Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines and looks deeper into
Speaker 1: the processes, challenges, and philosophies and security selection. I'm David Cohne,
Speaker 1: i lead mutual fund and active research at Bloomberg Intelligence.
Speaker 1: Today my co host is Gina Martin Adams, chief equity
Speaker 1: strategist at Bloomberg Intelligence. Gina, thanks for joining me today.
Speaker 2: Thank you for having me, David.
Speaker 1: So, last week you and Mike Casper put out a
Speaker 1: Q three earnings preview. What does the earnings outlook for
Speaker 1: the different sectors of the S and P five hundred?
Speaker 2: Yeah, I think it's a really interesting quarter. So a
Speaker 2: couple of things really came out of our research. The
Speaker 2: first is analysts are pretty pessimistic head it into the
Speaker 2: third quarter. They're anticipating just over four percent earnings growth. Remember,
Speaker 2: the average annual earnings growth over the last several quarters
Speaker 2: has been closed sort of eight. Last quarter we got
Speaker 2: about fourteen percent earnings growth, so analysts seem pretty pessimistic.
Speaker 2: Most of that pessimism is coming from the energy sector,
Speaker 2: where analysts are anticipating yet another double digit decline in earnings.
Speaker 2: A year over year for that space, and it's become
Speaker 2: a very big drag on the index for the last
Speaker 2: several consecutive quarters, So not a huge, huge surprise, but
Speaker 2: nonetheless a continuous drag there. One of the most interesting
Speaker 2: things that came out of our work is just the
Speaker 2: divergence between what analysts are saying and what companies are
Speaker 2: telling us is likely now. Naturally, we don't get every
Speaker 2: company in the index giving us guidance on what to expect,
Speaker 2: but of the companies that have given us guidance, our
Speaker 2: guidance model implies we could get up to triple the
Speaker 2: earnings growth rate in the index relative to consensus expectations.
Speaker 2: One of the segments of the index where analysts do
Speaker 2: appear to be inordinately pessimistic is actually financials, and our
Speaker 2: macro model for financials as we could get better earnings
Speaker 2: growth on financials than consensus is expecting. Also, I'm particularly
Speaker 2: keen to discuss this topic with our guest, who does
Speaker 2: have plenty of financials exposure in his portfolio. So excited
Speaker 2: to dive right into this coming earning season and more
Speaker 2: with you today, David, Thank you well.
Speaker 1: It's definitely a great time to introduce our guest. I'd
Speaker 1: like to welcome Bill Nygren, who is Chief Investment Officer
Speaker 1: of US at Harris Associates, vice president of Oakmark Funds,
Speaker 1: and a manager of the Oakmark Select Fund, oak LX
Speaker 1: and Oakmark Fund. Okay, excuse me, oh ak MX. Bill,
Speaker 1: thank you for joining us today.
Speaker 3: Thank you, David. Great to be with you.
Speaker 1: So, Bill, let's get started by asking how you got
Speaker 1: your start in investing.
Speaker 3: Well, it goes back to a childhood fascination. I was
Speaker 3: always fascinated with gambling and that line between when your
Speaker 3: expected value of a bet is negative and you call
Speaker 3: that gambling, or when it's positive and we call that investing.
Speaker 3: And combined that with being brought up, I would say
Speaker 3: as a value consumer, I remember being dragged at grocery
Speaker 3: stores with my mom and we'd buy grapes at one
Speaker 3: store if they were on sale, and if the following
Speaker 3: week grapes weren't on sale anymore, maybe we'd have a
Speaker 3: lot of cherries in the house. But our purchases always
Speaker 3: changed based on what the best opportunity was to make
Speaker 3: your dollar go the farthest. So when I started reading
Speaker 3: investing books when I was in high school, The value
Speaker 3: approach is what really appealed to me because it's how
Speaker 3: I was raised as a consumer, and I had decided
Speaker 3: by the time I was in high school that I
Speaker 3: wanted to pursue a career in investing, so I got
Speaker 3: an accounting degree. I still think it's kind of odd
Speaker 3: today how many kids you talk to who want to
Speaker 3: be in finance but don't think it's worth studying accounting.
Speaker 3: To me, that would be the equivalent of if I
Speaker 3: said I wanted to spend my career in South America,
Speaker 3: but not bother learning Spanish. It's the language of investing.
