How is it that a boutique portfolio manager from the quiet, beautiful coast of South Carolina has crushed the S&P 500 by an average of +5.95% since 2011? The Pawleys Growth Fund seeks to identify companies with low debt:equity ratios, strong earnings per-share growth, and solid cash-flow. The Pawleys Growth Fund typically holds 20-25 long positions at any given time. Why is this concentration of the portfolio important and how does it relate to the stunning eight buy-outs?
We use a strict, systematic selection process to identify growth-oriented companies that are reasonably priced. This non-emotional approach to investing is designed to beat the averages by holding best-in-breed companies across different sectors, and taking high-conviction positions. Index mutual funds and exchange-traded funds are riddled with mediocre stocks. As of this writing, there are 300 companies in the S&P 500 with earnings growth below 15%, and only 45 that exceed 25%. Why would anyone invest in a company that has shrinking earnings and gradually fading relevance? Anyone who invests in a tracker fund unknowingly owns these poor performers. Let’s review the returns that we have achieved for our investors over the past few years with the buy-outs:
Does the average premium gain for our investors of 43% for these eight companies get your attention? It should. This is a remarkable accomplishment, and speaks to the power of our stock selection process. The Pawleys Growth Fund is for investors looking for a repetitive portfolio process that takes calculated risks. Join us in the pursuit of beating the averages with wickedly smart investing!
© 2017 Pawleys Capital Management, LLC. All rights reserved. Total return figures are gross of fees which vary. Earnings figures are trailing 5-year earnings per share growth rates. Source S&P.
Every year or so, we expect the stock market to drop 10-15%, and view this as a healthy exhale or pause within a longer-term secular bull market. But when the market dips, how do we know the bull market is still alive and the drop is not the beginning of our next sustained bear market? For the stock market to enter prolonged bear territory, the underlying economy must first enter recession. Two things happen in advance of a recession: the yield curve flattens and inverts, and the Leading Economic Indicators drop.
The chart below shows the yield curve on U.S. treasury bonds from two different time periods – today, and late 2006. The vertical axis on the chart shows yield, and the horizontal axis shows maturity. The green line at the bottom shows yields from today. An upward-sloping yield curve where short-term rates are lower than long-term rates is referred to as “normal” in shape. The blue line at the top of the chart shows a curve that has flattened and actually inverted, where short-term rates have risen above long-term rates. This inverted curve from late 2006 was predictive of the recessionary period that started in 2007.
The Leading Economic index is a basket of data designed to signal the direction of the economy 6-12 months in the future. In the chart below, the two most recent recessionary periods are represented by the shaded grey bars, and the blue line represents the Leading Economic Index, or LEI’s. The blue line dips down several months in advance of the recessionary periods, signaling the economic slowdowns.
The next time the market swoons, drop us a line to find out if the yield curve has inverted and/or the LEI’s have dropped so you can respond accordingly to protect your stock portfolio!
Source: U.S. Treasury, © 2016 Pawleys Investment Advisors, LLC. All rights reserved.
Why should you distribute shares of company stock from your 401(k) instead of rolling them into an IRA? Many people are fortunate to own shares of company stock in their employer-sponsored retirement plans, including 401(k)’s. Often, these shares have been acquired over many years, and constitute a substantial portion of the overall retirement account balance. Many financial professionals will encourage employees to roll over company shares into an IRA, either during their working years as an in-service distribution, or after retirement. You also have the option of distributing the shares out of your plan. A good advisor will explain the tax implications related to company stock and work with your CPA to calculate how much you stand to gain or lose. You should also review this option any time you change employers during your career, as the potential savings can be significant over the years!
Let’s say you have $300,000 worth of company stock in your 401(k) with an original cost, or basis, of $100,000. The gain in value is referred to as net unrealized appreciation – $200,000 in this example. If you roll the shares into an IRA, when you later sell them and take cash as a distribution it will be taxed as ordinary income. If you distribute the shares from your 401(k) and continue to hold them, the NUA will not be taxed until you sell the shares, and will be taxed as a long-term capital gain. In our example, let’s assume you are in the 28% tax bracket. The potential tax on the $200,000 NUA if you roll the shares into an IRA is 28% of $200,000, or $56,000. If you distribute the shares and hold them, the tax on the $200,000 NUA once you sell the shares is subject to the long-term capital gain rate of 15%, or $30,000. In this example, we have created a savings of $26,000! Once you roll company shares into an IRA there is no way to reverse it, and you lose the opportunity to utilize the NUA strategy.
The potential savings can be significant, especially if you have a substantial NUA and are in a very high tax bracket. Although you are immediately taxed on the amount of the basis on the shares received, the deferred savings can be well worth it. Any gain above and beyond the NUA amount will be treated as short-term or long-term depending on how long you hold the shares after the distribution. Everyone’s situation is different and the tax code is always subject to change, so be sure to consult with your CPA. As always, feel free to contact us with any questions!
© 2016 Pawleys Investment Advisors, LLC. All rights reserved.