Shareholder Reports & Commentaries
03 Sep 2010 Clipper - Q2 2010 CommentaryBecause of the enormous risks in today’s economy, characteristics such as durability and adaptability should be especially highly valued. But despite these risks, shares in many global leaders are trading at or near their lowest absolute and relative valuations in decades, creating a significant opportunity for long-term investors. The best way to understand this opportunity is to take a moment to consider the alternatives. For example, money market funds now yield close to zero and in some cases actually have surcharges that result in a negative yield. That means money market investors today are simply accepting a zero percent return as their best case. But when (not if) we enter a period of inflation, real returns on money market funds will be negative and holders will suffer real losses in purchasing power.
Turning to intermediate and long-term U.S government bonds, these have done so well for so long, investors feel safe owning them. However, as is usually the case, those asset classes that investors feel are the least risky are often those that are in a bubble. For example, in the years leading up to the worst real estate decline on record, people could hardly imagine losing the equity in their home. In fact, the higher prices went, the more real estate seemed like a low-risk sure thing and the more comfortable people were increasing their leverage. Today the same is true of intermediate and long-term government bonds. A 10-year U.S. Treasury bond, for example, currently yields less than 3%. Because interest rates have fallen steadily for almost 30 years, few bond investors can recall more than a temporary period when bonds declined in value. Investors who know history, however, realize that the last time interest rates were at today’s levels, bonds went on to decline in value for more than 20 years. What’s more, on an inflation-adjusted basis, investors in U.S. Treasuries lost more in those 20 years than stock investors did during the Great Depression! It is striking today that the dividend yield alone on many high quality and durable companies is higher than the coupon on a 10-year government bond. In addition, this dividend generally represents a payout of less than half of earnings. This means investors in these equities are currently receiving an earnings yield more than twice the yield on bonds and a dividend yield that roughly matches. Furthermore, because such businesses maintain a certain amount of pricing power, these earnings and dividends should be somewhat inflation-protected compared to bonds whose real yields erode in times of inflation...
...While we would agree that it is likely that many emerging markets will grow faster than the United States, there may be ways to capitalize on this trend that involve less risk than blindly buying some foreign index. For example, in our view, where a company earns its money is more important than where its stock is listed. Although the S&P 500® Index is considered a domestic stock index, the companies that make up the Index earn roughly half of their profits outside the United States. In other words, although companies like Procter & Gamble, Coca-Cola and others are truly global companies, they often trade at a discount to foreign companies with similar growth prospects because they are wrongly perceived as domestic companies. As a result, they offer investors a good combination of exposure to higher growth economies such as China and India at a lower valuation and with better diversification, governance, liquidity, and financial transparency.
Coming through one of the worst decades ever for stock investors, commentators and the public are more pessimistic than ever. The term “black swan” was recently popularized by author Nassim Taleb to describe the rare, high-impact and hard-to-predict events that roiled financial markets in the last decade. But black swans are nothing new. The future has always been full of unpredictable but significant events.
What is new today is the assumption that black swans must necessarily be negative. While recent history is full of many negative surprises, investors and commentators have forgotten that many high-impact, hard-to-predict events are enormously positive for society as a whole and capitalism in particular. For example, over the last several decades biotech and pharmaceutical companies (like Merck) have produced almost miraculous cures to diseases that have plagued humanity for centuries. Is it possible in the years ahead that they will find a cure for costly and horrifying diseases like Alzheimer’s, Parkinson’s and diabetes and in doing so produce huge unexpected savings for our health care system? How about energy? Over the last several years, innovative companies have developed new technology that allows them to tap vast reserves of cheap, clean natural gas trapped in domestic shale formations. Is it possible in the years ahead there could be breakthroughs in solar or even nuclear technology as well as energy transmission and storage that could dramatically reduce the economic, political and environmental costs of energy?
01 Sep 2010 T2 Partners PresentationMakes the case for and recommends three large-cap blue chips: Anheuser-Busch InBev, Microsoft, and BP...