Speaker 3: I think you need to know it in order to
Speaker 3: succeed as an investor. I got my business school degree
Speaker 3: from the University of Wisconsin. I was part of their
Speaker 3: Applied Securities Analysis program, and then started working at investment firms.
Speaker 3: In nineteen eighty three, joined Harris Associates, where forty one
Speaker 3: years later, I'm still happily employed.
Speaker 1: Well, speaking of Harris Associates, how would you describe the
Speaker 1: investment philosophy of the company.
Speaker 3: I used to say we were old fashioned value investors,
Speaker 3: and that's still true, but there's so few of us
Speaker 3: today that invest that way, that I feel like people
Speaker 3: don't really even know what that means. So updating the language,
Speaker 3: I would say we bring a private equity perspective to
Speaker 3: public equity investing. And what I mean by that is
Speaker 3: we look for companies that we believe other investors will
Speaker 3: look at very differently five to seven years from now
Speaker 3: than they view them today, and then we try to
Speaker 3: align with management teams that we think have the same
Speaker 3: vision of what the company could ultimately be worth. So
Speaker 3: it has us looking at companies that are currently out
Speaker 3: of favor. Could be because of recent poor earnings performance,
Speaker 3: could be because there's a bad division inside the company
Speaker 3: that's losing money that's kind of masking what's going on
Speaker 3: at the other side of the company. When we make
Speaker 3: an investment, we're not focused on what next quarter or
Speaker 3: next year's earnings are going to be. We're looking out
Speaker 3: to what we think the company is capable of earning
Speaker 3: in a five to seven year period, and then we
Speaker 3: want to buy at a large discount to our estimate
Speaker 3: of business value. We want that value to grow, and
Speaker 3: we want managements that think and act like owners.
Speaker 2: Can we talk a little bit about this idea that
Speaker 2: you're one of few I think you're absolutely right, because
Speaker 2: David and I have been doing this podcast together for
Speaker 2: a few weeks going on months now, and you're the
Speaker 2: first value focused investor that we've talked to. It's all
Speaker 2: been growth, So this is very exciting. Maybe talk to
Speaker 2: us about why you think that's happening. Why is your
Speaker 2: process so different than the market itself. Is it really
Speaker 2: just that investors are generally migrating to what's been working.
Speaker 2: Is it about a time sort of horizon shrinkage where
Speaker 2: they're really focused more on short term return prospects and
Speaker 2: that's led them into grow. So what's your thesis as
Speaker 2: to why you're one of few now?
Speaker 3: Well? I think there are a number of reasons, and
Speaker 3: you hit on a couple of them. One is it's
Speaker 3: very hard to train your clients to look out as
Speaker 3: far into the future as we think you need to
Speaker 3: look to make value investing successful today, and that's a
Speaker 3: challenge that a lot of our peers or competitors don't
Speaker 3: want to take on. And when they shorten the timeframe
Speaker 3: that the client is looking at, it's natural that it
Speaker 3: also shortens their own investment horizon. Secondly, you're right that
Speaker 3: there is some performance chasing growth is outperformed value for
Speaker 3: a little more than a decade now, and I think
Speaker 3: you see both clients that move more toward growth because
Speaker 3: they want to be in the area that's been most successful,
Speaker 3: and then you see managers if their philosophies to what
Speaker 3: has been working. For example, today, I think there are
Speaker 3: very few investors who don't look for positive price momentum
Speaker 3: in the stocks they consider purchasing. We're one of the
Speaker 3: few that the cheaper the stock gets, the more attractive
Speaker 3: it seems to us. And then the last thing, and
Speaker 3: I think this has been going on for a generation
Speaker 3: at least, is gap accounting that was kind of the
Speaker 3: basis for value investing. You know, you just buy stocks
Speaker 3: that look cheap on price to earnings or price to
Speaker 3: book value kind of patiently wait for them to move
Speaker 3: back to regress to the mean, and that's what value
Speaker 3: investing was. But gap accounting was really made for an
Speaker 3: industrial world, and today in tangibles are so much more important.
Speaker 3: You know, the customer acquisition costs, R and D spending,
Speaker 3: brand advertising to name just a few. I think there
Speaker 3: are more companies today where gap accounting just doesn't do
Speaker 3: justice to the business value that's being created. So the
Speaker 3: value investors that were kind of stuck in that world
Speaker 3: of thirty years ago of just buying the statistically cheat
Speaker 3: pes and price to books on gap accounting, their performance
Speaker 3: has not been very good for quite a while, and
Speaker 3: I think they've just kind of naturally drifted out of
Speaker 3: the business.
