Stock Strategist
Free Advice from All-Star Managers
by Jim Callahan, CFA | 04-17-06 | 06:00 AM
Spring has arrived, and with it comes the latest round of shareholder reports from the mutual fund industry. For investors and portfolio managers alike, these reports provide a great opportunity to share investment commentary, market expectations, and stock ideas.
Although Warren Buffett's letter to Berkshire Hathaway BRK.B shareholders is arguably the most publicized annual letter, we believe that there are other managers whose quarterly or annual thoughts are worth a read. Mutual fund managers are required to publish quarterly reports, and many managers take the opportunity to share their thinking on their funds' performance and the overall market. Like the Berkshire Hathaway letter, these fund managers' publications are available for free on the firms' respective Web sites, and they're full of commentary on the markets, individual fund holdings, and expectations.
We've selected 13 mutual fund managers who deploy what we believe to be solid investment philosophies for picking stocks. Compared to previous versions of this article, it's important to note that the lower number of managers by no means reflects a change in the number of portfolio managers we admire. Jim Gipson was excluded because he no longer runs Clipper Fund CFIMX , while FPA Capital's FPPTX Bob Rodriguez and Torray Fund's TORYX Bob Torray publish letters only in September and March.
More importantly, the list of managers' letters is not a Morningstar endorsement of these funds. Rather, we believe that these money managers think about stocks the same way we do when we analyze companies and derive fair value estimates. We share these managers' underlying philosophy of buying good companies at discounted prices, and if you'd like to read the actual letters, the table below links to most of the available shareholder reports.
Shareholder Letters from All-Star Managers
Ariel ARGFX John Rogers Jr.
Gabelli Asset GABAX Mario J. Gabelli
Legg Mason Value LMNVX Bill Miller
Longleaf Partners LLPFX O. Mason Hawkins
G. Staley Cates
John B. Buford
Oak Value OAKVX David R. Carr Jr.
Larry Coats Jr.
Matthew Sauer
Oakmark Select OAKLX Bill Nygren
Henry Berghoef
Olstein Financial Alert OFALX Robert A. Olstein
Selected American Shares SLASX Christopher C. Davis
Kenneth C. Feinberg
Sequoia SEQUX Robert D. Goldfarb
David Poppe
Third Avenue Value TAVFX Martin J. Whitman
Tweedy, Browne Amer Val TWEBX Christopher H. Browne
William H. Browne
Weitz Partners Value WPVLX Wally Weitz
Yacktman YACKX Donald A. Yacktman
Stephen Yacktman
Common Themes
As compared with the last edition of this article, the general themes have not changed dramatically, nor should they if these long-term managers practice what they preach. But we've identified some common thoughts among the group that we'd like to share.
Energy Remains Unattractive...
The energy sector drove much of 2005's performance, but none of these managers jumped on the bandwagon. In fact, oil and other commodities only look more overvalued to many of these managers. Why? Well, commodity industries have little (if any) pricing power, and pricing cycles are largely a reflection of demand (which is economically driven) and supply (which, without profit incentive driving capital investment, usually lags behind demand). Today's high-priced commodity environment is unlikely to sustain itself over the long term, according to many of these managers. John Rogers of Ariel Funds termed the energy sector "volatile" and "boom-and-bust," while Oakmark's Bill Nygren said he believes that the long-term price of oil is less than $50 a barrel. In fact, of the 13 managers, six devoted some ink to energy-specific comments.
We'd largely agree with their energy-related commentary. As of April 7, we covered 125 energy companies, but only nine warranted a wide moat rating. (Most have our "narrow" moat rating.) This reflects our opinion of the industry's commoditylike characteristics, and we would expect oil prices to decline to near $40 per barrel over the next couple of years. Further, just three energy companies ( Devon Energy DVN , El Paso Energy EP , and Houston Exploration THX ) had a Morningstar Rating for stocks of 5 stars, while the average energy company traded at a 27% premium to our fair value estimates.
...But Media Appears Cheap
We find it interesting that, despite the acknowledgement of consumer debt levels and unlikely future spending growth, many of these mangers had overweightings in the consumer and media industries. The media sector got a lot of attention, as both old-world (think newspapers) and new-world (cable, Internet search engines) companies were cited.
Longleaf Partners' LLPFX managers Mason Hawkins and Staley Cates said they believe that the broadcast and entertainment stocks are selling cheap because of "Wall Street's discomfort with a changing competitive landscape." They own several big names, including Comcast CMCSK , which Wally Weitz (also a Comcast shareholder) believes has the best management team in the cable industry. Although not explicitly discussed, Legg Mason's Bill Miller maintains his large position in Google GOOG and continues to believe that the company remains attractive for long-term investors despite the intense debate of its valuation and recent quarterly earnings disappointment.
