Brady Report for May 2023

Dear investor,

My writing was put on hold earlier this year as we spent time out of town welcoming in a new addition to our family, Silas. He is such an incredible blessing. 

By virtue of being an adjunct Professor, I've been referred to as Mr. Brady, Dr. Brady, Dr. Ritchey, Professor, Professor Brady, Professor Ritchey, etc. Now being referred to as "Grandpa" is appropriate. While it makes me feel old, it also brings incredible joy.

Please see attached newsletter. Reach out with any questions, concerns, or anything you would like to discuss further.

Sincerely,

Brady Ritchey
Chief Investment Officer
Roth Investment Management

Brady Report for December 2022

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Dear Investors,

The ‘Santa Claus’ rally investors hoped for never came, instead, all major indexes fell. The Federal Reserve is telling us to expect higher rates for a longer period leading many to fear a recession in ’23. Professional investors struggled to navigate a market with so much uncertainty. Many amateur investors, who had taken up trading as a past time during ’20 and ’21, saw their game change and many decided to pursue other hobbies instead.

For 2022, our Opportunity Strategy was down 7.73% in ’22 vs. the S&P 500 stock index down 18.11%, (its worst year for stocks since 2008). Even through rough waters, many of the stocks we own ended the year higher. AutoZone, Cummins, Deere, Dollar General, Cheniere Energy, Olin, O’Reilly, Occidental Petroleum, Teva, and ExxonMobil all had gains. However, tech stocks suffered as stocks such as Apple (worst performance since 2008), Amazon (worst performance since 2000), Alphabet (Google), and Intel suffered substantial share price declines. Paramount Global, Home Depot and Target also saw declining share prices.

We sold out of higher growth companies such as Adobe and Booking Holdings which were selling at rich valuations and concentrated more money into companies with a history of sustainable, knowable, and predictable earnings.

Over the past 5 years, the stock market as measured by the S&P 500 index saw returns of -6%, 29%, 16%, 27%, and -19% for a 5-year average of 9.4%. With the 10-year U.S. Treasury bond (a risk-free investment) now earning 3.88%, we expect overall stock market returns to be lower. If you know me well, I often quote Mr. Buffett saying, “the key to happiness is low expectations.” As value investors, we attempt to buy lower and trim or sell as prices move toward what we believe their full value is. Our Opportunity Strategy currently trades at a price to earnings ratio of 14.5 vs. the S&P 500 index of 20.0. One could say our portfolio is about 27% cheaper than the overall market.

Investors can often offset losses in the stock market with gains or smaller losses in bonds. This time was different. The Bloomberg aggregate bond index was -13% for the year. The Bloomberg municipal bond index -8.5%.

Risk

This brings us back to how one should think about risk. Academia defines risk by the standard deviations of returns vs. those of an appropriate index. This is really a measure of volatility, not of risk. We view risk as a permanent loss of capital (money).

Going back to the very fundamentals of value investing found in Benjamin Graham and David Dodd’s Security Analysis, written in 1929. “A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.” In other words, investing is buying an ownership of business, not worrying about the day-to-day price. Warren Buffett, Graham’s most famous student, takes this a step further. He likes to talk about owning a farm. You do not get a quote on your farm every day, nor should you want one. You buy it for its earning power, not because you think you can sell it next week, month, or year to someone else for more money. You are concerned with what it produces over a long period of time, not the short-term value.

You do not need to own 50 to 100 stocks to have a diversified portfolio. I would argue, a concentrated portfolio, comprised of companies one thoroughly understands, has researched thoroughly, and spent much time with it, is less risky than a widely diversified portfolio made up of random securities chosen, based on economic forecasts, or selected by so-called experts which have never even read the company’s annual report.

During ’22, Energy made the biggest comeback since Lazarus. The sector was +59% with all other sectors in the S&P 500 index having negative returns. Consider how bad the S&P 500 return would have been if it did not contain any energy stocks.

This graph is from the Wall Street Journal’s Year-End Review & Outlook. ExxonMobil and Chevron were both resurrected into the top 20 companies as ranked by market capitalization. We also see the fall in Tesla and Meta Platforms (Facebook).

