The Peter Principle

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Peter Lynch, legendary manager of the Fidelity Magellan Fund and one of the greatest investors of all time, once said that you should “never invest in any idea you cannot illustrate with a crayon.” With this simple concept in mind, we present brief sketches of each of the 20 largest positions in our individual securities portfolios:

Verizon Communications Inc. (VZ) Verizon provides wireless, wireline, advertising, entertainment and cloud services to individuals and businesses. The smartphone revolution needs a wireless network to run on, and VZ provides it to more than 140 million customers. The company earns the best profit margin in the industry by emphasizing quality and low customer churn.

Microsoft Corporation (MSFT) Microsoft’s new CEO Satya Nadella continues to surprise, in a good way! The company has refocused itself on cloud and mobile computing, two of the fastest growth areas in tech. With continued success at transitioning legacy Windows applications to the cloud, we think there is more growth ahead for the company.

SanDisk Corp. (SNDK) Soon to be acquired by disk drive maker Western Digital Corporation (WDC), SanDisk is a leading purveyor of solid-state computer memory. As flash memory steadily supplants disk drives in both mobile and cloud applications, WDC offered to acquire SNDK for $16 billion in cash and WDC shares. We will likely hold the WDC shares we receive in the transaction, as the combined company should be well positioned in a rapidly consolidating industry.

AT&T, Inc. (T) The second largest U.S. telecom carrier, with 130 million customers, AT&T provides wireless, wireline and video services, the latter through its recently acquired DirecTV subsidiary. The company has a growth agenda, and recent purchases of Nextel Mexico and Iusacell give it plenty of running room south of the border.

The Boeing Company (BA) Boeing is one of a handful of providers in a duopoly market for commercial aircraft worldwide. Global air traffic continues to increase at rates about double real Gross Domestic Product (GDP), and both Boeing’s and main rival Airbus’ order backlogs are near all-time highs. With 5700 planes on order, including 800 of the revolutionary 787, Boeing need only execute on business it already has in order to grow earnings at 10% annually over the next 5 years.

General Electric Company (GE) A global industrial conglomerate, GE has transformed key aspects of its business over the past 5 years. The company sold most of its financial services operations in order to focus on industrial markets where it has scale advantages. This change has driven GE’s price earnings (P/E) multiple from 13 to 17 since 2012, and we think it can rise further as GE adds high-profit software and services to its business mix.

CA, Inc. (CA) CA is a business-focused software company, with an emphasis on mainframe and cloud-based utilities. Customers are long-lived due to the limited competition for mainframe software, which accounts for about 50% of revenues. CEO Michael Gregoire recently upgraded the sales force, and the changes are beginning to show traction.

Kimberly-Clark Corporation (KMB) A classic “steady Eddie” type company, KMB produces branded consumer products that every household needs on a day-to-day basis. Their story is more than just the consistent domestic success of Kleenex, Huggies and Depends, however. KMB has generated better than 15% annual sales growth in developing markets in each of the last 5 years, and we expect this growth to continue.

Medtronic PLC (MDT) Our investment in Medtronic is an amalgam of applied science, innovation and demographics. The world’s largest maker of medical devices, MDT uses their legacy advantage in intensive research and development to churn out implantable therapies for everything from cardiac arrhythmia to diabetes. We’re all getting older, living longer and demanding more health care. Medtronic CEO Omar Ishrak knows it, and he’s prepping the company for steady growth for years to come.

Honeywell International Inc. (HON) Honeywell is another story of a strong CEO (Dave Cote) guiding a very large company to consistent success. Brought in over a decade ago to fix a broken down industrial conglomerate, Cote has whipped HON into strong operating shape while generating lots of free cash for acquisitions, share  buybacks and dividends. Our main concern here is management succession and continuity.

Arthur J Gallagher & Co. (AJG) Unlike most of the names in our portfolio, insurance broker AJ Gallagher grows mostly by acquisition. Normally a fairly risky avenue for success, serial acquisitions can work well if executed with both price and operating discipline. This company demonstrates steady execution in a very fragmented industry. Layer in a strong sales culture and AJG is well positioned for continued success.

Loews Corporation (L) Loews is a family-run conglomerate with a good record of building shareholder value, checkered recently by overexposure to the energy area.  A “sum of the parts” valuation puts the market value of Loews’ public subsidiaries (CNA Financial, Diamond Offshore Drilling and Boardwalk Pipeline) at about $33 per Loews share. Adding the value of Loews hotels and a large investment portfolio (about $10 per share) gives a fair value of $43. The stock trades at $39.

PNC Financial Services Group, Inc. (PNC) PNC is one of the best managed superregional banks, as measured by both consistently high shareholder returns and low business risk. After integrating National City and two other acquisitions following the financial crisis, PNC has focused on keeping expenses low while building the high-tech bank of the future—delivered efficiently via smartphone rather than a costly brick-and-mortar branch on the corner.

Headwaters Incorporated (HW) Little-known Headwaters is a leader in several niche markets for building materials, including cement block, manufactured stone, siding, roofing and architectural trim. They are also the largest provider of recycled fly ash for use in ready-mix concrete. With sales and earnings growing at rates more than double GDP over each of the past 5 years, HW is poised to reap further gains in a steadily-improving U.S. housing market.

Xilinx Inc. (XLNX) Xilinx makes semiconductors that make a very diverse list of products work better and faster. The company sells field programmable gate array (FPGA) chips for use in cellular, automotive, industrial and medical and defense applications. With gross margins near the top of the semiconductor industry, XLNX is a growth company we’ve followed closely since its initial public offering in 1990.

NetScout Systems, Inc. (NTCT) NetScout doesn’t make computer networks; they make software that makes networks run better. Customers include large companies and telecom providers around the world. NTCT purchased its largest competitor in 2015, and investors had difficulty understanding the benefits of the deal. We think management will be able to grow the combined company.

V.F. Corporation (VFC) VF Corp manufactures and markets a set of niche clothing brands. They grow both organically and via acquisition, typically by buying recognizable “lifestyle” brands and scaling them. VF allows their stable of brand designers to handle creative aspects, while the parent company uses its extensive supply-chain expertise to maximize profits. Their brands include The North Face, Vans, and Wrangler.

Rockwell Automation Inc. (ROK) If robots are the future, ROK is a big part of the future of robots. The leading domestic provider of factory automation, Rockwell makes software and systems for automating everything from a whiskey distillery to a diamond saw factory. With high-margin software and services a growing fraction of future sales, the company expects steady increases in both gross and net profits.

Marsh & McLennan Companies, Inc. (MMC) Marsh Mac is the world’s second largest insurance broker, offering brokerage, benefits and management consulting to 92% of the Fortune 500. We’ve owned the shares since late 2004, when a bid-rigging scandal put the company under a cloud. New management has since put MMC back on a growth track, and the company (like our other holding AJ Gallagher) has had good success consolidating a fragmented industry.

Intel Corporation (INTC) Intel is known as the PC chip company. It also sells central processors for network and cloud servers. Recently INTC developed a proprietary transistor that allows high speed computing with low power consumption. As demand for powerful mobile chips grows, the company’s new design should allow them to capture market share.

The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. Any reference to specific securities or sectors should not be considered research or investment recommendations by Fort Pitt. Past performance is not a guarantee of future performance. The portfolio holdings described above are current as of the date of this publication, represent the top 20 holdings held in Fort Pitt’s managed stock strategy and are subject to change. Individual holdings may vary.

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