A lot of stocks look cheap today. Value stocks are cheap. But not every cheap stock is a value.
10 Questions With Greg Jackson
Fund: Oakmark Global
Assets: $28 million
1-Year Annualized Return/Ranking:
Expenses: No-Load, 1.75% annual expense ratio
That's important to remember at a time when the
Nasdaq Composite Index
is off more than 50% from its high and so many stocks are on the discount rack. Let's face it, if I could just hand you a list of stocks that are truly oversold and poised to run back up, I'd be on a beach somewhere, not tapping away on a laptop as my train rattles through podunk towns on the way to Boston (and no, Boston is not a podunk town).
That's where Greg Jackson comes in. He runs the
Oakmark Global fund, which trounced just about all of its peers on the way to a 15.8% gain last year, when the
lost more than 9%. It's great to talk to the folks who run the Oakmark Funds because there's a lot of work behind their ideas. Together they hash out a firmwide buy list and one of the folks doing the hashing is Bill Nygren -- no stranger to this column, he
sat down for a chat with us not long ago.
Jackson says they're not seeing much value in the Nasdaq, but they are finding some in telecom stocks -- even battered
, quietly up 27.7% this year. Read on for more on where you might be able to buy solid earnings growth for less, and what cheap stocks are traps.
1. It's messy in the U.S. People say it's a stock-pickers' market. Translation: Everything doesn't go up anymore. To start off, where are we, and where are we going?
I think you're right. What's important is that investors realize that valuations matter. I think the valuation band got stretched so far away from intrinsic values as it now moves back to intrinsic values, you've got to be able to figure out what that intrinsic value number is, how you calculate that. So I do believe it's a stock-pickers' market.
I don't see the momentum market coming back any time soon. I think some of the hot technology stocks are going to have bursts. But if the valuation isn't there, that burst will be just that. It's going to be fundamentally driven this year.
2. Everyone we talk to is tech-obsessed, a hangover from 1999. They're obsessed with it on the upside, they're obsessed with it on the downside -- probably a little bit too excited on both fronts. Have you looked at tech using your model for weighting values in the broad picture. Is there value in the Nasdaq?
I think I would say no.
I'm looking primarily Internet infrastructure companies. Even though all of these companies look very interesting, they're still 15 times revenue. They're making a big deal about how their stocks are down 70%-80%, but from a valuation metric at 15 times revenue, you see tremendous growth rates that may or may not last if these companies are willing to state publicly, "We're not sure of currently where the market is going, the market's shifting so rapidly." There are a lot of interesting ideas in the Nasdaq, but it's still not a value.
But we are finding niches or pockets and we're moving very, very slowly.
What pockets of tech look somewhat attractive to you and are worth watching?
People have the misperception that we haven't participated in tech. And I think we've done it via other avenues, not direct tech investments. A company that has probably been my favorite company for some time is
. It's an indirect beneficiary of anything that goes on via the Internet because it's a credit-card processor. They control 50% of the market.
, for example, is another indirect tech play. They make the computer systems for most of the auto dealerships in the nation. These stocks let us participate in the tech benefit without paying the multiples.
3. What sectors look intriguing in the U.S. right now from a valuation perspective?
We're looking at telco. The big question there that nobody wants to answer is the bandwidth: do we have enough capacity for the bandwidth? I mean, we're going to fill it up whether it's voice or video, conference calls and so forth, video via the Internet that's the debate. Is there so much capacity that we just won't fill it? I guess the jury's still out on that, but having said that, there are pockets like AT&T that I think are very cheap. We've bought a lot of that recently.
We do a sum of the parts on AT&T we can come up to a $35 number. The stock was at $16.625 at the end of the year. In this market, we have these dramatic swings now, going both ways. If the middle is intrinsic value, you've got it going way up this way and way down this way.
In the month of December, we were stunned by the number of companies that fell on tax selling, big companies as well as small companies. You receive a huge bounce from that.
I think that's a great point. If you look at AT&T and more pointedly, the likes of Microsoft (MSFT) - Get Report, stocks that made a lot of money for a lot of portfolios and got hit hard by tax-loss selling, those were the ones that really came back.
Exactly. They took the losses in November and December; it really beat these companies up. We were stunned by the level of decline.