Berkshire Hathaway, our largest holding, ended the year in the number five position. I would like to point out while Berkshire does not rate #1 in revenues, it does rate #2 in earnings with a net income of about $90 billion. Only Apple earns more, roughly $100 billion. Meta and Tesla earned $28 billion and $11 billion, respectively. This was a year that investors looked to companies with earnings and sold companies which had no earnings or are experiencing slowing growth, in the case of Meta.

Eli Lily and United Healthcare rose in the rankings over the prior two years. Pfizer also snuck into the #20 position, likely due to the COVID vaccine. We would be surprised to see them stick in this position. The only healthcare company we own is Teva, which is more of a special situation. Healthcare makes up about 17% of the U.S. economy and the demand for most services is virtually inelastic, meaning people must have it, it is not optional or discretionary. We believe in investing within a circle of competence and healthcare is not within ours.

What will happen in 2023?

As you may know, we do not believe in forecasts. One must however have an opinion or viewpoint on likely future outcomes based upon what is knowable and observable.

We believe interest rates will continue to rise as indicated by the Federal Reserve. They increased the Fed Funds rate (rates at which banks can borrow from one another) by one half of a percent at their last meeting in December to range of 4.25% - 4.50%. Note: Other rates are closely tied to or derived from the Fed Funds rate, thus our reason for discussing. They believe a rate of 5% is within the target range to be sufficiently restrictive. To tame inflation, they are putting the brakes on the economy. A change in the darker orange line (see this graph) may suggest a lower or higher policy rate, therefore we will just have to wait and see where inflation comes in once we are a few months into ’23 and see where the Fed takes it. The takeaway here is we have a good idea of where we are headed.

Companies with maturing debt in ’23 or ’24 will likely have to pay higher rates on new bonds. Loans will also be more costly. Therefore companies with debt maturing far out into the future or carrying a net cash position will have an advantage. Many of the stocks we like continue to be fairly valued, not bargains, in our opinion. There are generally moments which the market becomes pessimistic about an event or misunderstands something, and investors are offered a fat pitch to swing at. We will wait for our opportunities to swing the bat.

Lastly, I want to point out the long-term optimism we have. It is within our human nature to focus on short-term events; however, if we look at life through a longer-term lens, we can see economic shocks, recessions, depressions, and wars are merely bumps in the road. This Morningstar graph is a great picture of 150 years of the stock market. To my young readers, what has worked over time is continuous investing on a regular basis over a long period of time. My prayer for you is when you reach retirement age you have way more money than you will ever need and will seek to help those less fortunate than you.

I hope this provides insightful information with respect to our investment philosophy as well as some of the companies we like and why.

Thanks for reading and please contact us with any questions or comments.

Sincerely,
Brady Ritchey
Chief Investment Officer

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Brady Report for November 2022

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Dear Investors,

The stock and bond markets rallied in November after hearing comments from Federal Reserve Chairman Powell which suggesting interest rate increases may be smaller and come at a slower pace.

There is not a lot of news economically. After nine months, the conflict in Europe between Russia and Ukraine continues. Inflation is high yet seems to be on the way downward and the economy is strong yet many fear a recession next year.

This year differs from most in the past century in that both stocks and bonds are down. Many suggest a portfolio of 60% stocks and 40% bonds, building a diverse portfolio of assets which are not correlated to one another to decrease volatility. Not this year. I recently reviewed a portfolio comprised of a similar mix. It was -18% year-to-date. I am pleased to report our Opportunity Strategy, an all-stock portfolio containing less than 30 companies, is -3.14%, after fees, through November 30th. Clients with an average to above average risk tolerance are invested in a similar portfolio.

We continue to like companies which make things people need vs. want. Over 16% is represented by stocks in the energy sector. We do not believe fossil fuels will go away anytime soon. A barrel of oil provides more than gasoline for your automobile. Petroleum based products are used to produce plastics, items such as a toothbrush, the bag your potato chips are in, the cell phone you use, etc.

