In a post-recession world, you need serious experience to guide your portfolio. So we sat down with five pros who have the right guidance for these troubled times.
Roundtable interview by Geoff Colvin, senior editor at large
The financial crisis is over -- right? Just one problem: The markets haven't settled down, and investing hasn't become any easier. In a post-crisis environment where industries, economies, and currencies are all in turmoil, deciding which way to turn feels at least as tough as ever.
For guidance, we convened five battle-tested investing pros with diverse perspectives. Abhay Deshpande runs funds at First Eagle Investment Management, which oversees some $40 billion. He's a value stock investor who owns gold. David Ellison is president of FBR Fund Advisers; he brings long experience investing in shares of financial firms. Renée Haugerud, founder and chief investment officer of hedge fund Galtere Ltd., disdains all stocks in favor of grains and other commodities. James Swanson is chief investment strategist of MFS Investment Management, which offers more than 60 mutual funds pursuing a range of strategies. Omaha-based Wally Weitz is a longtime value investor who manages or co-manages four of his firm's eight funds.
When the members of our investing dream team sat down recently with Fortune's Geoff Colvin, they disagreed on some large issues, such as the wisdom of buying gold. But they all saw market opportunities -- yes, even in U.S. equities -- and were willing to offer specific ideas. Here are edited excerpts from the discussion:
We hear a lot of concern now about America's fiscal future and the economy's growth, or lack of it. Abhay, is the U.S. a good place for investors to be long term?
Deshpande: We're global investors, so we can invest around the world. We don't have to invest anywhere in particular, but we do tend to find more value in the United States than in some more popular areas -- emerging markets, for instance. That doesn't reflect our macro thesis. It's just that we see more value available in the U.S. than elsewhere.
So it's a matter of price?
Deshpande: It's a matter of price. Investors spend a lot of time on these macro issues, and it's scary. The fiscal situation is certainly poor, but that creates opportunities for value investors like us. We tend to thrive when there's a lot of uncertainty, which creates volatility. With a time horizon of three, five, 10, or 15 years, we can almost ignore what's going to happen over the next couple of years. The value of a business is a function of the cash flows generated over its entire life, not over the next year or two. With Wall Street focused on the next three to six months, that creates an arbitrage opportunity for us as long-term investors.
Jim, you're looking at big-picture themes. How does the U.S. look to you?
Swanson: Labor costs are very important here and everywhere in the world. Unit labor costs are rising in Europe, in Japan, and in most emerging-market countries. They're falling in the U.S. Look at the productivity numbers here and at the profit story -- we're maximizing our workforce, and the benefits are accruing to the owners of capital. You can see that in the numbers, and it's been consistently showing up quarter after quarter, not just during the recession.
Wally, you're a value investor -- what do you think?
Weitz: I don't know about the macro picture of the world. We're one-stock-at-a-time value investors. We need a more or less stable, predictable environment, and we'd like to know whether we have an economic headwind or tailwind. But we don't try to get much fancier than that. Our take is that the debt and the asset bubble were so big and so long in coming that it's going to take a lot longer than people think to work our way through them. Maybe this is analogous to the period from 1966 to 1982, when the Dow stayed in a 600-to-1,000 range for 16 years. There was a big bear market in the middle of that period. The market then came back strongly in the next year and a half, like we just did, but it was six more years before you really went to new high territory.
A discouraging picture.
Weitz: It's great for value investors, because as Abhay said, we're looking for mispriced assets. We can have a great time with a company that's growing slowly but faces overly negative perceptions. We're fine with six years of sideways growth if the next big move is on the upside.
Deshpande: I'd add one thing. It's not enough to think about what's going on in the United States. The Bureau of Economic Analysis says that almost 40% of U.S. corporate profits come from foreign affiliates. Even if you're indexed to the S&P 500 (SPX), you're in fact a global investor. For example, half of 3M's (MMM) earnings come from outside the U.S.
Weitz: Coke (KO) has 80%.
So far we've been talking about where to buy stocks, but Renée, you're saying don't buy them at all. How come?
Haugerud: We think stocks are the most overinvested, overvalued asset class in the world because everyone everywhere owns them. Everyone said in 2008, "Oh, look at asset-class synchronicity. The whole world isn't decoupling. It's synchronized." Of course the equity markets are synchronized -- everyone owns them and, in our estimation, owns too many of them.
That gets to the larger issue of asset allocation. Where do most individual investors go wrong?
Swanson: It depends on your time horizon, your risk preference, and how old you are, but Americans probably over-invest in the U.S., even though I happen to like U.S. equities right now. And the flows would suggest that America is becoming too addicted to fixed-income investing at very low returns. There's downside risk with fixed income, and you can get totally lopsided and ignore what's happening in commodities or equities.
