Fund Manager Makes a Big Bet on Buffett

Managing money is no laughing matter, but that's not stopping one fund manager from finding a little humor on Wall Street.

Fund manager Karl Mills draws cartoons depicting the funny side of finance when not selecting stocks for the $9 million (CPFSX Quote)Counterpoint Select fund. While the market's sharp downdraft recently has been anything but comical, his concentrated large-cap growth fund has fared relatively well, down 3.75% year-to-date compared with a 7.3% loss for the S&P 500. Last year was the fund's first full year in existence and it returned 2.6%, trailing the benchmark by almost 3 percentage points.

Mills sat down with TheStreet.com to discuss why he is positive on Berkshire Hathaway(BRKA Quote) and big-cap tech, as well as his peculiar hobby.

How do you choose stocks for the Counterpoint Select fund? It's a very concentrated, low-turnover fund holding just 20 or so stocks, so you certainly must have a great deal of faith in these names.

We focus on "franchise" businesses, and by that, we mean companies with a well established, valuable and durable market franchise. We combine core holdings in great franchises that sell for reasonable prices with more opportunistic investments in companies that may be out of favor, experiencing temporary -- but not fatal -- problems, or are just out of sight and mind, that sell for compelling valuations.

	Mills Cartoon
	Photo: Karl Mills

We believe in concentration because good investment opportunities don't come along every day -- although today they are plentiful -- and when they do, it makes sense to make them count. Diversification mitigates risk, but it also mitigates opportunity. Too many funds end up owning everything and become undifferentiated from the market.

Why do you hold 7% of your assets in Berkshire Hathaway? Also, what do you think of their move into the bond insurance business?

We added to our Berkshire holding substantially over the summer on the thesis that the dislocations in the market would provide great opportunities for companies like Berkshire that were sitting on piles of cash ($50 billion-plus in their case) and have a history of buying good-but-distressed assets on the cheap. This worked out well and Berkshire actually performed beautifully through all of the turmoil.

We also believe that during times of duress, the strong get stronger. The dislocation in the bond-insurance market has provided Berkshire the opportunity to use its balance sheet and good name to set up a competing entity. Meanwhile, Berkshire continues to venture into other areas such as railroads and overseas. We also own GE(GE Quote) and Goldman Sachs(GS Quote) partly on the same thesis.

You also own Moody's(MCO Quote), which Berkshire has a stake in. Why did you pick this up separately? Is this a good holding considering the potential lawsuits?

Moody's is a great business under the dark mortgage cloud. They were at the scene of the crime, but they also play a key role in the healing of the business going forward. Along with S&P, they have virtually a duopoly position in the marketplace, and our belief is that there is more noise than substance to the talk about restructuring the ratings industry.

We also don't believe that the lawsuits will be life-threatening. In our experience, these usually don't amount to much. The markets need Moody's and S&P, and the issuer-pay model is as good as any with proper disclosure.

Bond issuance is not going away, nor is securitization. Bond issuance is on the rise internationally and securitization is a necessary part of the financial-services digestive tract. It will return. Meanwhile, Moody's stock has been cut in half and it sells at 14 times depressed earnings. It has no debt, 30% profit margins and generates enormous free cash flow that it can use to buy in shares at depressed prices.

When did you start buying Merrill Lynch(MER Quote)? It has not been putting up a lot of positive headlines lately.

We stepped into Merrill in December on the belief that the franchise is substantially undervalued. The market is only focused on the CDO issue, but Merrill has one of the most productive broker forces around with 16,000 brokers and $1.7 trillion in assets. They also own 50% of Blackrock(BLK Quote) and 20% of Bloomberg, both great businesses.

Finally, their investment-banking business is competitive. With John Thain coming in to take over, we felt very comfortable that he would clean up the house of Merrill quickly, secure the balance sheet and start to move the franchise forward. So far, we are pleased with his progress.

You obviously like big-cap tech because you own Microsoft(MSFT Quote), Intel(INTC Quote), Cisco(CSCO Quote) and Google(GOOG Quote). What's the appeal? Also, why not Apple(AAPL Quote)? That's a surprising omission.

We started moving to big caps 18 months ago when nobody liked them. Now they are in vogue, although there are differences among the names mentioned. We are big fans of Apple's products, but as a stock, Microsoft offers much better value for the money, as does Intel, and we think Cisco is the most undervalued and attractive of the group. Cisco is beautifully positioned to participate in the build-out of Web 2.0 and sells for 13 times forward earnings, generates 25% returns on equity and has $25 billion in cash.

Google is our one indulgence in the portfolio. They have a highly differentiated business model, good long term growth prospects, and a lot of underleveraged assets such as YouTube. We used to own Apple, but sold it over the summer on valuation. As much as we love the company, we think the stock was priced for perfection. We don't normally like to pay more than 20-25 times forward earnings for a company. If Apple gets cheaper, we will be happy to own it again.

Why Pfizer(PFE Quote) as opposed to other big pharma? There are pipeline concerns there.

Pfizer is out of favor and is dirt cheap, selling at 9 times forward earnings. It also pays out a 5% dividend yield and generates close to $20 billion in cash flow on $48 billion in annual sales. The stock is cheap because of the belief that Pfizer has no pipeline and Lipitor is going off patent.

While Pfizer has a limited Phase III pipeline, it does have a lot of drugs in development in Phase II and beyond. With their $27 billion in cash on the balance sheet, they have the ability to make one or more acquisitions. Meanwhile, the decline in Pfizer's market cap has already discounted the decline of Lipitor. At current prices, there is much more that can go right than wrong with the company.

OK. Now for the fun stuff. Tell me about the cartoons. How does the drawing compare to stockpicking?

	Mills Cartoon
	Photo: Karl Mills

They are actually similar. Both relate to spotting absurdities around you. Sometimes the absurdities can be funny and sometimes they are investable. We use cartoons to underscore our investment outlook, to make comments on the markets, or sometimes, just for fun.

Our industry is famous for taking a good thing too far, so there is an endless supply of material. It is also this tendency to take a good thing too far that creates the investment opportunities to bet on areas of great negativity and against areas of great optimism. Good stock picking pays a lot better than good cartooning. My goal is to do both.