Another product, liquified natural gas (LNG), is a clean source of power and a commodity we have a surplus of in the United States. Natural gas is compressed 600 to 1 to create liquified natural gas (LNG). U.S. exporters of LNG have long-term contracts with countries in Europe and Asia. The long-term demand for LNG is greater than the supply and the economics of the business make it an attractive investment.

Auto part retailers are responsible for about 10% of the strategy. The average age of an automobile in the U.S. is the oldest on record. Those automobiles need new brakes, axels, windshield wipers, etc. and most do not put those purchases off for a very long.

Dollar General is a favorite of ours and one which should do well in any type of economy. We visited a Dollar General Market recently and were overly impressed with the variety of fresh meat, produce, and mix of other consumables. They have a remarkable growth opportunity and can earn high returns on each additional store.

Berkshire Hathaway, the conglomerate controlled by famous investor Warren Buffett, makes up about 10% of the strategy. Many associate the name with the real estate brokerage. It represents a small fraction of their total business. Originally a textile mill, Warren diversified into insurance in the early days. Today, Berkshire owns Government Employers Insurance Company (GEICO), Gen Re, and Allegany. They also own the Burlington Northern Santa Fe (BNSF) railroad. In retail, they own the Nebraska Furniture Mart, Justin Boots and Brooks athletics. Other companies widely recognized include Dairy Queen, See’s Candy, Fruit of the Loom, and others. In total, there are 63 subsidiary companies owned by Berkshire. Given the diversity of businesses, Berkshire has a wide reach through the economy.

In addition, Berkshire owns about $300 billion in the stocks of other companies, the largest being Apple. The position is currently $123 billion and represents a 5% ownership in the company. Other stocks include: Chevron, Bank of America, American Express, Occidental Petroleum, Moody’s, Kraft Heinz, and Taiwan Semiconductor.

Many of the companies losing significant value this year were trading at high multiples of their earnings or had no earnings at all. Exercise equipment maker Peloton, a darling of the pandemic era, has -63% of its value year-to-date.

Carvana, a company selling used cars online featuring car vending machines began the year valued at $15.5 billion. As I write this, the company is valued at just $680 million, a decline of 95%!

Perhaps you have been to an auction, an estate sale, or thrift shop and bought something that needed a little fixing. Despite your best efforts, it just did not work out. This happens with investing as well. It is called a ‘value trap.’ We have been there. Investing is simple but not easy. We may buy cheap and never realize gains, but we try and avoid high-fliers, which may only end up falling back to earth.

I hope this provides some insightful information to our readers with respect to our investment philosophy as well as some of the companies we like and why.

Thanks for reading and please contact us with any questions or comments.

Sincerely,
Brady Ritchey Chief Investment Officer

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Brady Report for October 2022

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Dear Investors,

The Dow Jones Industrial average had its best monthly performance since 1976. The index includes just 30 stocks and is price-weighted, meaning the highest priced stocks have the largest influence. While the S&P 500 and NASDAQ stock indexes also ended the month higher, their performance trailed the Dow. This was mostly due to investors shifting away from unprofitable technology companies and investing in growth companies now demonstrating a slowdown.

FAANG stocks, which led the stock market higher for many years, are beginning to experience slowing growth. Year-to-date performance is dragging on many investment portfolios with Alphabet (Google) -33%, Amazon -38%, Apple -12%, Meta (Facebook) -70%, and Netflix -51%.

In the 1970s, there was a group of stocks known as the Nifty Fifty. Widely regarded as stocks which could be bought at any price because they were only going to continue rising in price. It was as if investors thought you could not miss. In 1982, many of the Nifty Fifty stocks crashed, adjusting to prices in line with their fundamentals. Companies included: American Express, Avon, Eastman Kodak, General Electric, IBM, McDonalds, Revlon, and Texas Instruments. Most of the companies are still in existence yet some merged or were acquired by another company. The business was good, the price investors were paying was too high.

“History doesn’t repeat itself, but it often rhymes” – Mark Twain

This year, new public companies (those having an initial public offering) were among the worst performing stocks. Approximately 87% of the companies are trading below their initial offering price, with the average -49% according to Dealogic.

