If valuations matter again, you want to talk with Bill Nygren.
The manager of the
Oakmark Select and
Oakmark funds only buys a stock when he thinks it's selling for less than 60% of what it's worth. That kind of measured approach has paid off over the past three years, especially in 2000. Nygren sees plenty of value in the market and says that he and his analysts have actually started sniffing around some profoundly downtrodden tech stocks.
He might invest in some pretty boring stuff -- financial stocks and the likes of
-- but that type of fare has held up a lot better than last year's highfliers.
Managed Fund Since
YTD Return/ Percentile Rank in Category (1-best, 100-worst)
3-Year Annualize Return/Rank in Category
Source: Oakmark Funds and Morningstar. Performance figures through Nov. 20. Holdings as of Nov. 20.
1. It's a pretty tough market right now. Folks are concerned about economic slowdown, who the next president's going to be, a lot of uncertainty. What's your take on where we are and where we might be going into next year?
Well, I think the cyclical issue and the presidential issue are issues that are only important in the very short term. I think the more important issue for an investor thinking out a couple years is that the market has been a very divided market over the past few years.
High profile, large technology companies made enormous amounts of money through March of this year, and have started to reverse that since March. The average stock did almost nothing that last couple years and has been a good performer since March.
I think we're likely to see a continuation of the way the market has behaved since March where traditional companies that have decent growth rates continue to perform very well. Companies that had very high prices relative to their sales or earnings continue to perform poorly.
2. This is probably the $64,000 question these days. Where are you currently seeing value today? Perhaps you could name two or three sectors and maybe one or two stocks within each sector that jump out to you as being undervalued relative to their intrinsic worth.
We continue to see value in the traditional economy names where we have been invested for most of the last couple of years: financials, consumer products, industrial companies.
I don't have any specific names to give you on the technology side, but I would say that some of the out-of-the-way names in the technology sector that have come down, 50%-80% are starting to occupy more of our research department's time.
If we could first start with the older economy companies then come back to the tech, that would be great.
Sure. In the consumer side, a name like Energizer Holdings is one of my favorites. The stock sold at about 10 times next year's expected cash earnings. They're regaining market share now that they have better segmented the market with the Eveready brand at the low end and the E2 name at the high end. There has been a tremendous amount of insider purchases of stock and I think one of the reasons the stock is low is because they have one bad quarter ahead of them: Last year, calendar fourth quarter was an enormous quarter for the company because of stockpiling for Y2K worries. That won't happen, obviously, this year.
So they will clearly have a down fourth quarter, and I think there are a number of, I think a lot of potential investors are waiting for that to be behind them. The financial services area, I continue to very much like my largest holding,
It is one of the best-managed financial-services companies in the country; it sells at 10 times earnings. Their business is primarily in the West Coast and Sun Belt states, which have better than average population growth. They are the low-cost provider; pricing their product for Middle America, they can make higher margins and take market share from other providers.
What I like about them is this business strategy of pursuing Middle America. Most of the financial service companies have gotten into the very competitive market of trying to provide financial services to the top 10%. Washington Mutual is kind of the
of the financial-services industry, and that's not a crowded field.
I mentioned industrial companies. A recent purchase that we've made is
, the auto-parts spinoff from Ford. This clearly does not have the potential to become an
multiple stock, but Visteon sells at about four times expected next year's earnings, and I believe they are not being given credit for very heavy R&D spending that puts them in a leadership position in the emerging area of telematics.
I never figured out exactly how they came out with that word telematics. I first heard it and I thought it had to be like two words that were put together. It doesn't seem to be. It's just like the word that is used to describe all the new stuff you'll have in your car to deliver information to you, everything from advanced sound systems to the onboard navigational devices and potentially Internet-enabled vehicles. They've got a lot of the old-line metal bending auto-parts business but this other part, they're an emerging leader. At four times earnings I don't think I'm paying anything for that.
Right. Back to tech: Which stocks do you think are oversold and might actually look like something of a value these days?
Well, we have nibbled in the tech area over the past couple of years. We have owned names like
, which got acquired, so that's out.
is a name that we still very much like.