Within our coverage universe, we separate the media, consumer services, and consumer goods sectors. As we've recently highlighted, the media sector presents a compelling opportunity right now: A full 90% of the media companies we follow offer an economic moat while trading at a 10% average discount to our fair value estimates.
High-Quality Stocks Remain Cheap
Another common theme was the attractiveness of high-quality companies, and various managers each took a different approach to making his case. Nygren and Weitz both point to strong growth in business fundamentals without the corresponding growth in share price. Nygren further adds that he believed high-quality name were overvalued in 1999 and that about 100 companies in the S&P 500 traded at half the market multiple. Today, only 13 trade at half the market's multiple, meaning that the index (representing high-quality stocks) contains undervalued, high-quality stocks. Interestingly, Selected American Shares SLASX managers Chris Davis and Ken Feinberg reached a similar conclusion using the same numbers. They noted that the top 50 companies in 1999 traded at a 169% premium to the next 450 companies, but today trade at a 5% discount. In this vein, Wal-Mart WMT and Anheuser-Busch BUD were mentioned more than once.
A Note on Cash
If an investor maintains a long-term philosophy, then he or she would prefer equities to cash given the two assets' historical inflation-adjusted returns. That said, if equity market valuations offer no attractive purchase opportunities, then a large cash position is prudent, and this is what we heard from many of these managers in June. However, whereas previous commentary focused on why cash isn't a bad investment during certain market environments, the latest round of shareholder letters seems to point to a more bullish position.
David Carr and Larry Coates of the Oak Value Fund OAKVX point to the decade's poor first-half results as a positive factor for the next five years, while Mario Gabelli noted that there is still a lot of cash on the sidelines. Gabelli's cash position is down from 30% a year ago to 8%, and Sequoia's SEQUX position has been halved from 10% as of year-end 2005.
Of course, there were plenty of opposing opinions. Yacktman YACKX managers Stephen and Donald Yacktman stated that today's market isn't any cheaper than it was in 2000, and their funds' sales in 2005 exceeded purchases. Robert Olstein of the Olstein Financial Alert OFALX stated that his predicted catalysts for 2005 simply haven't played out yet, but he's maintaining his 10% cash position, as are the managers of Tweedy, Browne American Value TWEBX . Ariel's Rogers notes that bullish investors outweigh the bearish by a 3-to-1 margin, which could weigh heavily on 2006 results.
Free Advice from All-Star Managers
by Jim Callahan, CFA | 04-17-06 | 06:00 AM
Spring has arrived, and with it comes the latest round of shareholder reports from the mutual fund industry. For investors and portfolio managers alike, these reports provide a great opportunity to share investment commentary, market expectations, and stock ideas.
Although Warren Buffett's letter to Berkshire Hathaway BRK.B shareholders is arguably the most publicized annual letter, we believe that there are other managers whose quarterly or annual thoughts are worth a read. Mutual fund managers are required to publish quarterly reports, and many managers take the opportunity to share their thinking on their funds' performance and the overall market. Like the Berkshire Hathaway letter, these fund managers' publications are available for free on the firms' respective Web sites, and they're full of commentary on the markets, individual fund holdings, and expectations.
We've selected 13 mutual fund managers who deploy what we believe to be solid investment philosophies for picking stocks. Compared to previous versions of this article, it's important to note that the lower number of managers by no means reflects a change in the number of portfolio managers we admire. Jim Gipson was excluded because he no longer runs Clipper Fund CFIMX , while FPA Capital's FPPTX Bob Rodriguez and Torray Fund's TORYX Bob Torray publish letters only in September and March.
More importantly, the list of managers' letters is not a Morningstar endorsement of these funds. Rather, we believe that these money managers think about stocks the same way we do when we analyze companies and derive fair value estimates. We share these managers' underlying philosophy of buying good companies at discounted prices, and if you'd like to read the actual letters, the table below links to most of the available shareholder reports.
Shareholder Letters from All-Star Managers
Ariel ARGFX John Rogers Jr.
Gabelli Asset GABAX Mario J. Gabelli
Legg Mason Value LMNVX Bill Miller
Longleaf Partners LLPFX O. Mason Hawkins
G. Staley Cates
John B. Buford
Oak Value OAKVX David R. Carr Jr.
Larry Coats Jr.
Matthew Sauer
Oakmark Select OAKLX Bill Nygren
Henry Berghoef
Olstein Financial Alert OFALX Robert A. Olstein
Selected American Shares SLASX Christopher C. Davis
Kenneth C. Feinberg
Sequoia SEQUX Robert D. Goldfarb
David Poppe
Third Avenue Value TAVFX Martin J. Whitman
Tweedy, Browne Amer Val TWEBX Christopher H. Browne
William H. Browne
Weitz Partners Value WPVLX Wally Weitz
Yacktman YACKX Donald A. Yacktman
Stephen Yacktman
Common Themes
As compared with the last edition of this article, the general themes have not changed dramatically, nor should they if these long-term managers practice what they preach. But we've identified some common thoughts among the group that we'd like to share.