Speaker 1: Do you use any quantitative metrics to narrow your universe
Speaker 1: of stocks to invest in?
Speaker 3: Well, we use a lot of them. First, we only
Speaker 3: invest in big businesses, so we're looking at market cap
Speaker 3: we want to be We think stock selection is the
Speaker 3: skill we bring to the table, and we want to
Speaker 3: be able to take meaningful positions in the companies we
Speaker 3: think are attractive. We also think our investors want a
Speaker 3: lower risk portfolio, and we think lower risk tends to
Speaker 3: align with bigger businesses. So the first thing we do
Speaker 3: to narrow down our universe is we only look at
Speaker 3: big businesses for the Oakmark Fund, and by that we
Speaker 3: don't mean the two hundred and fifty largest market cap.
Speaker 3: We mean the two hundred and fifty largest on fundamental
Speaker 3: metrics such as sales, earnings and shareholders' equity, because we
Speaker 3: think it's those fundamentals that bring the lower risk as
Speaker 3: opposed to a high market valuation bringing that risk, and
Speaker 3: then when you move to individual stock selection, I think
Speaker 3: the definition of value is always the present value of
Speaker 3: the future cash flows out to infinity that a company
Speaker 3: would earn. But for shortcuts, we look at pe ratios,
Speaker 3: price to cash flow ratios, price to book value ratios,
Speaker 3: really whatever metric we think business buyers in that specific
Speaker 3: industry would use if they were acquiring an entire company.
Speaker 3: So you know, for example, in the banking industry, price
Speaker 3: to book might still be a perfectly good metric, or
Speaker 3: for consumer durables, price to earnings ratio might still work
Speaker 3: pretty well. But if we're in the healthcare space, we're
Speaker 3: going to look at price to earnings before R and
Speaker 3: D spending because we want to adjust for those income
Speaker 3: statement of investments, the gap accounting doesn't give credit to.
Speaker 2: Can we go back to your early statement about how
Speaker 2: you operate a lot like a private equity fund in
Speaker 2: kind of determining the intrinsic value of a company, maybe
Speaker 2: dig in for us a little bit on what makes
Speaker 2: for intrinsic value? How do you determine intrinsic value? What's
Speaker 2: your unique approach there?
Speaker 3: Sure? So, first, and importantly they're two or maybe three
Speaker 3: really major differences between US and private equity firms. Number One,
Speaker 3: we try to invest with managements that we think behave
Speaker 3: like owners of a business, not as hired hands. Private
Speaker 3: equity is typically investing in companies where they want to
Speaker 3: replace management. Second is fee structure, where a fraction of
Speaker 3: a percent like most of the mutual fund industry, not
Speaker 3: the two and twenty that private equity firms charge. And
Speaker 3: third is liquidity. Our fund investors have the option of
Speaker 3: selling out our funds on any day. Our price quotes
Speaker 3: are kept up daily, and clearly that doesn't happen with
Speaker 3: private equity. But I think where the similarities are, and
Speaker 3: these are important too, is private equity is looking for
Speaker 3: companies that are selling well under what they think think
Speaker 3: the business might be worth. And that often means looking
Speaker 3: division by division at what you think the potential is
Speaker 3: for each of those divisions. And in some cases that
Speaker 3: might mean selling off a division where the company doesn't
Speaker 3: have critical mass and that division might be worth more
Speaker 3: to someone else who's already in the industry. It might
Speaker 3: mean valuing separately two streams of income. You know, an example,
Speaker 3: one of our large holdings. Alphabet makes a lot of
Speaker 3: money on search, but they have reported losses for all
Speaker 3: of their venture capital investing. Well, clearly you don't want
Speaker 3: to value all of that at a negative number, which
Speaker 3: is what would happen if you just slapped a PE
Speaker 3: multiple on their reported earnings. So we go to the
Speaker 3: trouble of separating out each of the income streams and
Speaker 3: trying to figure out what that what that industry would
Speaker 3: look like at its highest and best use, and what
Speaker 3: it could potentially be worth. Will forecast out for seven
Speaker 3: years present value those numbers, and then we look for
Speaker 3: opportunities where we can purchase at two thirds or less
Speaker 3: of that value. That's typically what a private equity firm
Speaker 3: is doing, because then they'll go into the market and
Speaker 3: pay a premium to acquire the whole business. So another
Speaker 3: of the advantages of doing this in the public markets
Speaker 3: is we don't have to pay that premium, the acquisition
Speaker 3: premium that the PE firms are paying.
