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CAN$ & Kraft / J&J


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A light bulb went on for me today (kind of scary as it only happens a couple of times a year)...


I have been thinking lately about what asset classes are in a bear market right now... not government bonds, corporate bonds, stocks (in general) or commodities. One thing that does look quite ugly right now is the US$.


I was looking at the list of companies that FFH owns and two jumped out at me KFT & J&J. Both are up only a small amount since June 30 (KFT +5% & J&J +7%) in US $ terms.


I am a Canadian investor; when you overlay currency things get interesting...


Let's dial back to the March lows when the CAN$ was at about US$0.80:

1.) KFT = US$21.00 = CAN$26.25

2.) J&J = US$48.00 = CAN$60.00


Fast forward to today, where the CAN$ is about US$96.50:

1.) KFT = US$26.63 = CAN$$27.60 = 5.1% increase

2.) J&J = US$60.94 = CAN$63.15 = 5.25% increase


With most global stock markets up 50% since the March lows, here we have two companies up only 5% (in CAN$ terms).


Are they worthy long term investments? These two companies represent 17% of FFH's US stock holdings and BRK also holds both of these companies so I think we can assume two of the saviest investors around like them. Both sport very good dividend yields with KFT at US$1.16 = 4.4% and J&J at US$1.96 = 3.2%.


My thinking is to take advantage of the level of the CAN$ to invest in some large US multinationals. Should the US$ continue to fall these companies will report stronger earnings (US$); should the US$ rise then I will get the currency gain. Should we get abroad based sell off in global stock markets there likely will be a flight to quality and multinationals and the US$ will likely do well...


My financial advisor called me recently with the idea of 'putting at least some of my cash to work' and floated the idea of an 8 year TD bond with a yield of 5% (I said, thanks, but no). My thinking is to perhaps build a portfolio of 20% or so of these kinds of companies in place of holding bonds.


Am I simply playing with numbers on this one???

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You can't use FFH and BRK as role models without allowing for their circumstances. Both FFH and BRK have large USD liabilities - these investments are properly matched. You have to ask yourself whether you have any USD liabilities.


Even though I live in Canada, I reckon that some of my expenses are USD denominated - e.g. travel expenses in the US, many products we consume are priced in USD (books, electronics, gas, etc) so I believe in having some USD exposure under normal circumstances. This doesn't mean that there may not be times, like now, when I take a consciously negative position against the USD.


So, my exposure in JNJ is through options (not leveraged) but solely to minimise USD risk.

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Somewhat along the same line of thought, I am recently a new investor in both JNJ and Kraft. The weak dollar will help earnings, especially on a YOY basis in the coming quarters. Both are always on investors' top 10 list of the most stable, respectable, and steady companies. The dividend yields on both are great. And as investors begin to ponder the sustainability in the massive run up in the more risky names, they may decide to move to quality names such as the two mentioned. The fed is begging investors to purchase equities by flooding the system with liquidity, which will eventually scare fixed income investors out of those lower yielding treasury markets (in real terms once inflation presents itself). Eventually investors will be forced to invest in appreciable assets in an inflationary environment, and be forced to move along the risk curve away from bonds. Yet those bond investors will want the steady income of an equity-like bond in a quality name like JNJ, especially given the recent large moves of higher risk equities, which may be overvalued. Quality is on sale in a big way right now. JNJ, KFT, PG are all quality names with nice yields trading at large discounts to the S&P, although historically they have traded at a premium to the S&P.



Long JNJ equity, and  2011 & 2012 JNJ LEAPS $60 strike


Long KFT equity


Long PG

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If I was looking to build a portfolio of conservative names that would still deliver a solid 10% a year going forward these two would definitely be in. I think this is a great time for buy and hold investors looking for respectable returns without too much work (little trading/research/taxes) to load up on large and very high quality companies. Berkshire is another one.


Both KFT and JNJ are trading at a P/E of 12.4 times 2010 earnings estimates. This is much cheaper than what they have been at historically and their "moat" would call for a higher P/E. Remember that the market or the average stock has been trading at a P/E of 14-15 historically. These are cash machines, safe and their yield has to tempt people hungry for income. It just does not make sense for them to stay at these low level of valuation.


I typically invest in smaller companies because I can find much bigger discounts relative to intrinsic value. So "locking" myself into 10% returns is not my game. However, it would not surprise me to see these stocks go up 30 or even 40% in fairly short order to correct this mispricing. They won't be cheap forever. So what I have considered is to buy long term calls (at the money to in the money) on a basket of these to make their return on my cash comparable to my small caps. It is still a working project...  


Your logic around the currencies also makes sense, although we have seen that even these "safe" stocks come down with the general market and I would be hesitant to assume that there will always be a flight to the USD whenever there is a crisis. Things have changed this past year and these discussions around the USD losing its reserve status are too frequent and coming from too many countries/sources to just be some blah blah blah.



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Recognize that if the $C goes up 12% to $1.10, these US companies need to rise by at least that much, and within the same time frame, just to break even. But ... if you bought these companies when the $C was at $1.10, & the $C then fell to $.97 - you would earn an additional 10% for literally nothing. IE:You buy $US cash when the $C is rising, & spend that $US cash when the $C falls


The investment decision itself is the same on both sides of the border.






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Those two are no brainers. If you want to save the cost of hedging, better to buy when Cnd dollar is high.  You may still want to hedge a bit of the currency - say 50%.


KO is like a commodity play, its currency neutral given 80% revenues from overseas.  JNJ has similar attributes but with less overseas exposure.


I am invested in


1.  Silver

2.  KO, JNJ, COP, somewhat hedged against USD or using longest term in the money options on these instead of hedging

3.  Deflation/low interest rates - large variable rate Cnd mortgage partially funding certain investments

4.  Puts on the US stock market (and long BRK to get some yield to offset that a bit)


Call that my macro positioning.  Half my portfolio is in cash and I need good bottom up small/mid cap traditional value investing ideas for that - if I find them, I will hedge them against USD and S&P risk at least 50%.







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