In our opinion, many investors were simply too willing to bet their hard-earned money on tech companies with no earnings, crypto currencies, derivatives, and stocks being pushed on social media. One of the unfortunate outcomes of investors losing money by “gambling it away” is that it often leaves them with a sour feeling about investing.

However, investing in good businesses, paying reasonable prices and waiting decades has historically been a wise decision with one’s money.

Why is the stock market so volatile this year?

To fight inflation, the Federal Reserve is using the tools it has available to get inflation under control, back to around 2%. By raising interest rates, it reduces consumer demand and the economy is slowed. Interest rates paid on bonds by companies and municipalities, certificates of deposit (CDs), savings accounts all rise which is good for savers. For those requiring financing, interest rates for loans, such as car loans and mortgages increase making these purchases more expensive or pushing buyers out of the market.

The markets are fixated on what the Federal Reserve will do next, the questions are: how much? how fast? and how long? Will they decide to raise interest rates by half of a percent at the next meeting vs. three quarters of a percent? All indications recently given by members of the Federal Reserve suggest a pivot from current policy is not likely to happen soon.

We are moving our way through company’s quarterly earnings reports. Each company provides a level of transparency into the economy. Railroads and trucking companies indicate the goods are still being moved. Advertising companies provide data on how much is being spent to advertising and promotion. Payment companies like Visa and Mastercard help us to understand consumer spending trends. Generally, some reports are good, and some are bad. Their respective stock prices adjust accordingly.

Inflation

There is more than one measure for inflation, here we will discuss the consumer price index (CPI). Reported monthly by the Bureau of Labor Statistics it is comprised of a basket of goods - the two largest components are Food & Beverages (15%) and Housing (42%).

The tool being used by the Federal Reserve, is raising interest rates. The higher the rate, the lower consumer demand. If we look at food and beverages, while this is partially discretionary, people still need to eat. The components making up food include commodities such as wheat, corn, soybeans, eggs, beef, pork, etc. What determines the prices for these commodities? The futures market. Can the Federal Reserve control the futures market? No, they can only send a message traders will find to be economically pessimistic resulting in lower commodity prices which will then lower the cost of food. Keep in mind, this is an oversimplification as there are other factors to be considered.

Housing is the largest category and worth paying attention to. It is also important to note that housing

comprises 16% of the gross domestic product (GDP) in the U.S. We see distinct trends in housing. Many who were renting, especially in larger cities, have decided to either move back in with parents or take in a roommate to help offset costs. Nationally, rents are up 8.8% year-over-year. Only five states saw rents decline, New York seeing the largest decrease in rents, -10% year-over-year and -17% month-over-month. Florida was the largest increase, +25%, with Delaware +24% and New Mexico +21%. The median monthly rent in September was $2,002.

High interest rates are discouraging homebuyers from moving. According to Redfin, 85% of homeowners with mortgage rates below 5% are staying put. These homeowners are much more likely to rent, allowing them to keep their low interest rate, than they are to sell.

Freddie Mac estimated that as of the end of 2020, the country was 3.8 million housing units short. “With monthly mortgage payments +75% higher than last year, many first-time buyers are locked-out of housing markets, unable to find homes with budgets that have lost $100,000 in purchasing power this year,” said George Ratiu, senior economist at Realtor.com.

Annualized single family housing starts of 892,000 homes were -18.5% year-over- year. The month prior, annualized housing starts were 1.439 million homes. The higher the Fed raises rates, the more unaffordable it makes housing, driving up prices as supplies decrease. The higher prices result in increased inflation. It is sadly ironic that the Federal Reserve’s actions are making the housing situation worse instead of better. To a man with a hammer every problem looks like a nail. I am not an economist, but it begs to question if the Fed possess the right tools to fight the source of the problem.

Why are mortgage rates so high?

The average 30-year mortgage rate now exceeds 7%, a first in two decades. At the beginning of the year, 30-year mortgage rates were about 4% and the 10-year U.S. Treasury bond yield was 1.5%. The difference, known as the spread, was roughly 2.5%. At the end of October, the spread between the 30-year mortgage and the 10-year U.S. Treasury bond was roughly 3%.

