2014: The Year in Review

2014: The Year In Review

Earlier this week, a friend of mine in the investment world and I were discussing one of our passions outside of finance – home brewing. After our conversation I went back to working on my annual report and realized there was some remarkable similarities between the two. These include:

1. One can never learn everything about home brewing. To be a successful and happy brewer, you never stop learning. There is always a new development just around the corner. Whether it comes from reading an article about new hops being developed to trying new yeast in one of your recipes, the challenge is to keep up with a remarkable amount of change in the technology, ingredients, and business of brewing. And that’s a great thing for those who brew and even better for those who drink beer.
2. It doesn't seem possible that something made with four ingredients – water, malt, hops, and yeast – can provide so much variability. Try as you might, it’s likely you will never get a chance to experience more than 10% of what the beer world has to offer.
3. Really good home brew comes from two main things. First is a superior process of cleaning, sanitizing, and the mechanics of brewing. Second is really superior ingredients – high quality malt, clean water, carefully packaged hops free of oxidation (usually), and fresh, healthy yeast. Ask a brewer about why their beer turned out badly and nearly all accept there was a flaw in their process.
4. Finally, the whole brewing experience I’ve found is made up of really honest, fun-loving, and relaxed individuals. People share ideas and recipes expecting nothing in return except to try some new and interesting beer in the future. You can’t underestimate the need to find a hobby filled with great people you genuinely enjoy working and drinking with day in and day out.

As my friend and I ended our call and I went back to preparing my Annual Report, it occurred to me that investment management and home brewing are actually pretty similar. At Nintai, we spend an inordinate amount of time acquiring knowledge by researching companies, trends, and relationships that are evolving and dynamic. Second, the act of investing – both buying and selling a stock – is actually far more complex than it seems. It’s extraordinary how much diversity can be found in the market. Third, successful investments cannot be made by cutting corners, sloppy research, and terrible companies (at least not the way we approach investing). Last, we work with people we genuinely admire and respect. These are people who constantly acquire new knowledge and freely share it to become a better team member.

So as the New Year starts and perhaps you kick back with a beverage to celebrate, take pride in the fact that we are involved in a remarkable business. We can make of it what we want, but how far you succeed is entirely and ultimately up to you.

The Year in Review: Why Do We Do This?

At the beginning of each year, we take a look back and see how the portfolio performed over the past 12 months and also see how we are doing over the long term. Because we trade so rarely, many people ask us why we even bother to send out an annual report. We believe there are three major compelling reasons:

1. Does Our Philosophy and Process Work?

There really isn't any better way for analyze whether our investment process works than measuring our returns against our proxies. It's our goal to significantly outperform the markets in the long term. To prove that we need to demonstrate an ability to beat our benchmark and explain why we have or haven't done so.

2. Is It Worth It for Our Investors to Remain Invested With Us?

Everyday we go to work knowing it is extraordinarily difficult to beat a low cost index fund over time. To make it worthwhile for our investors, we need to both outperform the indices and do it in a way that our investors are comfortable supporting and can sleep well at night. If we meet these conditions we are confident our investors will remain long-term partners on our journey.

3. How Do We Improve Our Process and Returns?

No investment process we've designed - or seen - has been perfect for its entire lifetime. We like to use our annual reports to discuss what we've learned and what steps we are taking to improve our professional knowledge as well as investment process. We believe we owe it to our investors to acknowledge our mistakes. It's even more important to discuss what we learned and what we've done to avoid making such mistakes in the future.

So without further ado, lets take a look at our results and see how we did.

2014 Review

2014 was a year very similar to 2013 in that the Nintai Holdings portfolio underperformed both the S&P 500 and the Morningstar Total Stock Market Index. The portfolio handily beat what we consider a more appropriate comparison - a blend of the Vanguard Total US Stock Market Index, Vanguard Foreign Stock Market Index, and cash returns. For 2014, the Nintai Portfolio returned 7.9% versus a 10.7% return for the Morningstar US Market Index and a 13.7% return for the S&P 500 TR Index. The Nintai Portfolio outperformed its recommended bogey's (82% Vanguard Total Market Index, 16% Vanguard International Stock Market Index and 2% cash) return of 1.9%.

Historical Returns

Since inception in 2004, the Nintai Holdings portfolio has generated a 15.0% annual return (net fees of 0.75% annually) versus a 6.3% return for the Morningstar Total Stock Market Index and a 7.7% return for the S&P 500 TR. An investment of $100,000 in the Nintai portfolio in 2004 is currently worth (net fees) $465,200 versus $195,800 for the Morningstar Total Stock Index and $226,100 for the S&P 500 TR. A blend of Vanguard Total Market Index and Vanguard International Stock Index (rebalanced each year to reflect Nintai’s percentages) produced an annual return of 4.8% leaving an investor with $167,500 after the same period.

The following are comparative historic returns:

A couple of things to keep in mind. We’ve actually been outperformed by the Morningstar Total Stock Index over the past three years. The S&P 500 TR has outperformed the Nintai Portfolio over both the past three and five-year periods. While disappointing, we believe our long term performance demonstrates the value of our investment philosophy.

Finally, Nintai really earned its management fee when in 2008 the portfolio lost less that 17% versus losses of well over 35% for most of the markets. As we’ve mentioned previously, sometimes the best value we can add is by not losing rather than trying to shoot the lights out.

Conclusions

Even though the Nintai portfolio has underperformed both the S&P 500 and Morningstar Stock Market Index, we are quite comfortable with our holdings and positions. The current PE of our portfolio is 15.5 or roughly 15% less than the S&P 500. In addition, the portfolio has an average ROA of 22.4% and an ROE of 33.2%. Respectively, these are roughly double and 50% higher than the S&P 500. Finally, projected earnings growth over the next 5 years is projected at 13.3%, or roughly 40% greater than the S&P 500. In essence, the Nintai Portfolio is cheaper and far more profitable than the broader markets and expected to grow considerably faster. This is a situation we are very comfortable to remain fully invested and quite patient.

Going forward only one stock in the portfolio is being seriously considered as a potential source for funds - Manhattan Associates (MANH, Financial). During the next few weeks, we will review many of the companies in the portfolio and discuss their investment case and current valuations. Manhattan will certainly be one of these we take a long look at from a price/valuation standpoint.

Over the past 10 years, we have a turnover ratio of roughly 5-7% annually. We expect this to continue into the foreseeable future. Each of the companies in the portfolio shares common characteristics - excellent profitability signified by high ROA, ROE, and ROIC, little to no debt, management who are great allocators of capital, and they were purchased at a significant discount to fair value. Our turnover is low because there are simply not that many companies that meet such criteria.

We made one change in the portfolio that came too late to be included in the annual report. This was the purchase of a small position (1.5% of total assets) in Computer Programs and Systems (CPSI). Additional thoughts and reasoning for our investment in the company can be found in our article entitled "The Search for Compounding Machines" published on Nov. 21, 2014.

Over the course of the year, we will notify members of the GuruFocus community of any additional changes to the portfolio. With a cash balance of roughly 2%, it's not likely there will be any significant purchases without the sale of a current holding.

We appreciate everyone's thoughts and comments over the past year here on GuruFocus. We don't believe there is a better website to meet fellow value investors, learn from a fantastic group of writers, and conduct research from data that really is unique to the Internet. We wish everyone a very prosperous, happy, and healthy New Year.

- Nintai Partners

Nintai Portfolio Holdings

December 31st, 2014