Vertical Merger Landscape and ESRX

On March 8th, Cigna announced it will buy Express Scripts, giving ESRX shareholders a combination of cash and CI stock. The deal, expected to close before year-end, will represent the 10th buy-out of a Pawleys Growth Fund holding at a significant premium for our investors. This is a stunning accomplishment, given that we typically hold a concentrated portfolio of only 20-25 different stocks, and just launched in 2010. We have a systematic process which strives to identify stock of companies with little or no debt, good earnings growth, and rock-solid cash flow. We never take a position in the hopes that it will be bought-out, it just happens that our methodology has identified stocks that others deem to be very valuable. The initial Cigna offer represented a 31% premium for ESRX shareholders.
Recently there have been a few landmark anti-trust cases that have gone in favor of corporations merging with or acquiring other companies. For example, the U.S. District Court in Washington court approved without any provisions the AT&T buy-out of Time Warner. A vertical merger occurs when two companies within the same industry but at different places along the supply chain come together, meaning they do not compete with each other and thus would not create a monopoly. This is a positive sign that the pending buy-out of Express Scripts by Cigna will be completed, since they are both healthcare companies but perform different functions. On July 12th, CNBC reported that the Department of Justice will not challenge the planned merger of CVS and Aetna, yet another positive sign for the ESRX/CI deal. Since ESRX continues to trade at a discount to the offer, we feel the market believes the deal will not go through. The market may also be worried about competition created by AMZN’s announced acquisition of PillPack. We recognize these risks but continue to add to our position of ESRX because we believe the stock remains undervalued independent of the pending CI acquisition. We are confident in our methodology of buying stock of companies with little or no debt, good earnings growth and rock-solid cash-flow. The landscape is ripe for additional mergers and acquisitions to occur, so we may see more activity with the Pawleys Growth Fund holdings going forward.

© 2018 Pawleys Capital Management, LLC. All rights reserved.

Investing in the Good, the Bad and the Ugly

Given the opportunity to invest in one of two S&P 500 stocks, which of the following would you choose?  Company A has no debt, and is consistently delivering solid earnings gains.  Company B is heavily laden with debt and has experienced rapidly contracting earnings.  Of course, most prudent investors would invest in Company A (and possibly sell short Company B).   But if you invest in an S&P 500 index fund, you will end up owning both, and stock in 498 other companies, including the good, the bad, and the ugly.  Why not try to identify just the good opportunities?

Successful marketing by low-cost providers has driven investors, frustrated by low-performing, high cost investments, into Index Funds and broad-based ETF’s.  Index Funds deliver returns that merely track the markets, and prevent investors from gaining valuable advantages to improve portfolio performance.   Over the past 35 years, the S&P 500 has included companies such as Palm, Circuit City, Sears, and Eastman Kodak.  If you invested in an S&P 500 fund, you owned stock in these companies as they were rapidly losing relevance and watching profits fall.  In the meantime, innovators such as Whole Foods and Apple entered the S&P 500, and luckily investors who held S&P 500 Index funds owned these as well.  Active managers like Pawleys seek to identify good investment opportunities and discern those from the bad and ugly.  Please check out our performance record to see how well we are accomplishing that objective.

Index funds, ETF’s and Target Date Retirement Funds are great products for investors who are just getting started.  But managers who go long the good stocks and sell short the bad and ugly can provide a valuable advantage to investors over the long term.

Source: The Capital Group.

© 2015 Pawleys Investment Advisors, LLC. All rights reserved.

Thoughts from Pawleys on Investment Strategy

Sometimes the noise of the markets can be a distraction from basic fundamentals. The best strategy to cushion both stocks and bonds (including mutual funds) is to focus on quality. For fixed income (and we do a fair amount of tax-free municipal bonds, especially within South Carolina), the highest rated bonds will be less volatile when interest rates rise. When the economy slows, corporations with consistent earnings and little debt tend to be less volatile. Look for consistency and quality, and avoid swinging for the fences with low-quality momentum stocks and poorly rated bonds, because you will likely get burned. Having a plan can help you stay on track, especially when news and political events start to cause anxiety in an otherwise healthy market. Random, unplanned changes rarely pay off. Remove low quality investments and trim over-weighted areas in your portfolio. Many investors lost 50, 60, even 70% during 2008 because they forgot to rebalance and held lower quality investments. A well balanced, 50/50 portfolio of high quality investments would have dropped approximately 15% that year. Adding structure sounds like an obvious guideline, but because most investments are sold on a commission-basis, many people end up with a random collection of investments that don’t necessarily fit together. Like any sports team, a solid portfolio is constructed of individual parts that work well together as a whole. Lastly, news sources can generate lots of hype and create worry…but investing should be fun. Having our local schools and parks operate effectively would not be possible without the debt issued by municipalities, which enables investors to enjoy a stream of tax-free income. The creation of capital through the equity markets is what allows innovative companies to grow and expand, while investors reap the benefit of growing capital and even dividend income along the way. Enjoy the process and have fun!

© 2014 Pawleys Investment Advisors, LLC. All rights reserved.