31 Aug 2010 Sound Shore - Q2 2010 CommentaryThere is much fretting about equity markets currently due to sovereign stress and the possibility of a US and/or worldwide “re-recession.” Long-term investors, however, should also keep in mind that the S&P 500’s forward P/E multiple of 13.0 times, according to Thomson Baseline, is reasonable when compared to the 15-year median P/E of 17.0 times and also attractive versus the limited competition from interest rates. As well, corporate America’s financial health, unlike that of households and most governments, is in aggregate very strong.
We anticipate the unpopular, yet higher quality stocks we have favored are poised to resume their outperformance particularly if economic concerns continue. Sound Shore’s process remains focused on locating and investing in companies that we believe have market or better financial prospects which are priced at a discount to historic norms and the market. Currently our portfolio’s aggregate forward four quarter P/E multiple and 2011 earnings per share growth are estimated at 10.6 times and 21%, respectively, based on consensus estimates, both of which compare favorably with the S&P 500.
30 Aug 2010 Meridian - Q2 2010 CommentaryThe economy is growing, but at a disappointing pace, especially for the early stages of an economic recovery. The recent news on housing, consumer confidence and job creation has been disappointing. Interest rates remain low and inflation does not appear to be an issue at this time. Deflation, in fact, appears to be more of an immediate concern. Europe has hit the wall on borrowing to finance government programs and has announced austerity measures, including spending reductions and tax increases. The United States has potentially large tax increases on the horizon and, in our opinion, will soon be forced to cut spending also. Many states face the same issues. We believe the only solution is a strong private sector that innovates, invests and creates jobs. This, unfortunately, has not been a priority of the Obama Administration and Congress. Our outlook is for a period of slow growth, large deficits, high levels of unemployment, low interest rates and moderate inflation.
28 Aug 2010 Video: Bruce Berkowitz on Consuelo Mack WealthTrackBruce Berkowitz,. Morningstar’s Fund Manager of the Decade is raising eyebrows by investing more than half of his Fairholme Fund in beaten down financial stocks. He’ll explain why he believes it will pay off...
27 Aug 2010 Video: Christopher Davis on Consuelo Mack WealthTrackAn exclusive television interview with third generation value investor Christopher Davis. This former Morningstar “Money Manager of the Year” discusses how family tradition helps him find long term financial values...
11 Aug 2010 Bill Nygren: Growing Macro Focus Creates Micro OpportunitiesThe competition has definitely decreased for those of us who make long-term investments based on a company's internal dynamics. More trading by others wouldn't necessarily change things for us, but with most traders wanting short-term price momentum on their side, it has led to more extreme price swings.
With the majority focused on momentum instead of value, more stocks are selling at either abnormally large discounts or premiums to long-term value. It gives us more cheap stocks to choose from but hasn't really altered how we build or exit positions...
05 Aug 2010 Yacktman - Q2 2010 CommentaryWe like businesses that sell products in well-established, slowly changing markets like beverage, household products, personal care, and food. These “consumer staple” products typically sell at low price points and are consumed and repurchased frequently.
Category leaders like Coca-Cola in soft drinks or Tide in laundry detergents may continue their dominance for generations, making it easier to predict the future prospects of these businesses.
The media companies we own are largely subscription businesses, which we also like. Comcast gets paid predictable monthly fees from its customers for providing cable television, internet, and telephone services. News Corp and Viacom receive recurring monthly fees for the cable content they provide to pay television providers. Even in a challenged economy, pay television is one of the last items to be cut by households.
Identifying great companies is not especially difficult. Appraising the future prospects of a business and paying an appropriate price are far more critical to managing risk and generating attractive returns than just picking leaders.
Economic issues may cause short term pressure on the earnings of some of the companies in our funds, though we think we are being sufficiently compensated for that possibility by current valuation levels. We are optimistic and patient, and believe that owning securities at attractive prices and adhering to high quality standards will allow us to the endure bumps in the road that may lie ahead.
05 Aug 2010 Muhlenkamp Funds - Adviser ConferenceWell, there are several [events] that are somewhat at cross purposes. We’re seeing great companies selling at good prices. I think I end the quarterly newsletter [Muhlenkamp Memorandum #95] by saying, “If we thought this was a normal cyclical recession we’d be fully invested, but we’re not.” One of the things that occurred in ’08 was good companies got cheap, and then got a whole lot cheaper. Since that time, we’ve been asking ourselves: “Who might have to sell and how much?” We believe that the prices that were reached in late ’08, early ’09, were heavily driven by people who were forced to sell—particularly hedge funds that had to cut back on their leverage, and both hedge funds and mutual funds that had to meet redemptions.