I don't have any names to mention because we only disclose our purchases at the end of each quarter, so there's nothing further to be disclosed. But I guess I would sum up our position as saying we still believe that the area is generally overvalued. The relative multiple on the
compared with the multiple of traditional companies to us still seems to be much too high. Nasdaq may be selling at 50-something times next year's earnings and traditional companies are more like a low-teens multiple. Nasdaq stocks, we believe, deserve to sell at some premium, but it shouldn't be three or four times the level of traditional companies.
So where there have been fundamental disappointments and the stocks have been very severely punished for them, that's kind of our hunting ground.
3. I was speaking to a value manager named Tim Quinlisk -- he works over at John Hancock -- a few weeks ago. And one stock that jumped out to him as an intriguing play after a lot of disappointments was Lucent Technologies (LU) . Is that something that is on your radar screen these days?
We had originally owned Lucent right after the spinoff and made a small amount of money and sold it at what was, in hindsight, way too early. It's one of the names that would be on the radar screen. I know we've had people who have looked intensively at Lucent. We've been a bit concerned about their receivables exposure.
Now, when we say receivables exposure, what do you mean there?
Lucent has had a history of selling to emerging telecommunications companies and not having to worry too much about the credit ratings of those companies because their equipment was in such demand that if somebody didn't pay them, they could just repossess the equipment and resell it.
But pricing has come down so sharply on much of their product base that we don't think that approach to managing their credit exposure will work going forward.
And the companies that they're selling to are in much weaker shape than they were a year or two years ago. So we want to see how that washes out before we get involved there.
4. As a value investor, what do you see as the biggest traps out there? Value investing is more than just looking for cheap stocks, because a lot of times cheap stocks are cheap for a reason and they just get cheaper.
I think one of the biggest mistakes you can make as a value investor is to be too enamored with absolute cheapness. In a purely statistical sense, going after the absolute cheapest companies, I think you end up with structurally disadvantaged companies whose pasts will be much better than their futures.
And when I talk about structurally disadvantaged, I'm basically referring to companies
that have to invest large sums of money into their basic business, but they won't get a good return on them. Something like the steel industry, where if you want to stay competitive, you have to reinvest the money, but you won't earn a good return on it. We try to avoid that by focusing on companies as, where we project forward we would expect the combination of the dividend yield in the business value growth to exceed 10% per year.
And I think there are so many opportunities available in undervalued companies today that you don't have to be a bottom scrounger to pick up the absolute cheapest.
5. We're coming off of a period of several years where big-cap growth stocks were the market. Styles exchange leadership position every couple of years. Is value back? Do you see this as being sort of a turning point where value stocks are going to get more attention? What's your read on growth vs. value going forward?
I've never liked opposing growth vs. value. To me, it's more momentum vs. value. If I can go with the momentum vs. value ...
I think there's been a tremendous growth in how much weight gets placed on price momentum in decision making throughout the investment process. Professional portfolio managers, advisors, the media, individuals who are selecting funds or stocks, all seem to want companies that had positive price momentum before they bought them. I think that has led to this last cycle where the momentum stocks continued much longer than they historically had.
I think there was a dramatic change on March 10.
When the Nasdaq peaked.
Right. The rubber band got stretched as far as it could stretch and it's starting to come back to normal. It's not back to normal yet, but I think that the peak that we saw in the Nasdaq on March 10 is one that's likely to last for five, 10 years as those companies grow and become deserving of the prices they sold at back in March.
I struggle a little bit with the idea of, can value have that same kind of extended rally because by its very definition, if you're trying to buy undervalued companies, if the same stocks keep going and they become overvalued, then a value investor ought to be selling those and buying something different.
So I don't think that a value sector rally has the potential to last as long as the high-growth stock rally that took place these past few years. That natural cycle of a stock being attractively priced, going up in price, becoming owned by the momentum investors, having a disappointment, stock prices coming down until it gets repurchased by value investors, I think that cycle has to continue. It's almost a definitional one
I think the natural extension of that is that the value investor who today is overweighted in the industries I mentioned, the traditional companies, the value investor is the logical buyer of the technology stocks when the momentum investors give up on them.
I think we're seeing very early stages of that right now.
So you think that technology has a lot further to fall?