Speaker 2: Can I just follow up real quickly on that, Is
Speaker 2: there any commonality sort of when you're looking across and
Speaker 2: you're valuing these businesses, you're finding businesses that are worth
Speaker 2: two thirds or less of what you think they're worth.
Speaker 2: Is there any kind of commonality between those businesses? What
Speaker 2: is the market usually missing? If we're to put it
Speaker 2: at painted with one big brush.
Speaker 3: The good news is what's available in the market right
Speaker 3: now is there's not a lot of commonality across industries.
Speaker 3: We're finding these in financials, in media and healthcare, and
Speaker 3: consumer durables in the energy space. But I think what
Speaker 3: is typical is there's some big worry that the market has,
Speaker 3: and maybe it's about what the industry will look like
Speaker 3: a decade from now. Oil and gas and auto are
Speaker 3: two examples of that. So the transition to less carbon
Speaker 3: intensive fuels has people worried about what the future of
Speaker 3: the oil industry will look like, or the transition to
Speaker 3: evs what the future will look like for the ice
Speaker 3: auto related businesses. We get comfortable that these companies are
Speaker 3: generating so much cash in their current form that by
Speaker 3: the time you get to seven to ten years from now,
Speaker 3: you should have already received back your entire investment. So
Speaker 3: we think the market is overly penalizing these businesses for
Speaker 3: an uncertain future quite a way quite a ways out.
Speaker 3: The other thing that I think is pretty typical is
Speaker 3: depressed current results in one of the business segments. Oftentimes
Speaker 3: the companies were invested in have a couple of different divisions.
Speaker 3: Maybe they fall between the cracks for the industry specific analysts,
Speaker 3: and one of the divisions might be cyclically out of favor,
Speaker 3: and the analysts aren't going to the trouble of trying
Speaker 3: to normalize that division when they compute what they think
Speaker 3: the appropriate pe multiple for a business like that would
Speaker 3: be today.
Speaker 2: And I have one last follow up because I think
Speaker 2: this topic is really fascinating. I think that most of
Speaker 2: us think the process starts with sort of a screen
Speaker 2: of these are all the cheap stocks, these are all
Speaker 2: the cheap multiples, and then look in that pile. Is
Speaker 2: that not true? Are you thinking in a different way?
Speaker 2: Is sort of where does your process start? Does it
Speaker 2: start with a multiple or does it start with, you know,
Speaker 2: all of the constituents of an index or a group
Speaker 2: that you're looking at from a sector perspective. How do
Speaker 2: you begin the process of search?
Speaker 3: So it could start with cheap names, and sometimes it does.
Speaker 3: Thirty years ago, that was probably almost all of our ideas.
Speaker 3: They look cheap on price to book or price to earnings,
Speaker 3: and that's what ignited the excitement to research it more thoroughly.
Speaker 3: At Harris Oakmark, there are three things we look for
Speaker 3: in companies. We want them less than two thirds of
Speaker 3: our estimated business value. So sometimes a cheap price is
Speaker 3: what first intrigues us, and that often happens after a
Speaker 3: company reports a disappointing quarter the stock all substantially. The
Speaker 3: second thing we look for is businesses that will grow
Speaker 3: or return dividends at least in total, at least what
Speaker 3: we expect to the market. We're trying to avoid value
Speaker 3: traps with that criteria, so that could ignite interests in
Speaker 3: companies that are paying large dividends but aren't growing very
Speaker 3: much so are out of favor. And then last, we
Speaker 3: want to invest side by side with good management teams,
Speaker 3: not only competent, but managements that understand we own the
Speaker 3: business and are trying to maximize long term per share value.
Speaker 3: So it could start with seeing a management team that
Speaker 3: we're highly impressed with, and then you kind of hope
Speaker 3: that the stock looks cheap enough. When you start the
Speaker 3: other direction, you're starting with the stock you know is
Speaker 3: cheap enough, and you hope it's well managed. There's no
Speaker 3: reason the process can't be reversed. And you know, if
Speaker 3: we see a management team move, maybe their company gets acquired,
Speaker 3: the former CEO then goes to a new business. You
Speaker 3: know that that triggers an interest for us, and then
Speaker 3: UH that that will be the catalyst for us doing
Speaker 3: more serious research.