If it were a normal cyclical recession, big and good companies should be selling higher than they are. We had a conversation here [at the office] where one of my analysts said, “Microsoft, at these levels, is a screaming buy.” And I agree with that. My question is: “How did it get to these levels in the first place?” My suspicion is somebody sold it for reasons other than investment assessments; e.g. how good the company is; its cash flows; what the price should be.
We know that pension funds in this country have been moving a certain amount of their allocation from stocks to bonds for about two years now, and that we should be getting near the end of that. We know that’s been going on, which, frankly, is one of the reasons that interest rates... We think U.S. Treasury rates are below where they should be. When that turns, I’m not quite sure. Along with that, if we have major European banks cutting back on their balance sheets, that, too, would have an effect similar to hedge funds and mutual funds selling a couple of years ago; i.e. if I wanted to sell something—and if I can’t get a bid on the stocks I want to sell—I’ll sell the stocks where I can get a bid. So, that’s giving us pause...
05 Aug 2010 Hancock Classic Value Fund - Q2 2010 CommentaryIn our view, the market fears have created significant opportunities for the long-term investor. We believe investors are overlooking the opportunity in equities, both from a broad market perspective, as well as at the company level. The expected return on the S&P 500 is now over 11% per annum, versus roughly 3% for U.S. Treasuries, or an 8% equity risk premium. Value stocks, defined as the cheapest quintile of the 1,000 company universe, now have an expected return of over 16% per annum over the medium to long term given today’s valuations.
04 Aug 2010 How Fairholme Is Breaking Wall Street's RulesIt is a double irony that Mr. Berkowitz happened to launch Fairholme in 1999, near the peak of the big 1990s bubble. That was the high water mark of two myths: That stocks 'always outperform,' and that you can't possibly beat the market, so you should stop trying and just give in to index funds. The decade since has buried both of those myths. And Mr. Berkowitz, and his investors, have been dancing on their graves.
02 Aug 2010 Dodge & Cox - Q2 2010 CommentaryWe believe a long-term perspective on investing is especially important during periods like the first half of 2010. Short-term concerns can often deflect attention from longer-term positive developments. After the events of 2008, it is not surprising that many are searching to identify the next “crisis.” In the United States, for example, high unemployment, rising health care costs, and weakness in real estate are real concerns. Past economic recoveries have struggled with similar issues, yet the economic rebound was sustained (the post-1982 and post-1991 recoveries are two examples). The current environment has significant positives: interest rates are at record lows, inflation remains subdued, home prices are stabilizing, and household net worth is rising. While some
economic indicators may lag, the economic recovery can continue. This optimism, combined with what we believe are attractive current valuations, leads us to the view that the long-term prospects for equity investing are favorable.
30 Jul 2010 Weitz Funds - Q2 2010 CommentaryDuring the late 1990’s, large capitalization growth stocks—especially those with any connection to technology and the Internet—were stock market leaders. Investors were so focused on the largest 25- 50 stocks that these stocks became over-valued (and the small- and mid-cap companies’ stocks languished at relatively cheap valuation levels).
Since then, the tables have turned. Over the past ten years, the small-cap Russell 2000 Index has risen by 3% per year (or 34% on a cumulative basis) while the large company-dominated S&P 500 has actually declined by -1.6% per year (or a cumulative -15%). During this period, many of the large- and mega-cap companies grew nicely, but their valuations shrank. For example, suppose a company earned $1 per share in 2000 and sold at 30 times earnings, or $30. If earnings tripled over the next ten years to $3 per share but the price-earnings ratio fell to 10 times, the stock would trade at the same $30 per share, even though its business was clearly more valuable ten years later.