No one is lukewarm on AT&T. You either love it or you hate it. An awful lot of folks out there own it, and are disappointed. They want to know why they should hang on to it. What's your reasoning for them?
Well, I think the valuation is summing up the parts and saying the cable business is worth, what the consumer long distance is worth, what the business services is worth if you sum all those pieces together, you get something between a $30 and a $35 value.
And that's -- I think our estimates are very conservative. It could be far higher than that. And the stock's trading in the low 20s, so you have roughly 50% from outside here. So that would not be a sell. I think too many times, I think the chairman, Mike Armstrong, made an interesting point, he said when there's uncertainty about a company, the market goes to the lowest common denominator, and values the company based on that. In this industry, it's earnings per share.
Whereas, if you look at pure cable companies, they're always valued on enterprise value
EBITDA, or cash flow generation. And yet people forget that AT&T owns a huge amount of cable assets, and they're valuing their entire enterprise on an earnings per share basis. So, I think the market has gotten the pessimistic view, it's the manic-depressive cycle.
Two years ago, telecom ruled the world, AT&T was trading at $50 a share, everybody had the manic side going. Now, everybody's so depressed they're valuing it at earnings per share. Back then they were valuing it on EBITDA. So I think, yes, there are some issues in consumer-long distance. Those aren't going to go away any time soon, prices are going to continue to erode. The risk also is business services. Is the business segment going to erode? There's a potential for that, but I think at this price, that's more than factored in.
What about PC stocks? Those had a huge bounce in January.
Actually, that's a sector that I've been working on recently.
( HWP), all of those companies we have up on our radar screen and I've been looking at them. It's just interesting that even though they declined a great deal, Hewlett-Packard is still trading at about 18 times earnings and their earnings are actually projected to be flat to down this year.
If you go back to the early 1990s, the rule of thumb was you buy a PC stock at eight times earnings and sell it at 12 times earnings. We're still trading at 18, 20 times earnings for some of these things.
has shifted everyone's mind-set because of the virtual nature of their inventory. They deserve a higher multiple than they once did, but I still think people have unreal expectations about that.
Maybe information technology spending is not going to be cut, but people are not spending as much as they used to. Or they're allocating capital a lot more, whether it's upgrading networks and so forth; it may not all be on PCs. So, the jury's still out in my opinion.
4. What's turning up on your radar screen as a great opportunity? Let's put the tech sector question aside and drive down to the company level.
If you go industry agnostic now, probably my favorite idea is
, they do the ITT Technical Schools. There's a lot of reasons to like this sector. It's a counter-cyclical sector, to begin with. So in an economic downturn, these are great companies.
If you think about it, our employment, the unemployment rate in the U.S. has been at a 30-year low. So high school grads are coming out of school, going right into the job market, getting good-paying jobs and so they don't need to go to college. The other thing is, older people who are at work -- because there's such a low level of unemployment -- basically say, I'm very comfortable here and nobody's going to force me out of my job. So they get really complacent.
Well, now the economy's turning again and people are worried about being laid off, high school kids are worried about jobs, so they go back to college. So this is a counter-cyclical play. ITT is the only pure tech company. Pure IT is their background. If you look at any consensus data or any of that stuff put out by the
Department of Commerce
, IT is the market that still has more than 800,000 jobs still open, and it's projected to be the fastest-growing sector. So that's one company I really like. Its stock's trading at seven times earnings before interest, taxes, depreciation and amortization; 17 times earnings. Its peers are
; those companies are trading at over 40 times earnings.
ITT has had its own individual problems, and so it's been beaten up, deservedly so, but I think that turn has now come and now the company's on a major upswing. So that's our biggest position, and that's the one I like the most right now.
In the tech sector, another name we like is
( NOVL). We think Novell is extremely cheap here. It's trading about seven times EBITDA. It's got $3 a share in cash, the stock's at $8 so it's a $5 net value. It's trading about 1.5 times revenue.
Eric Schmidt took over, he's the former CIO at
. He took over as CEO in 1997 -- he's a visionary, very brilliant. People were very excited about what he had to say about the new Novell he was creating and so the stock went from $6 to $45, because everybody was so excited about what he was doing.