Speaker 1: When you're conducting fundamental research, you know you're looking at
Speaker 1: financial statements. Do you also look at outside or external
Speaker 1: financial reports?
Speaker 3: Sure, we try. We try to look at any information
Speaker 3: that that we think sheds light onto what the business
Speaker 3: is actually worth. So it starts with the the information
Speaker 3: the company puts out themselves.
Speaker 2: UH.
Speaker 3: Three financial statements that are all very important the balance sheet,
Speaker 3: income statement, and statement of cash flow. UH, and our
Speaker 3: analysts are looking at those historically and projecting those out
Speaker 3: for the next several years, and then a growth rate
Speaker 3: for the five years after that. We're also looking at competitors' statements,
Speaker 3: trying to understand why one company may be performing better
Speaker 3: than the other, and is one performing so well it
Speaker 3: can't keep that up long term, or is one underperforming
Speaker 3: maybe for reasons that can be addressed and that gap
Speaker 3: can be eliminated. We read Wall Street reports. Our analysts
Speaker 3: here are all generalists, they know we're looking for cheap,
Speaker 3: well managed businesses, and they look across different industry sectors.
Speaker 3: But we'll go to the Wall Street analysts who have
Speaker 3: been industry specialists their entire career to learn what we
Speaker 3: can from them about how an industry has evolved to
Speaker 3: the state that it's in today, what they know about
Speaker 3: the different management teams. So we're really trying to put
Speaker 3: together information that we can find from whatever source is
Speaker 3: out there.
Speaker 2: We haven't had a chance to talk really about macro.
Speaker 2: Do you ever include sort of macro inputs in your process?
Speaker 2: Are there macro considerations? You know, for instance, FEDS reducing
Speaker 2: interest rates suddenly that clearly changes a discount rate potentially
Speaker 2: longer term, maybe pushes you towards higher duration versus lower
Speaker 2: duration assets. Or is it really pretty pretty specifically focused
Speaker 2: on this intrinsic value calculation.
Speaker 3: It's very very much focused on a bottom up company
Speaker 3: by company analysis. And I joke that we we do
Speaker 3: have a macro overlay, but it's always the same, and
Speaker 3: it's that the world will be normal seven years from now,
Speaker 3: and to us, normal means an average GDP growth rate,
Speaker 3: an interest rate that's a little bit higher than the
Speaker 3: inflation rate, and normally it sounds like that's the same
Speaker 3: as saying macro doesn't impact us, but at turning points
Speaker 3: it can be really important. Coming out of the Great
Speaker 3: Financial Crisis two thousand and eight, two thousand and nine,
Speaker 3: the idea that the world would be returned to normal
Speaker 3: within seven years was a pretty optimistic point of view.
Speaker 3: In twenty twenty, the idea that travel would return back
Speaker 3: to normal over the next five to seven years was
Speaker 3: a wildly optimistic point of view. So normally the answer
Speaker 3: is we don't have a macro overlay, but when we do,
Speaker 3: it's because the idea that normal will be returning is
Speaker 3: an outlier view.
Speaker 2: So when do you think about selling. We've talked a
Speaker 2: lot about buying with a seven year time horizon, five
Speaker 2: to seven year time horizon, we think longer term. When
Speaker 2: do you think about shaving positions?
Speaker 3: Yeah, it's funny, Gina. The typical viewpoint out there is
Speaker 3: it's really easy to buy stocks and very hard to
Speaker 3: figure out when to sell them. I think people have
Speaker 3: that backwards. If you put in the work when you
Speaker 3: buy a company to really know why you own it,
Speaker 3: then the sell decision becomes easy. And it's that one
Speaker 3: of the important reasons that you bought the stock no
Speaker 3: longer exists. So for us, we'll only buy a stock
Speaker 3: if we think it's a selling at a large discount
Speaker 3: to value, if it's growing and returning capital at a
Speaker 3: combined pace at least as fast as the market, and
Speaker 3: if it's managed by shareholder friendly management teams. We will
Speaker 3: sell if any one of those three is no longer true.