There are a number of reasons for this reversal of fortunes. We believe that the most important is that “value matters” and since the large-cap growth companies entered the decade over-valued relative to the smaller companies (thanks to the tech bubble), it was natural that they under-performed in the subsequent ten years. Another factor was the shift in asset allocation by pension and endowment fund managers from U.S. (primarily large-cap) stocks to private equity and hedge fund “alternative investments” over the past ten years. Also, since all of these companies are global businesses, there is probably concern that the European debt crisis will depress their earnings. Finally, “performance chasing” investors probably helped carry this trend too far by selling their stock laggards and buying those that were “working.” Whatever the reasons, the result is that a number of terrific companies with many good years of growth in front of them are selling at very cheap prices.
The diversity of businesses is surprising—consulting services (Accenture), insurance brokerage (Aon), computer hardware, software and services (Dell and Microsoft), spirits and beer (Diageo), advertising (Omnicom), industrial gases (Praxair), electronic components (Texas Instruments), and package delivery (UPS). It is almost as if “large” and “high quality” have become disqualifying characteristics. We believe that these stocks are cheap and well- positioned for a rising stock market and strong and defensive enough to hold up well if the economy were to suffer a “relapse.”
30 Jul 2010 Fairholme Fund - Q2 2010 CommentaryOver one-half of The Fairholme Fund’s assets are invested in securities of mostly hated financial services and real estate related companies. After all, “there is no job growth without economic growth; no economic growth without access to credit; no access to credit without a stable, functioning financial system. Financials tend to lead markets into and then out of recessions followed by asset deflation and then inflation. Never being 100% certain as to events and timing, approximately 20% of the Fund’s assets are in relatively, short-maturity corporate debt and cash equivalents.
Over one-third of The Fairholme Focused Income Fund is invested in short-term credits of American International Group, Inc. (“AIG”), General Growth Properties, Inc. (“GGP”) and others that are perceived to be or are in actual financial stress. Underlying equities lead us to believe that all are “money good.” Nearly two-thirds of the Fund is invested in cash and what we consider to be cash equivalents.
You should also note our large and growing debt and equity holdings of AIG and GGP. Like their industry brethren, both were in critical condition from last year’s credit freeze and both appear to be thawing from near-death experiences. We believe a moderate climate will allow AIG to repay U.S. taxpayers and GGP to emerge from its self-induced bankruptcy. Further, Fairholme Funds has agreed to buy new GGP trust shares, subject to numerous terms and conditions.
Portfolios are positioned for today’s nascent recovery with its fits and starts. Don’t Lose remains Rule #1 as we strive to be greedy when most remain fearful about the future.
29 Jul 2010 Video: Don Yacktman on BloombergDonald Yacktman, manager of the Yacktman Focused Fund, discusses the performance of Viacom Inc., ConocoPhillips and Microsoft Corp. shares and the outlook for the companies...
26 Jul 2010 Tweedy Browne - Q2 2010 CommentaryVolatility returned to global equity markets in the second quarter in large part due to uncertainties surrounding the debt crisis in Greece and Spain and concerns about economic policies in the U.S. and Europe. As a result, the gains of the first quarter were largely erased in the second quarter. While unsettling for many, the silver lining is that volatility often brings with it investment opportunities to those with a longer term perspective. It’s hard to imagine that just a few months back, market commentators were talking about the pricing of oil being changed to Euros, given the rather grim outlook for the U.S. dollar. Instead, the mounting deficits in a number of southern European countries have increased pressure on the Euro, with the currency declining against the dollar by nearly 20% from its previous high late last Fall. Memories are indeed short.
We feel that our Fund portfolios are currently well positioned, particularly in light of some of the macroeconomic challenges we are facing around the globe. Our Fund portfolios have very little direct exposure to the PIIGS (Portugal, Ireland Italy, Greece, and Spain), our financial exposure in Europe is limited to a couple of insurance companies, and we have no investments in European bank stocks at this time. The bulk of our investments today in Europe and elsewhere are in larger, globally diversified, conservatively financed businesses that generate a considerable amount of their sales and profits in the emerging markets, and often pay an attractive dividend. While many of these companies, such as Nestle, Diageo, Heineken, Unilever, Kone, Novartis, and Total, among others, are headquartered in Europe, they are truly global enterprises. In our view, valuations remain reasonably attractive, and business is steadily improving. While many western governments wrestle with how to rein in large deficits, businesses have adjusted relatively well to the new economic realities.