My investment thesis for CINF, Goldman and Morgan Stanley – Andy Schornack

Author: Andy Schornack

Covestor model: Financial Services

Disclosure: Long CINF, GS, MS

The performance of the portfolio for July was negative for the third month in a row as the financial sector continues to struggle. It again trailed both its benchmarks, SPSY (the S&P Financials Index) and the S&P 500 Index.

This is not acceptable from my viewpoint, and I am reviewing my positions and my thesis on each investment to ensure that situations have not changed materially to require a position change.

Following along with last month’s Investment Report, I am going to review some of the largest positions in the portfolio. Given earnings and changes in the marketplace, the position sizes have changed since June 30, 2011.

As of July 31, 2011, the third largest position in the portfolio is Cincinnati Financial Corporation (NASDAQ: CINF). CINF is primarily a property and casualty insurance company with a historical stable and increasing dividend. CINF has a longer record of consecutive-year dividend increases than all but nine other publicly traded U.S. companies according to a recent news release from the company. Q2 2011 posted a loss due to the storms in the company’s coverage area. The general thesis for CINF is that the firm has good management, pricing power for P&C insurance providers is anticipated to increase over the next couple of years, and the firm provides a nice and stable dividend yield.

Two investment banks were added in the past two months. Goldman Sachs (NYSE: GS) was added in June and Morgan Stanley (NYSE: MS) was the most recent addition in July.

GS is an investment in a premier investment bank trading at a relatively low multiple of book value compared to historical averages and an attractive price to earnings. GS is facing some legal headwinds, but I think the pullback in the stock has been too severe. Furthermore, GS is very well capitalized and management continues to buy back shares in the firm which will further improve the earnings per share and long-term value to shareholders.

Morgan Stanley was added more recently due primarily to its significant discount to tangible book value and what I believe significant opportunities for upside as management completes the repositioning of MS. MS trades at a significant discount to GS and Q2 earnings were impressive. A large charge was taken in Q2 related to the conversion Mitsubishi UFJ Financial Group, Inc’s preferred stock in the company with a 10% coupon. The conversion alone is expected to improve earnings by $780 million annually.

The target portfolio yield is 3% and currently the portfolio provides for a monthly dividend stream. This is driven by the composition and historical timing of dividends from the different stocks in the portfolio and could change at any time.

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CINF Press Release Announcing Dividend:

CINF Earnings Report:

GS Book Value per Share from Q2 Earnings Release:

MS Book Value per Share from Q2 Earnings Release:

MS Earnings Call Transcript:

MS Analyst Estimates: