Hello everyone. Would welcome some feedback on my current portfolio and potential watch list along with any other insights. My situation is somewhat unique in that I sold my portion of an engineering firm as part of an ESOP (Employee Stock Ownership Plan) in Feb. of 2017. Within that transaction, as a C-Corp, the sellers are able to treat their sale under the 1042 rollover provisions and reinvest in Qualified Replacement Property (QRP) within 12 months and avoid capital gains taxation of let's say Fed/State of around 28-30%. While this sounds like a fantastic opportunity it creates several challenges.
The first challenge was the simple fact that rarely do sellers of small businesses get 100% cash up front. That leaves the remainder in interest bearing subordinated seller notes. The second challenge is how to do you assemble a portfolio of 100% of the sales prices when you are lucky if you get 1/3 in cash at closing? Third is the what constitutes QRP. Its a pretty tight list. US based, non-fund, non-REIT, non-muni, non-treasury stocks. Essentially your large name blue chips along with corporate bonds and floating rate notes (FRNs). And last but not least is that who would want to sell their No. 1 asset only to lock the entire sale down into a portfolio of even high quality DG stocks when there is no way to exit without incurring the cap gains taxation. And at 41 that's a long time (hopefully!).
In my case I've elected a portfolio of FRN's and equities. I'm not crazy about the bond environment given my time horizon and the likelihood of rate increases. My FRN's are purchased using a line of credit and have been formally transferred to Citi who now holds the assets and will monetize them at 90% value. At death the basis is stepped up and the 10% held back will pass to heirs without cap gains taxation. They will do the same on equities once assembled usually at around a 70% LTV. The interest delta between what the notes earn and the monetization loan are both tied to LIBOR so they move together and will always be ~1 to 1.5 depending on the Note. That's a tax deductible interest as it is part of an investment interest expense so it's a very manageable expense to avoid 30% taxation.
Which brings me to the purpose of this post. I've been working since mid-summer to identify and purchase at least 50 stocks across 10 sectors (eliminating real estate by and large for the moment). I'd like to generally be equally weighted and split between the sectors but I'm already a little heavy in staples because of the value they offered from the AMZN/WF deal late last year. My struggle is I have to get this done by Feb 5, 2018 to qualify. Which means buying headlong into the records it seems near daily. I've been pretty patient and added on dips and opportunities. Current portfolio has an average yield right at 4% (I want to stay above 3%) and return over the last 6 months of around 18%. Keep in mind I may have these equities for the next 40 years. There will rarely be selling opportunities unless there is a loss harvest I can use from time to time. But generally speaking it is a forced buy and hold. The dividends will be used to offset the cost of the aforementioned loan and not dripped. The total required equity investment as part of this 1042 QRP is $550k and I'm about half way to that goal.
I am really under invested in Financials, Industrial and Materials. Current portfolio:
Symbol
MO
KMB
MDT
ED
JNJ
D
K
PEP
KMI
VZ
COST
XOM
GE
HRL
SJM
T
CTL
TGT
AAPL
CAH
DUK
EPD
IBM
MRK
NUE
QCOM
SO
STX
DAL
WBA
AFL
CVS
I'll post my target names shortly but I wanted to see what feedback might be out there. Thanks so much, look forward to the discussion.
Side Notes: I may have to sell out of MDT because they are Irish based in the inversion meaning it might not qualify as QRP. Waiting on clarity on that stock.
Not a huge GE fan but it's a small piece of the picture and in at upper mid 17's or so.
I'm a big COSTCO guy and I know going in my store they are not going anywhere - it's a strong business even though the dividend stinks.
My target/watch list includes the following.
ABBV
PFE
INTC
MSFT
CINF
JPM
BAC
C
TROW
HD
LOW
WRK
HON
UPS
MMM
IP
crimsonghost747
Unregistered
So let's see if I understood this correctly. Basically any tinkering with the portfolio after February will lead to massive capital gains taxes? So this is a true buy-hold-don't even look type of situation? In that case the 50 stocks might be a good number, but if you have any breathing room with making trades inside the portfolio then I would highly recommend somewhere around 30 stocks... keeping an eye on 50 stocks takes a lot of time.
