In our most recent series written by Jamie Cornehlsen, CFA and founder of Capstone, FLOW examines how we seek out investments and make selections based on current market trends and future forecasts. Part eight of our series discusses why the investment weeding process is important for investors looking to sustain a steady stream of cash flow.
The most significant part of any portfolio is the weeding process. Specifically, this means making the decision to sell an investment and replacing it with an investment that may have better opportunity in the future.
Selling is by far the most intensive portion of the investing process. Too often, it is overlooked in place of buying. But selling, in my opinion, is what drives performance. The process of deciding to sell an investment begins with determining why you chose the investment in the first place, and evaluating the chances that your original projections will continue.
For those of us in the FLOW mode, such projections include the following: having the ability to generate 10% cash flow, increasing sales growth to provide cash flow, managing costs to provide an elevated flow, and obtaining a reasonable return on invested capital.
APOLLO GLOBAL MANAGEMENT INVESTMENT (AINV)
It has only been one month since the FLOW portfolio was initially developed, but after a further analysis of Apollo, I determined the outlook does not support my continuing to hold this investment.
This was because I felt the dividend was at risk of being cut.
Let’s begin with some background: Apollo Global Management is a specialty finance company, providing investments in the form of equity and preferred loans. Most recently, the company acquired $3.1 billion in loans to companies in business services, aviation, oil and gas, diversified companies, and financial services. The company also has exposure to credit derivative obligations (CDOs), which are organized financial products that are supported through a series of loans.
REASONS TO WEED
In evaluating Apollo, I realized the company’s ability to pay $0.80 per share in a dividend for a yield of 16.4% may no longer be sustainable. Overall, the outlook for Apollo is unclear. The holdings of CDOs and exposure to oil and gas have made future calculations hazy.
Further, the dividend was not being covered by the existing earnings. Earnings for 2015 came in at $0.15 per share, failing to offset the $0.80 dividend exposure. Consequently, this put the dividend at risk of being cut.
The prime objective of the FLOW portfolio is to achieve a 10% dividend payout; therefore, the risk of holding Apollo became too great to continue.
As a result, we sold Apollo for a loss of 3.5%.
As I indicated earlier, weeding is the most important process of investing. Often times, investors hold onto investments for a number of reasons: emotions, to avoid taxes, intentions of earning the initial price back, etc. Yet none of these are good enough to carry on owning an investment. The only sensible reason to own an investment is if it continues to meet your original expectations. In our case, Apollo was unlikely to sustain its dividend and we chose to eliminate it and pursue more successful opportunities instead.
Past performance is not indicative of future results. This article is intended for informational purposes only and is not intended as investment advice. Individual investor experiences and results will vary.