And then, as typically happens in that market, the valuation band did a major disconnect from the real value, and that's what's going on at Novell. Yes, he's building value, but nowhere near that $6 to $45 jump. So I think people were dismayed when the stock disappointed; it was $44 back to $6, and now people have forgotten what the new Novell was all about. So they're going back to the old Novell, forgetting what Eric Smith was there to create.
So, you've got this manic-depressive market that we always talks about; that's the benefit of a value investor.
5. Where would you caution folks about value traps in the market today? Where people might be getting excited but they might be pretty early?
The typical mistake by value investors, myself included, occurs because I look at the cheapest stock, and I say, Wow, this is extremely cheap. And I ignore one component of value that we want in almost every investment we have: The company has to be growing over time.
I think a lot of value investors get caught in the trap of looking at an absolute cheap stock, but the valuation is actually declining, or if you're lucky, holding static. And so you're missing that growth component. The mistakes I've made, one of them is
in our portfolio -- value there has not grown in four years. It's unbelievably cheap, it's trading at three times EBITDA, yet it doesn't matter.
Because it's not growing.
Exactly. It's not growing and so what does the market do? It turns it into a bomb. Well, that's what it should be.
Another area where I think you can get caught in a value trap is these economically sensitive stocks -- building materials and so forth -- these companies are consistently disappointing, and yet the market's bidding the stock prices up.
Now, in order to do that, you're betting that the economic slowdown is only going to be six months or a year in length. I find that interesting that almost every company says they're expecting a second-half pickup. Yet everything you read, why suddenly are we going to have this pickup in the second half? What is it that is driving that? I don't see the second-half pick up myself; if we have it, great. But if we don't, you're getting in early on stocks that probably won't rebound, or earnings that won't rebound.
Why do you think it might be a rose-colored glasses scenario to expect a good second half?
I just don't see any data to really hang your hat on that suggests that the economy's going to pick up in the second half. OK, we'll have a tax cut. We've had 100 basis-points in cuts in rates. I don't see the major stimulus yet. We had that one-day bump when the rate cut happened, or was potentially announced, but we had a 50 basis-point cut last week and the market went down, after the rate cut.
So we're going to need more stimulus on that. I just don't see anything on the economic horizon that suggests a bounce back -- consumer spending, consumer confidence, they're at 1990 levels.
The thing the market has forgotten is this huge amount of money has been taken out of the whole economy with the dot-com meltdown. That flush economy went away a year ago, and that money's not coming back.
So without all that extra money, where is the stimulus coming from? The tax cut may help, but, the other thing you have a problem, I don't see natural gas prices going away any time soon. I don't see oil prices abating any time soon, so unless those things happen, the average American is paying twice the heating bill that they normally do. That's a huge crimp in their income. So I just don't see it.
It's had a great run. As a firm, I'll say we've actually sold our Philip Morris. The problem is you don't know when you get involved in on the litigation side. The tail on that litigation is so long.
The other thing with Philip Morris is we don't know how much of that money they're going to generate. They're going to generate a lot of money, it's a fabulous company. How much of that money is going to litigants, and how much to the plaintiffs and how much to the shareholders?
So, at this price I would take my profits and say thank you and move on. There's enough other value stocks out there in general to not have to worry about that litigation risk. There's a big unknown out there that potentially could make the company worthless.
7. Now let's shift gears and talk about overseas. It looks like at the end of the year, your fund was about half and half. And a lot of folks were saying after 1999, that folks should go overseas, because things couldn't get much better at home. Do you think that things look cheaper if more volatile overseas? What's your thinking, U.S. vs. foreign?
You just said it perfectly. We actually manage this literally day-to-day and we let the ideas fight it out. So we present a domestic idea along with an international idea; the better of the two gets the funds. In 2000, as things started melting down, we actually went as high as 58% domestic, because there were so many values here, and so we kept adding money domestically, and we felt that they trumped the return we were getting internationally.
At the end of the year we sat down and we compared notes, new names to new names. The international stocks won, so we shifted almost 10% of the portfolio internationally.
One market we're looking at is Korea. Korea has been just severely beaten down, a company we added the fourth quarter is
, which is a beverage company. They're a Pepsi bottler in Korea. They also do their own beverages and juice drinks. We were able to buy that company at four times earnings. That just is a giveaway price.
is another one we own in the country, the largest brewer in that country. When we bought the stock we only paid five times earnings.