It's quite a challenge indeed to buy into something for 40 years if you have no viable exit strategy. Is the endgame simply to leave this money for your kids? Because, if I understood it correctly, if you want to use it yourself then you'll end up paying the taxes at some point anyway. Keep in mind, you've hopefully got another 40 years left to roam around the planet.
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Congratulations!
All your stock choices look great; however, being that I'll never be in your shoes investing through a QRP I wouldn't be able to give sound advice particularly that February 2018 will be here in a blink of an eye.
The rules do kind of follow my own investing philosophy: buy quality/buy at a decent price/look for that dividend/and try never to sell
Would you be able to consider any Canadian companies? Such as banks? They do throw off some nice yields to this date.
(01-01-2018, 11:31 PM)crimsonghost747 Wrote: So let's see if I understood this correctly. Basically any tinkering with the portfolio after February will lead to massive capital gains taxes? So this is a true buy-hold-don't even look type of situation? In that case the 50 stocks might be a good number, but if you have any breathing room with making trades inside the portfolio then I would highly recommend somewhere around 30 stocks... keeping an eye on 50 stocks takes a lot of time.
It's quite a challenge indeed to buy into something for 40 years if you have no viable exit strategy. Is the endgame simply to leave this money for your kids? Because, if I understood it correctly, if you want to use it yourself then you'll end up paying the taxes at some point anyway. Keep in mind, you've hopefully got another 40 years left to roam around the planet.
That is partially correct, however the idea would be to use this portfolio and combine it with the FRN's and monetize the entire package. I need to complete my investments by 2/5 as I am only about half there. The dividends and interest in the FRN's pays (nearly) the cost to carry the loan. Ultimately I end up at a blended LTV of around 88%. I'm pretty committed to the 1042 even with all the rules and having to have such a short window to purchase QRP. It's really one of the few "gifts" in the tax code. Very similar to the 1031 Real Estate rollover.
So for example on hypothetical $5m sale price it would look roughly like this:
Pay tax of ~$1.5m with net after tax proceeds of $3.5m. Invest as you see fit.
OR
1042 rollover, defer/avoid cap gains. Purchase $5m in QRP. Secure that portfolio with a large institutional lender. Monetize to around $4.4m and invest as you see fit. Cost per year is a pre-tax hit of around $25,000 in interest. The entire portfolio would get stepped up in basis at death so depending on the loan balance on it the remainder would go to heirs without taxation.
So it is a true buy and hold and maybe even never look at it situation. If I want to donate to charity, CRUT, etc. then I would of course use QRP and not cash as the donation of QRP doesn't constitute disposition (or taxation). If the value rises enough or gains taxes get reduced and I want to re-adjust I could easily sell and just pay the tax at any time. It's usually a game of loss harvesting throughout the years to get rid of some bad apples, but that's getting beyond my mission just yet.
Ultimately the benefit of this is that in the hypothetical example for a cost of $25,000 per year (pre-tax) you start your outside investment portfolio with $0.9 to $1m more in funds. If it did nothing but earn 3% until death you'd do better than break even and your heirs would have nice inheritance. Of course that's not the goal. Once monetized it opens up the world of investing - real estate, REIT's, foreign, munis, ETF's, etc. Start an investor with an extra $1m and even the most fundamental investment strategy and the law of compounding would (or should) win every time.
(01-02-2018, 01:36 AM)rayray Wrote: Congratulations!
All your stock choices look great; however, being that I'll never be in your shoes investing through a QRP I wouldn't be able to give sound advice particularly that February 2018 will be here in a blink of an eye.
The rules do kind of follow my own investing philosophy: buy quality/buy at a decent price/look for that dividend/and try never to sell
Would you be able to consider any Canadian companies? Such as banks? They do throw off some nice yields to this date.
Thanks rayray. It was a great situation for owners and employees both and really is a nice exit strategy that I think is under utilized (but catching on with boomers for sure).
I wish I could consider some outside companies like Canadian banks for sure. I've seen the yields and relative strength of several of them. I guess that will have to be "Phase 2" since it isn't allowed as part of the 1042.
I've got some real gaps in Industrial/Materials and Finance. I think I'm light in any sort of defense related names too - as in none. I like the names I have I suppose, some more than others. Really just looking for thoughts on potentially where to fill in the gaps in a MUST invest scenario including maybe not so common names or even something a tad more risky or growth heavy vs. a nice dividend payer. With 50 names I can afford to have a few names out of the norm I suppose. Not easy right?