Why has the spread widened so much? In the past, when the spread has widened, the Federal Reserve entered the market to buy mortgage bonds (bonds comprised of hundreds of mortgages), bringing down mortgage rates and the spreads between them and treasury bonds.

The Federal Reserve bought up trillions of dollars of mortgage bonds and treasury bonds to stimulate the economy in 2020 and now it is in the process of unwinding it by raising interest rates letting bonds roll off (not replace with new ones) their balance sheet as they mature.

The Federal Reserve together with banks own about 75% of the mortgage-backed securities according to Bank of America.

GDP Growth

For some good news, the Bureau of Economic Analysis (BEA) reported the U.S. economy posted its first quarter of positive growth for in Q3 ‘22. Gross domestic product (GDP), +2.6% from July to September. Generally, two consecutive quarters of negative growth signal a recession. The graph below demonstrates the long-term trend for GDP growth, which is normally between 2% and 2.5%.

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A narrowing trade deficit increases in consumer spending, nonresidential fixed investment and government spending led the way higher. Economists do not expect the trend to continue. Much of the trade deficit gains were due to exports of energy such as LNG (liquified natural gas) to Europe. Residential investment, a gauge of homebuilding, -26.4% during the quarter.

The personal consumption expenditures price index (PCE), the preferred inflation indicator used by the Federal Reserve, + 4.2%, down sharply from 7.3% in the prior quarter. The move downward provides at least one data point core inflation (inflation with food and energy costs) has peaked.

When interest rate hikes stop or even pause, the stock market should rejoice.

If there is a theme to our investing at this time it would include a focus of needs vs. wants. Food and energy are needs and we have a significant portion of investments in this area. We also believe automobile maintenance and repairs fall more into a need as these purchases can only be put off for a limited amount of time, even in a recession. We continue to like some of the large technology-based companies, yet we focus on those with a proven history and demonstrated competitive advantages which can be bought at a reasonable price.

Thanks for reading and please contact us with any questions or comments.

Sincerely,
Brady Ritchey
Chief Investment Officer

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Brady Report for September 2022

What is the number?

Dear Investors,

The end of September brings about the end of yet another quarter. At one point, the S&P 500 stock index was + 14.3% yet closed - 5.3%. Investors are closely watching the actions of the Federal Reserve and the Fed is closely watching the monthly report for inflation and signs the economy is slowing. Without a doubt, the most watched number is the inflation report, be it the CPI, PPI, or another economic indicator.

While inflation fell in September on a month-over-month basis, investors were hoping for a larger drop considering the large decline in energy prices. While inflation remains high, the Fed will likely continue to raise interest rates. Higher rates contribute to lower business valuations as it raises their costs to borrow and makes their future cash flows worth less. The farther in the future cash flows are, the greater the impact, thus the reason growth companies are more heavily impacted.

I have heard it said, the value of something is determined by the price someone is willing to pay for it. It has some merit. Such would be the case for collectables. Businesses, however, have an intrinsic value, determined by their future cash flows discounted to today at the appropriate rate. In the stock market, there exists a discrepancy between a business’s stock price and its value. Sometimes it is large and other times small. The psychology of the participants (investors) plays a crucial role.

In 1934, Security Analysis was published, authored by Benjamin Graham and David Dodd, it eventually became considered the bible for value investing. Graham, whom was one of Warren Buffett’s professors at Columbia Business School, introduced a fictitious character known as Mr. Market.

In his allegory, each day, your business partner, Mr. Market, offers to buy your share of the business or sell you his. The net worth of the business would not necessarily change day-to-day, yet the price offered would. This is how the stock market works.

Warren Buffett has used another example and I will paraphrase, “Let’s say you bought a farm. You were interested in the long-term productivity of the farm and knew that some years would be good and others bad. In some years corn and soybean prices will be high, in other years, low. Suppose a guy buys the farm next to you, with the same number of acres and soil quality. Every day that farmer offers to buy your farm or sell his farm to you. He is somewhat manic-depressive and the prices he offers all over the place.”