Yeah. Look back almost four years ago to the day that
first talked about irrational exuberance in equity prices and the Nasdaq -- Dec. 5, 1996 -- irrational exuberance, the Nasdaq was at 1300 on that day.
Clearly values have grown some since then. But that was already a high-enough level that the chairman of the
was concerned about it being excessive. Today, since it hit 5000 in between, everybody sees 2800 or 2900, whatever we're at now as an incredible value, but with a little longer period of history, if you'd fallen asleep for the last 12 months, you'd look at this and say, wow, the tech stocks have really done well.
6. If you asked 10 value investors about this stock you'd probably get 10 different answers. What's your take on Philip Morris (MO) - Get Report? I know it's one you inherited when you took over the Oakmark Fund in March. Correct me if I'm wrong, but you exited that position, right?
And the stock has had a nice run-up this year in general, compared to the past few years. What's your take on the company on its prospects going forward? It has some big, dark clouds over it.
When I inherited the stock it was selling in the very low 20s. Our belief at the time was that their food operations alone were probably worth $30 a share. That with the litigation risks that they faced on the tobacco side, that it was difficult to assign a substantial, positive value to their tobacco operations. But in the low 20s, the stock didn't reflect the full value of their food operations.
The Kraft business?
Kraft, yes. Now with the stock in the mid-30s, you have to believe that the company shareholders, rather than the litigants, will get the major benefit of the tobacco cash flow.
And without an opinion on what's right or wrong, given the precedent of so many other companies that have been defendants and lost vs. the consumers of their products, I just have a hard time believing the tobacco industry is going to escape enormous liability.
I look at a mistake that I made in the Oakmark Select Fund with
, believing that their litigation was very manageable. They produced a product according to government specifications that contained asbestos, they quit producing it as soon as there was any scientific evidence that the product was harmful. They haven't made the stuff for 25 years or so, and yet the litigation costs are destroying that industry today. I've just been amazed at how much it could spiral out of control.
You contrast that to the tobacco industry, where there's been a body of scientific evidence for a generation suggesting tobacco is very harmful, and yet the CEOs of the tobacco companies get up in front of
and say that they don't think there's any problem with their product. Knowledgeable medical people talk about hundreds of thousands of people a year that die because they smoke.
I can't believe the tobacco industry will end up faring much better. It doesn't seem equitable.
7. There are a wide variety of definitions of value. What's yours?
Our approach to value is a concept we call enterprise value, where we try to estimate what the price an acquirer would pay if they were buying the entire business today for cash, and to us that's value. And we try to buy a stock at less than 60% of that number.
There are two continuums, if you will, that value managers separate on. On one end, you've got a more eclectic view of value where within any given industry you try to use the appropriate measures of value that are used by acquirers in that industry.
At the other end, which is more the old school of value investing, you try to define value by simple GAP accounting statistics like price to earnings, price to book value. We think that GAP accounting is not doing as good a job of capturing value changes as it used to, as so many of the important assets of business have become intangible assets, which is why we have moved more to the concept of business value and what acquirers would pay to buy specific assets.
I think the other area where there's important distinction is the sell discipline. We're pretty old-fashioned on our sell discipline. When we own the stock, we monitor our estimate of the fundamental business value, we make adjustments as appropriate for fundamental changes in the business, but when a stock hits 90% of what we think it's worth, we sell it.
I think there's a new school of value investing that is very disciplined on the buy side and then takes the point of view of, we'll let the market tell us when the right time to sell this is. Basically, disciplined value on the buy side and a momentum investor mentality on the sell side. I think it's important people understand their portfolio managers sell disciplines, because they introduce very different levels of risk into the portfolio.
I believe a disciplined sell approach is likely to give us less volatile results over a long period of time, and hopefully, somewhat higher rates of return.
In the last couple of years, though, we have not done as well as value managers that followed a momentum-based sell strategy. But I obviously have my doubts about how well that strategy will serve them going forward.
8. You noted that tech was getting some more of your analysts' time these days than maybe in the past few years. During the sellout a lot of folks have been saying that the likes of Microsoft (MSFT) - Get Report, Intel (INTC) - Get Report, folks that are more dependent on maturing PC sales are starting to climb to value investors' radar screens. Are those names on your screen?