Energy Remains Unattractive...
The energy sector drove much of 2005's performance, but none of these managers jumped on the bandwagon. In fact, oil and other commodities only look more overvalued to many of these managers. Why? Well, commodity industries have little (if any) pricing power, and pricing cycles are largely a reflection of demand (which is economically driven) and supply (which, without profit incentive driving capital investment, usually lags behind demand). Today's high-priced commodity environment is unlikely to sustain itself over the long term, according to many of these managers. John Rogers of Ariel Funds termed the energy sector "volatile" and "boom-and-bust," while Oakmark's Bill Nygren said he believes that the long-term price of oil is less than $50 a barrel. In fact, of the 13 managers, six devoted some ink to energy-specific comments.
We'd largely agree with their energy-related commentary. As of April 7, we covered 125 energy companies, but only nine warranted a wide moat rating. (Most have our "narrow" moat rating.) This reflects our opinion of the industry's commoditylike characteristics, and we would expect oil prices to decline to near $40 per barrel over the next couple of years. Further, just three energy companies ( Devon Energy DVN , El Paso Energy EP , and Houston Exploration THX ) had a Morningstar Rating for stocks of 5 stars, while the average energy company traded at a 27% premium to our fair value estimates.
...But Media Appears Cheap
We find it interesting that, despite the acknowledgement of consumer debt levels and unlikely future spending growth, many of these mangers had overweightings in the consumer and media industries. The media sector got a lot of attention, as both old-world (think newspapers) and new-world (cable, Internet search engines) companies were cited.
Longleaf Partners' LLPFX managers Mason Hawkins and Staley Cates said they believe that the broadcast and entertainment stocks are selling cheap because of "Wall Street's discomfort with a changing competitive landscape." They own several big names, including Comcast CMCSK , which Wally Weitz (also a Comcast shareholder) believes has the best management team in the cable industry. Although not explicitly discussed, Legg Mason's Bill Miller maintains his large position in Google GOOG and continues to believe that the company remains attractive for long-term investors despite the intense debate of its valuation and recent quarterly earnings disappointment.
Within our coverage universe, we separate the media, consumer services, and consumer goods sectors. As we've recently highlighted, the media sector presents a compelling opportunity right now: A full 90% of the media companies we follow offer an economic moat while trading at a 10% average discount to our fair value estimates.
High-Quality Stocks Remain Cheap
Another common theme was the attractiveness of high-quality companies, and various managers each took a different approach to making his case. Nygren and Weitz both point to strong growth in business fundamentals without the corresponding growth in share price. Nygren further adds that he believed high-quality name were overvalued in 1999 and that about 100 companies in the S&P 500 traded at half the market multiple. Today, only 13 trade at half the market's multiple, meaning that the index (representing high-quality stocks) contains undervalued, high-quality stocks. Interestingly, Selected American Shares SLASX managers Chris Davis and Ken Feinberg reached a similar conclusion using the same numbers. They noted that the top 50 companies in 1999 traded at a 169% premium to the next 450 companies, but today trade at a 5% discount. In this vein, Wal-Mart WMT and Anheuser-Busch BUD were mentioned more than once.
A Note on Cash
If an investor maintains a long-term philosophy, then he or she would prefer equities to cash given the two assets' historical inflation-adjusted returns. That said, if equity market valuations offer no attractive purchase opportunities, then a large cash position is prudent, and this is what we heard from many of these managers in June. However, whereas previous commentary focused on why cash isn't a bad investment during certain market environments, the latest round of shareholder letters seems to point to a more bullish position.
David Carr and Larry Coates of the Oak Value Fund OAKVX point to the decade's poor first-half results as a positive factor for the next five years, while Mario Gabelli noted that there is still a lot of cash on the sidelines. Gabelli's cash position is down from 30% a year ago to 8%, and Sequoia's SEQUX position has been halved from 10% as of year-end 2005.
Of course, there were plenty of opposing opinions. Yacktman YACKX managers Stephen and Donald Yacktman stated that today's market isn't any cheaper than it was in 2000, and their funds' sales in 2005 exceeded purchases. Robert Olstein of the Olstein Financial Alert OFALX stated that his predicted catalysts for 2005 simply haven't played out yet, but he's maintaining his 10% cash position, as are the managers of Tweedy, Browne American Value TWEBX . Ariel's Rogers notes that bullish investors outweigh the bearish by a 3-to-1 margin, which could weigh heavily on 2006 results.