When you bought the farm, you looked at what it would produce, its potential. You do not really need continuous quotes on the value of the farm. If offered a silly price, high or low, you may sell to him or buy his farm. In stocks, like farms, no one is forcing you to buy or sell.

This is where investors often get twisted up. They feel that because prices are changing back and forth that they must do “something.” There is a lot of money available to so-called experts who claim to be able to tell you where the prices will be going. Over the last 50 years, if you had taken Mr. Buffett’s advice, you would have done well as an investor. You would not have done much buying or selling. Mr. Buffett’s business partner Charlie Munger has said, “The money is not in the buying and selling, it is in the waiting.” This is really a lesson in behavior and managing one’s behavior over time does not change much from decade to decade. The lesson is timeless.

Chances are you have realized the price of most stocks are lower this year than last year. Year-to-date, the S&P 500 stock index is - 25%. Does that mean the value of the businesses in which you own a part of have decreased? Not necessarily. It is possible for the company’s earnings to be increasing while the company’s stock price is falling? Absolutely!

Al Root recently wrote a column in Barron’s investment publication and selected twelve stocks which include O’Reilly Automotive, Dollar Tree and United Health Group. All have P/E (price to earnings) ratios which have declined about 21% (lower P/E ratio is indicative here of a cheaper stock) yet have earnings expected to grow 7% year-over-year. None of the companies lowered their earnings estimates during the past 6 months. Earnings have increased yet their respective prices have remained about the same. Therefore, we suggest value is increasing while the price is decreasing.

These types of disconnects between price and value lead us to believe the market is not efficient and that hard work and thorough analysis can produce favorable results.

Inflation

In August, the consumer price index (CPI) was + 8.3% year-over-year. According to the Bureau of Labor Statistics, “Increases in the shelter, food, and medical care indexes were the largest of many contributors to the broad-based monthly all items increase. These increases were mostly offset by a 10.6% decline in the gasoline index.” In July, CPI was + 8.5% and June was + 9.1%.

Investors were disappointed with this news as they seemed to have hoped the lower energy prices would have a greater effect on a declining inflation number.

What the average U.S. consumer who shops for their own food already knows, is showing up in the economic reports. The cost of eating at home has skyrocketed.

The food-at-home index rose to its largest 12-month increase since 1979. Cereals and baked goods + 15% year-over-year. Milk and dairy products + 14.9%, and fruits and vegetables + 9.3% year-over-year.

The Federal Reserve is continuing to raise interest rates in order to bring down inflation. Based on their latest information, interest rates will rise to about 4.6% in 2023. After the most recent increase, rates are now 3% to 3.25%. It is likely interest rates will rise to roughly 4.4% by the end of this year. In the long run, the Fed forecasts rates to decline back to around 2.5% to 3%.

Some fear the Federal Reserve will go too far, raising rates too far too quickly.

Even more challenging for investors, those investing in bonds have experienced the same type of volatility as stock investors. The Vanguard total market bond index is - 11% year-to-date and Gold, thought to be a safe haven, is - 5% for the year. Investors are finding difficultly looking for a safe place to hide.

Sincerely,

Brady Ritchey
Chief Investment Officer

The rest of the report includes housing news, economic news, business highlights, Warren Buffet’s new favorite stock, impulse buying, market highlights, and notable earnings.
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Brady Report for March 2022

Good afternoon,

We are in the midst of the quarterly earnings season. An incredible amount of information is being disseminated by companies. While the stock market is down this year, overall earnings from S&P 500 companies are up.

The Berkshire Hathaway annual shareholder's meeting is being held on Saturday and streamed on CNBC's website. Investors from all over the globe will be on the edge of their seats to hear what Warren Buffett and his long-time Vice Chairman Charlie Munger have to say about Berkshire's businesses, investments, their view of the economy and other issues.

Stay tuned and we will update you on all the events and news next month, which is just days away...

In the meantime, see our newsletter here.

Website Disclosure: No client or potential client should assume that any information presented or made available on or through this website should be construed as personalized financial planning or investment advice. Personalized financial planning and investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Please contact the firm for further information. Roth Investment Management is a state registered investment advisor in Missouri and Illinois.