Not even close to on our screens. The kinds of names that we are spending time on tend to be the names that are down somewhere between 50% to 80%, frequently they've got single-digit P/Es. We're not close on those two.
It's not that I've got a problem paying 20 to 25 times earnings if I think the growth and stability make it worth that. We're really talking about the stuff we're looking at as the real damaged goods of that sector.
9. If you had to pick three stocks to buy today and hold for at least five years, which would they be?
I would pick
Toys R Us
I think it's a great franchise that is finally being managed by a high-quality merchant, John Eiler, who came from
, and the stock is at a small premium to book value, like 12 times earnings. If you add back Internet losses, so the starting valuation is also very attractive.
But what I like about them is that unlike other retail turnarounds, there's very little, if any, competition in their sector, which I think gives them a tremendous opportunity to turn the franchise.
I would put Energizer on that list. The battery category is one of the most rapid growth areas in the consumer nondurable industry. I believe they'll gain market share, I think they'll do smart things with their excess cash generation during that period. And a third name, I'd put in
Dun & Bradstreet
It recently split up from old Dun & Bradstreet, which was the credit operations; now they've spun off
. I think Dun & Bradstreet has been a long mismanaged franchise.
Didn't you folks ask them t . ...
We were uncharacteristically public in our dispute with management at Dun & Bradstreet. Normally, our approach is to quietly nudge and suggest behind the scenes. But with Dun & Bradstreet, we were frustrated with the way the past management was running the company, and we exchanged in letter writing to the board of directors, which became public via 13D filings. Encouraged the company to seek a buyer for the whole company. They didn't do that, but the path they chose may in the end even be better for us. They accepted the resignation of the past CEO, they agreed to split the company into two pieces.
Moody's had been exceptionally run, continues to be a great company and on the credit report side, the new Dun & Bradstreet brought in topnotch management from
. And I think that the mismanagement of this company has had historically has been a testament to how strong the Dun & Bradstreet franchise is, that they could be run so poorly and yet still be the dominant leader in credit reports.
The concern on the stock has been data will be easily, more easily accessible via the Internet, and people might be able to bypass Dun & Bradstreet. But I think offsetting that is in a world where more business is done through the Internet, more business would be done with parties who don't know one another. Dun & Bradstreet, I believe, has the opportunity to play an important middleman role, where, rather than just selling you data, they will be able to sell you decisions about who you should be doing business with, and who you shouldn't.
And if they can make that transition from selling bits of data to helping organizations achieve the cost-reduction potential of the Internet in a creditworthy manner, I think this company has tremendous growth opportunities ahead of it. And it'll probably take them a couple years to start seeing results from any of those opportunities, but I think you gave me a five-year time frame and that should be more than enough time to evolve into whatever they're becoming.
10. What's the most recent stock added to the fund's portfolio, and the most recent new name added to your personal portfolio?
I don't buy stocks personally that would be eligible for the mutual funds, so I really don't have anything to offer on the personal side. The majority of my net worth is invested in Oakmark Select Fund. My second largest personal investment is the Oakmark Fund.
In the mutual fund, the most recent holding that has been disclosed is
What do you see in there?
Office Depot last year hit a high of $26 and it's at about $6.8125 right now. So obviously, there's been a dramatic falloff in the stock price. That has largely been because the retail category of office products has excess competition -- with Office Depot the largest,
the more rapidly growing and a company that's a very close No. 2, and
, a struggling company, No. 3, and further inroads by Wal-Mart
in trying to sell office equipment.
What we like about this company is at this price, the enterprise value is about equal to the
acquisition that they made a couple years ago. That business has continued to grow very well. We believe that business is worth more than they paid for it two years ago and the former head of Viking Products has just taken over this summer as the new head of Office Depot.
They've got some things going for them outside of U.S. retail. They've got a very strong European business and if our work was correct, we think Office Depot's the second-largest Internet retailer behind
, with sales at about a billion-dollar run rate this quarter.
Unlike Amazon, they're profitable, and one of the reasons is because Viking's business was a catalog-based overnight delivery office products business. So the infrastructure for Internet fulfillment was already in place, which is where so many of the traditional retailers have struggled. So transitioning that catalog business to the Internet and also expanding the potential market of customers via the Internet to us seemed like a very natural move for Office Depot.