Speaker 3: So obviously our preferred reason to sell is we think
Speaker 3: a business is worth one hundred. It's selling at sixty
Speaker 3: and over a couple of years values grown to one
Speaker 3: hundred and fifteen, and so is the stock price. We're
Speaker 3: happy to move on, take profits and reinvest in something
Speaker 3: that's selling at a large discount. Again, but we'll also
Speaker 3: sell if we lose confidence in the business being able
Speaker 3: to grow, because we want it to grow at least
Speaker 3: as fast as the market. And if we see management
Speaker 3: activity that we think is inconsistent with maximizing long term
Speaker 3: per share value, will also sell. So maybe we've identified
Speaker 3: this nicely cash generative company that's been returning a lot
Speaker 3: of capital to shareholders, and suddenly they make a big acquisition,
Speaker 3: they issue stock to do it, and we think they
Speaker 3: paid too much for the business and it grew. The
Speaker 3: size of the business might help management increase their own compensation,
Speaker 3: but it decreased per share business value for us. We
Speaker 3: would say we made a mistake in identifying high quality management,
Speaker 3: and we would sell I wanted.
Speaker 1: To ask you. You know, Oakmark selects very concentrated, and
Speaker 1: so I wanted to know if you have any type
Speaker 1: of risk management process you know, due to that concentration
Speaker 1: or any other risk you might think of.
Speaker 3: Well, I think part of risk management is helping investors
Speaker 3: know what funds are appropriate for them, and so I
Speaker 3: would say risk management starts there by explaining to an
Speaker 3: investor that it's probably not appropriate for them to put
Speaker 3: their entire net worth in a fund that has only
Speaker 3: twenty names in it. So we manage Oakmark Select as
Speaker 3: if the shareholders have already taken some of the responsibility
Speaker 3: of risk management for their personal portfolio into their own
Speaker 3: hands and have allocated an appropriate percentage to us. Beyond that,
Speaker 3: the risk management for both Oakmark Fund and Oakmark Select
Speaker 3: is very similar. We start with an investment approach with
Speaker 3: the three criteria I've mentioned. Each criteria we believe lowers
Speaker 3: risk and increases return if you buy at a discount
Speaker 3: to value, if you're wrong, the stock usually loses less
Speaker 3: than if you pay a premium to value and you're wrong.
Speaker 3: If the business is growing, then as time goes by,
Speaker 3: you're kind of growing your way out of a risky position.
Speaker 3: And if management behaves in the shareholder's interest, they're likely
Speaker 3: to take steps during the time you own the stock
Speaker 3: that increase value beyond what you were able to model
Speaker 3: the day you purchased it. So that's all important risk management.
Speaker 3: I think how we position size is important. We think
Speaker 3: we could be wrong on any one of our ideas,
Speaker 3: so in the Oakmark Fund, we don't want to have
Speaker 3: more than four percent in any single idea. In the
Speaker 3: Select Fund, that number is more like a double digit
Speaker 3: percentage investment that we would typically trim if the stocks
Speaker 3: grew to the point that they were larger than that.
Speaker 3: In our portfolio, we position size based on attractiveness of
Speaker 3: the idea, not on market cap. So in the Oakmark Fund,
Speaker 3: where we don't want to have more than four or
Speaker 3: five percent in one name, there are three names in
Speaker 3: the S and P five hundred we couldn't even market
Speaker 3: weight if we like them because they have more than
Speaker 3: five percent. We don't think that's appropriate for an individual investor,
Speaker 3: So we position size based on how attractive we think
Speaker 3: the risk return profile is. It's kind of funny our
Speaker 3: two largest holdings and on any given day it can
Speaker 3: get bounced back and forth between them at about three
Speaker 3: percent of the Portfoliolio alphabet and five Serve alphabet is
Speaker 3: it between eighty and ninety percent of the SMP waiting
Speaker 3: five Serve is at fifteen times the SMP weighting. It's
Speaker 3: because we think about risk is losing money, not tracking error,
Speaker 3: not standard deviation. But if we're wrong, how much money
Speaker 3: could we lose? And based on how attractive we think
Speaker 3: those two stocks are, we think they merit three percent
Speaker 3: each in the portfolio. It's just a very different way
Speaker 3: of thinking about risk than most investors approach that topic today.
Speaker 2: That's really interesting. Can you talk to us a little
Speaker 2: bit about your position in financials. I mentioned at the
Speaker 2: forefront that you know, well, we're very short term thinking
Speaker 2: really just about the third quarter coming, and financial seems
Speaker 2: to be an opportunity. Your portfolio does tend to skew
Speaker 2: toward financials from a sector allocation perspective. What are you
Speaker 2: seeing there? What are some of the long term themes
Speaker 2: maybe that you see in the financial sector relative to others.
