’t

Watchlist Additions

Below are the companies that I added to my Watchlist

• • Adobe Inc. (ADBE)

  • Autodesk (ADSK)

  • CarMax, Inc. (KMX)

  • Caterpillar, Inc. (CAT)

  • Constellation Energy (CEG)

  • Constellation Software (OTCPK:CNSWF)

  • Domino’s Pizza (DPZ)

  • Elevance Health (ELV)

  • Fair Isaac Corporation (FICO)

  • Johnson & Johnson (JNJ)

  • McDonald’s Corporation (MCD)

  • The Procter & Gamble Company (PG)

  • Restoration Hardware (RH)

  • Roper Technologies (ROP)

  • Sysco Corporation (SYY)

  • Taiwan Semi (TSM)

  • Texas Pacific Land (TPL)

  • Tractor Supply Company (TSCO)

  • Tyler Technologies, Inc. (TYL)

These are some very high quality companies I’m adding to my watchlist. DPZ and MCD are two well run consumer discretionary companies, with DPZ being a high dividend grower and MCD being a steady defensive name.

FICO, TYL, ADSK, ADBE, and KMX are strong players in their respective verticals and I’d welcome the opportunity to gain exposure to these names when capital allows.

ELV and JNJ are the only two other healthcare companies I’m interested in outside of what I already have on my watchlist. ELV is a high quality insurance company (although I like UNH slightly more) and JNJ is the only other pharma company I’m interested in.

I’m woefully underallocated to utility companies, and CEG is the utility company that most interests me. I’m quite bullish on nuclear power, and I’ve spent quite a bit of time learning about the industry and CEG.

Current Watchlist

Below is my watchlist of stocks, grouped by my five buckets:

Company	Ticker
Core Dividend Growth
Abbott Laboratories	ABT
Aflac Incorporated	AFL
Carrier Global	CARR
Caterpillar, Inc.	CAT
CME Group	CME
FactSet Research Systems	FDS
The Hershey Company	HSY
Johnson & Johnson	JNJ
McDonald’s Corporation	MCD
MSCI Inc.	MSCI
Otis Worldwide	OTIS
PepsiCo	PEP
The Procter & Gamble Company	PG
Raytheon Technologies	RTX
Sysco Corporation	SYY
Texas Pacific Land	TPL
Waste Management	WM
High Dividend Growth
Accenture	ACN
Applied Materials	AMAT
Cigna Corporation	CI
Cintas Corporation	CTAS
Deere & Company	DE
Dollar General	DG
Domino’s Pizza	DPZ
Elevance Health Inc.	ELV
Intercontinental Exchange	ICE
Intuit	INTU
KLA Corporation	KLAC
Lam Research Corporation	LRCX
Lockheed Martin Corporation	LMT
McKesson Corporation	MCK
Nike	NKE
Northrop Grumman	NOC
Roper Technologies	ROP
Sherwin-Williams	SHW
Stryker Corporation	SYK
Thermo Fisher Scientific	TMO
Tractor Supply Co.	TSCO
UnitedHealth Group	UNH
High Yield
Magellan Midstream Partners	MMP
Phillips 66	PSX
Non-Dividend Payer
Adobe Inc.	ADBE
Amazon.com, Inc.	AMZN
Advanced Micro Devices	AMD
Autodesk, Inc.	ADSK
AutoZone, Inc.	AZO
Berkshire Hathaway	BRK.B
CarMax, Inc.	KMX
Copart	CPRT
Fair Isaac Corporation	FICO
Markel Corporation	MKL
O’Reilly Automotive	ORLY
Restoration Hardware	RH
Tyler Technologies, Inc.	TYL
TransDigm	TDG
Ulta Beauty	ULTA
Other Bets
Activision Blizzard	ATVI
Constellation Software Inc.	OTCPK:CNSWF
LVMH	OTCPK:LVMUY
Nvidia Corporation	NVDA
Taiwan Semiconductor	TSM

Click to enlarge

The top companies I’m likely to add to my portfolio over the next few months are (in no particular order):

• Constellation Energy

• UnitedHealth Group

• Amazon.com, Inc.

• Copart, Inc.

• Berkshire Hathaway

• Otis Worldwide

Conclusion

Since this is a bi-monthly article (and there wasn’t any desire for a monthly article) and my watchlist changes constantly, this can become out of date quickly. Weekly changes aren’t out of the norm, and a company may drop off or jump on within a day of positing.

Are there some high quality companies I’m missing from my watchlist? Let me know in the comments section. For my most current portfolio, check out my December 2022 portfolio update.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.