Those things were good, solid businesses. These aren't fly-by-night companies, they've been around a long time so, I think you made the right assessment. International markets tend to be more volatile, so expect that, but the valuations are appropriate.
One of the big beefs about international investing has always been that unlike here, a lot of times you'll find great companies that are in these weird situations. For instance, the managers don't own any of it and have no incentive to build value. Is that shifting on a widespread basis, or is that still catch as catch can?
I would say that the boulder is just starting to roll. It is slowly evolving that way. But you're right, it doesn't matter what international market you go to. You have controlling family owners. In Latin America you have a lot of situations where certain people own preferred shares and you own the commons, and no matter what you do, there's nothing you can do to affect change.
Domestically, we have the benefit because we have more proactive shareholder activism. That's really where the analytical work comes in with international investing, and that's why international investing demands onsite visits. You need to sit down and find out what the manager is doing with the cash, what their interests are, what the interest of the controlling shareholder is. That requires one-on-one visits.
8. I noticed that you folks have paid a lot of attention to mid-cap stocks. What intrigues you most about mid-caps and made you focus there?
We usually do analysis stock by stock. But if you want to categorize stock, the mid-cap and small-cap companies are still so much cheaper.
If you look at the larger companies, even today we're having a hard time finding values. When we say big companies, we're talking, usually, $5 billion and up market cap, and we define that a little differently than the market. The market says $5 billion is a large-cap company, but yet you can have a
or somebody else that is a huge-cap company, that on a normal basis, whether it's revenue, or profits and so forth, they really don't rank in the top 100.
9. If you had to buy and hold three stocks for five years, what would they be and why?
That's easy. I get asked this question often.
One I always mention is
. They are by far the market leader in every category they compete in, so the tide is going to benefit them. It's more expensive than it's been in some time -- it's about 25 times earnings -- but I see their earnings growing 15%-18% a year in the next five to 10 years, so that would be one.
ITT would be my favorite stock. It's trading at seven times enterprise value EBITDA, you have earnings growth at 25% a year for probably the next five years, it's trading right now at 18 times earnings, seven times EBITDA. It's counter cyclical so if the economy slows down that's a benefit, so I'd definitely pick that.
The last one would be
; that's a cable processor. It's almost like a First Data story. The outsourcing of payroll human resources is a market that's lifting, the tide is rising on all companies. Over 50% of companies are still in-house for payroll processing and HR. Actually, HR is more like 85%. So, the outsourcing benefit there is just starting and I think you can have at least a five-year benefit there.
They're spinning off their Arbitron unit, which will be later this quarter. You're basically paying 14 times earnings today.
What type of time frame do you usually have when you look at a name and you want to add a name?
We more or less have a buy target than a sell target in mind on every company, so if a company's away from our buy target now, if they're going through a massive transition, we may want to wait and see how that transition plays out.
We typically take a three-year minimum time horizon, five-year is probably more typical, and sometimes even longer. When we're looking out that far, we'll say, OK in five years it could be worth X, discount the fact that it's worth this today. So, we're pretty stringent on the buy and sell criteria, and we think we do a pretty good job of valuing the companies, so if it gets to our sell target, and we think we've been fairly generous or fairly fair in valuing the company, and when it gets there we'll sell it.
10. What's the most recent new name that you've added to the fund, and what's the most recent new name you've added to your personal portfolio?
Nothing we can buy personally can be in the fund, so that really isn't anything that anybody could buy, so that's probably not relevant.
The last stock we added to the portfolio was probably
. They basically own the Moneygram business. We actually sold some of our First Data to buy it, and the reason being is First Data was trading at about a 100% premium on a multiple basis, on an EBITDA basis. Moneygram's the No. 2 player behind
in wire transfer. It was trading about seven times EBITDA.
Where would you get intrigued by First Data again?
In the low-50s, I would buy it
it recently traded about $60. Without swapping it for something else, I wouldn't sell First Data. First Data's a long-term hold; I think it's a great business if you can participate for three to five years. But we just made a valuation call. The gap was too wide.
Fund Junkie runs every Monday, Wednesday and Friday, as well as occasional dispatches. Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
email@example.com, but he cannot give specific financial advice.