Speaker 3: So first point I'd like to make. We do have
Speaker 3: a large investment in financials. It's about forty percent of
Speaker 3: the portfolio and the Oakmart Fund. But the way financials
Speaker 3: as a sector is defined today, it's a very broad definition.
Speaker 3: I think sometimes people hear forty percent in financials, they
Speaker 3: think that means forty percent in banks, and less than
Speaker 3: half of our financials waiting is in banks. But we
Speaker 3: do have banks, and we like them a lot. But
Speaker 3: we also have insurance companies, we have some of the
Speaker 3: credit card processing companies, asset management businesses, exchanges data, financial
Speaker 3: data companies. So across that forty percent, it's pretty widespread.
Speaker 3: But I'll start with banks. Most of them are selling
Speaker 3: at small premiums to book value, summer significant discounts, single
Speaker 3: digit PE multiples. We think much better managed than they
Speaker 3: were when we went into the GFC fifteen years ago,
Speaker 3: and importantly, much more capital to support the assets that
Speaker 3: they have on their balance sheet. That serves to significantly
Speaker 3: lower the risk. We don't think other investors have lowered
Speaker 3: their required returns as they would appropriately do, as these
Speaker 3: companies have been de risked. Insurance businesses AIG Property and
Speaker 3: Casualty Core Bridge Life Insurance both single digit pes, both
Speaker 3: discounts to book value. Company like Charles Schwab that sells
Speaker 3: in the upper sixties today, their earnings are depressed because
Speaker 3: of investments in intermediate term bonds that they had purchased
Speaker 3: several years ago. Those aren't the bonds that they purchased.
Speaker 3: We're at a price where the yields are not as
Speaker 3: high as what you can get in the market today.
Speaker 3: But we're already a couple of years into rolling off
Speaker 3: five years worth of bonds. There we think after those
Speaker 3: are gone and they're replaced with current market yields, this
Speaker 3: is a company that could be earning close to six
Speaker 3: dollars a share, very financially advantaged relative to their asset
Speaker 3: management peers. So you know, it's not a monolithic forty
Speaker 3: percent of the portfolio. There are different reasons for each
Speaker 3: of them, but the theme is the stocks are really
Speaker 3: cheap relative to what we think the businesses are worth.
Speaker 2: Can you talk to us a little bit about why
Speaker 2: this is something that I've struggled with in our models too.
Speaker 2: Is it feels like the stocks are perpetually cheap in
Speaker 2: financials right, And I can't help but wonder if they're
Speaker 2: this permanent elevated risk premium that investors are requiring to
Speaker 2: get into this space just as a reflection of a
Speaker 2: very dated analysis of financials based upon the financial crisis
Speaker 2: of two thousand and eight two thousand and nine, or
Speaker 2: if there's something more that's just holding them back.
Speaker 3: So I think there are a couple things. One is,
Speaker 3: there are absolutely a lot of value investors that were
Speaker 3: overweight financials in two thousand and eight. We lost a
Speaker 3: lot of money in financials at that point in time too.
Speaker 3: I wish I could say we were smart enough to
Speaker 3: have seen the financial crisis coming, but we weren't. And
Speaker 3: I think a lot of those investors learned the wrong lesson.
Speaker 3: Instead of saying, you don't want to go into a
Speaker 3: real estate collapse with companies that are levered bets on
Speaker 3: real estate loans, they said financial companies are too difficult
Speaker 3: to understand, and I'm never going to purchase them again
Speaker 3: the rest of my career. We think that, we think
Speaker 3: they're making a mistake doing that. I think there are
Speaker 3: other investors that fear over regulation of the sector, And
Speaker 3: a question we often get asked is isn't it possible
Speaker 3: that the banks could get regulated so far that they
Speaker 3: almost become like electric utilities? And well, we think that's unlikely.