I feel like I am waving a red flag at the bull but there really is no waiting for the exact moment. In fact I've been slow to act thinking there might be a pull back throughout late 2017 or trying to over analyze names and dips. I haven't done bad and actually learned a great deal about all the names I own but do I wait for a dip between now and 2/5? Unlikely.
Regardless now I have ~25 trading days to get it done.
crimsonghost747
Unregistered
Finance: Well since Canadian banks are out of the question, then you might as well go with the US ones. The tax cuts should benefits banks nicely, so any of the big ones should do. Pick two or three big ones and split it equally?
Industrial: You already have HON in your watch list, I can highly recommend it. The price has shot up quite a bit (just like most industrials) but it's still not a bad buy at these levels. Defence stocks are a tough deal right now, prices are all time highs, the EPS is following but the revenue growth really isn't... but it's still a sector I would highly recommend including. I'd go with RTN or BA even though I don't really consider either to be in the buy range.
Since it's an eternity portfolio and you're planning on around 50 companies, you could also look into some more or less wild bets. Things like cyber security solutions, robotics, 3d printing or whatever wild but plausible trends you can see.
(01-02-2018, 09:38 AM)crimsonghost747 Wrote: Finance: Well since Canadian banks are out of the question, then you might as well go with the US ones. The tax cuts should benefits banks nicely, so any of the big ones should do. Pick two or three big ones and split it equally?
Industrial: You already have HON in your watch list, I can highly recommend it. The price has shot up quite a bit (just like most industrials) but it's still not a bad buy at these levels. Defence stocks are a tough deal right now, prices are all time highs, the EPS is following but the revenue growth really isn't... but it's still a sector I would highly recommend including. I'd go with RTN or BA even though I don't really consider either to be in the buy range.
Since it's an eternity portfolio and you're planning on around 50 companies, you could also look into some more or less wild bets. Things like cyber security solutions, robotics, 3d printing or whatever wild but plausible trends you can see.
Thanks, yeah I will do some (more) research on some of the "wild bets" and maybe find a name or two.
Added positions to JPM and BAC this week along with HON, TROW, DUK, QCOM and SCG (yesterday! nice...) Some of these are rounding out, so smaller positions. My posture has been to make about half of my total planned investment in each name at a time then move into a full position in either 1 or 2 more trades as the deadline approaches. Found a few pull backs along the way in some of the names. QCOM for example was 20 shares to round out the total I was targeting in the name. Looking at NEE a little right now. Curious what happens here with INTC. Since I am a long term investor even with the issue it might be a good entry point if I can ignore the beating it might take short term.
Been an interesting run the last few weeks! I'm about 3/4 of the way through assembling the portfolio and about 14 trading days left.
Recently added:
GM
MSFT
AAPL
AFL
ABBV
STX
C
BAC
JPM
SO
Some of these were purchased to round out positions or on big drops that I felt were overdone. Also added some different players to the mix just for some...spice? All of these are 1/2 positions. I'll have a few extra names but since it isn't actively managed day in and day out having over 50 names won't be a hindrance. Some of these were also used to just draw in the weighting balance in a various sector or two. I'll full on Staples, Financials and Discretionary. Way short on IT, Industrial and Materials.
PACW
ORI
NTRI
GME
SUP
PLOW
Planning on filling out final positions in HON, DAL, AAPL, MSFT, ED, ABBV and SAFT in the coming days. Unfortunately nearly all at 52 week highs....
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Just a few thoughts.
I'll point out that airlines are historically pretty cyclical companies, so keep that in mind with DAL.
The FAST Graph on SAFT looks pretty bad. Volatile earnings and little growth over the years. ORI, SUP, and PACW have similar trends.
Also not a fan of GME. In a raging bull market and decent economy it has grown EPS at a negative rate over the last 5 years. It's also just BB rated, which is junk bond status.
Also might want to look at D, DUK, WEC, LNT, NEE, AEP as potential alternatives to ED. They have similar or higher yields but are all growing at faster rates.
Just my $0.02 if you wanted some input.
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