Speaker 3: That's not such a scary outcome, given that electric utilities
Speaker 3: sell at mid teens multiples and twice book value. The
Speaker 3: financial bank stocks will go up a lot if they
Speaker 3: got priced like electric utilities. And then, third, the question
Speaker 3: you're asking specific to banks is being applied more broadly
Speaker 3: today in a lot of academic circles with just value
Speaker 3: stocks in general? Are there so few value investors out
Speaker 3: there that the cheap stocks just keep under And that's
Speaker 3: why it's so important to us that managements have the
Speaker 3: mentality that they are only going to reinvest their earnings
Speaker 3: in the business when they have great organic growth opportunities
Speaker 3: where they're competitively advantaged, and if those don't exist, they're
Speaker 3: going to give the capital back to shareholders, either as
Speaker 3: dividends or share repurchase. We are very happy to invest
Speaker 3: when management teams look at their stock and say there's
Speaker 3: almost nothing we can invest in that will give us
Speaker 3: as high a return as the stock will, So we're
Speaker 3: radically reallocating capital to share repurchase. One of the names.
Speaker 3: We've got a large position in General Motors. They've been
Speaker 3: trying to diversify away from Ice Auto for probably the
Speaker 3: past decade, and just this past year they kind of said,
Speaker 3: screw it. If the market's not to value us at
Speaker 3: even five times earnings, we're going to use all this
Speaker 3: capital to buy back stock. They're buying back about twenty
Speaker 3: five percent of the company this year and are committed
Speaker 3: to continue doing that. So in four to five years,
Speaker 3: either the market has to respond or they will have
Speaker 3: repurchased all the shares except ours because we're not selling
Speaker 3: at this price. And I think if more managements had
Speaker 3: that mentality, that they view a cheap stock price as
Speaker 3: an opportunity rather than the problem, you'd see this undervaluation
Speaker 3: solving itself. They don't have to just be out there
Speaker 3: in a giant pity party. They can solve this problem
Speaker 3: on their own.
Speaker 1: I want to go back to something you said earlier.
Speaker 1: You mentioned investment books, and so as our final question,
Speaker 1: I'd love to know what your favorite investment books are.
Speaker 3: Well, you can't be a value investor and not have
Speaker 3: your favorite book be one about war and Buffett, So
Speaker 3: there are a lot of them written. I'm not going
Speaker 3: to elevate one above the others, but I think anyone
Speaker 3: who's intrigued with value investing needs to read a book
Speaker 3: about Warren Buffett. But I think the mistake a lot
Speaker 3: of value investors make is reading more and more and
Speaker 3: more about Buffett is kind of like comfort food. It
Speaker 3: makes you feel good, but it's not really good for you.
Speaker 3: So I think it's good for investors to branch out.
Speaker 3: And I like the books that have a chapter each
Speaker 3: on lots of different successful investors from a lot of
Speaker 3: different styles. There's a William Green book, Richard Wiser, Happier,
Speaker 3: there are some older books market Wizards, New market Wizards,
Speaker 3: And I find I learn as much reading about a
Speaker 3: growth investor or, a macro investor, a commodity investor and
Speaker 3: what has made them successful as I do reading another
Speaker 3: book about another investor that does things like we do
Speaker 3: at Oakmark. And I think you can broaden it and
Speaker 3: look beyond investors, look at people who've been really successful
Speaker 3: building businesses. I love the book New Rules Rule by
Speaker 3: Read Hastings, the CEO of Netflix, which we've sold out of,
Speaker 3: because it's become a market favorite again, but when it
Speaker 3: was out of favor, it was an important holding for us.
Speaker 3: I think you can read books about successful politicians, successful athletes,
Speaker 3: you learn how they have had to make sacrifices throughout
Speaker 3: their lives to achieve the greatness that they achieved in
Speaker 3: their specific, their specific careers. And I think that's a
Speaker 3: lesson that's really important to learn, especially as we have
Speaker 3: a younger workforce today that at a young age seems
Speaker 3: much more focused on work life balance than they ever
Speaker 3: used to be. So you know, maybe maybe you know,
Speaker 3: after forty years in this industry, I'm just becoming another
Speaker 3: crotchety old man. But I don't think that change is
Speaker 3: helpful for individuals that really want to try and rise
Speaker 3: to the top of the pyramid in their profession.
Speaker 1: Oh, definitely makes sense.
Speaker 3: This is great, Bill, Thanks David, Thanks Gina.
Speaker 1: It was a pleasure, and Gina, thank you again for
Speaker 1: joining today.
Speaker 2: Oh my pleasure. Thank you so much, David, and really
Speaker 2: nice to meet you. Bill. Thanks so much for sharing
Speaker 2: your journey and your process with us. We all learned
Speaker 2: a lot.
Speaker 1: Until our next episode, This is David Cohne with Inside
Speaker 1: Act