Weitz: I agree. All the flows we see are into bond funds, and it's over our protests because there's really nothing very good that can happen from 0% interest rates.
Every financial expert I talk to, without exception, says individual investors are putting too much into bonds. It's a logical point, but whenever everybody agrees, I get nervous. In this case are all the experts actually right?
Deshpande: On this question of, Is it a bubble or not a bubble in Treasuries, it probably is a bubble. But is it irrational for an aging population to seek income? Probably not. There's an element of rational behavior. The question I have is, Why isn't some of that dedicated to equities, which themselves pay income? There are many dividend-oriented securities in our portfolio yielding well over 3%. In some cases, these are companies like the 3Ms of the world that have some pricing power. You can potentially have, in effect, an inflation-protected security with a much higher yield than TIPS.
As we sit here today, gold is close to $1,400. Is it a good buy at that price?
Haugerud: We think gold will eventually go higher, but it's a very volatile commodity. Close to 50% of the demand is investment flow, as opposed to industrial demand, jewelry fabrication, or whatever. But we do think gold will go up in the long term because of our dollar view. As long as the dollar goes down, we see gold going up.
Abhay, about 12% of your global fund is in gold-related investments. How do you like gold at today's price?
Deshpande: We have no view on the future direction of the price of gold. Generally speaking, in a fiat-money world we believe it's almost a mathematical identity that the value of gold will go up. Gold ETFs, such as GLD (GLD), have of course risen. GLD may be the fifth-largest holder of gold in the world, after the central banks of the world. So people from the ground up have chosen to put some of their reserves in gold as a hedge against the currency. To me, it doesn't feel like speculation like in the late 1990s with Internet stocks, or the credit bubble. This seems to be rational behavior. Whether we're ahead of ourselves temporarily or not, I have no clue. What we've said for ages is keep 5% to 10% of your assets in gold, just in case.
Jim, does it make sense to you that some small percentage of an individual's assets should be in gold?
Swanson: No, it makes no sense to me. All through my career I've looked for reliable or reasonably growing streams of income. That is how I've built my idea of how you can do well from financial markets. Gold has to be stored, it has to be insured, and then what is it used for? I go back to Shakespeare, who said, "How quickly nature falls into revolt when gold becomes her object!"
I'm paying $1,400 for gold today because I hope someone will pay more for it next year. And what will they do with it? They hope someone else will come. Eventually you end up with a psychological asset class that I'm not comfortable with. Even if they're devaluing the currencies of the world, you have to ask yourself, Where does this end? And I do know the price can fall. It does when the Fed funds rate rises above 2%. So I'm not a fan of gold. I don't know how to value it.
Wally, you say you're finding the best bargains in large, high-quality companies. What are some of them?
Weitz: Texas Instruments (TXN) has gone up some the past few months, but it's a cyclical growth company that is a leader in its field and that reinvents itself every eight or 10 years as its world changes. It's growing probably more than 10% a year. It took advantage of the recession to buy assets from bankrupt competitors at 10¢ on the dollar and to buy a significant amount of its own shares at cheap prices. Management is very shareholder-oriented. They're authorized to buy in another 30% of their stock. And unlike a lot of companies that talk about buying back stock, Texas Instruments really does it. Even if the economy goes sideways for quite a while, there will be strong demand for game consoles and retrofitting motors for energy efficiency and other things that most of us don't often think about.
You manage or co-manage a number of funds, but the top holdings in all of them are pretty much the same: Liberty Media, Omnicare, Berkshire Hathaway, and Microsoft. Any of those that you like even at today's prices?
Weitz: Berkshire (BRKA) I think we don't need to talk a lot about. It's the best asset allocator out there, generating tons of cash, and probably selling at 75¢ on the dollar. I love Berkshire. Omnicare (OCR) is a more obscure company that d
elivers pills to nursing homes. It's the biggest at what it does. Omnicare has disappointed people over the years because it's had trouble digesting acquisitions. Even though the stock was cheap, the company's main stumbling block was a CEO whom we were not fond of. The board finally took over. Denny Shelton, whom we've known from other companies, is running the company, changing the culture, making employees excited about working there again. The stock is at $22 or $23, and the business is generating over $3 a share of free cash available to the shareholders and growing. I'm in heaven buying it at seven times free cash, growing, with management I like.
Renée, how should individuals invest in the commodities that you favor?
Haugerud: Wealth is shifting from developed economies to developing ones. As incomes grow, you move up the protein food chain. So you eat more meat, chicken, beef, and pork, which creates more demand for grain. In addition, populations in emerging economies are generally younger, and younger people eat a lot more than older people. So we like corn, beans, wheat, rice, cattle.
But should ordinary investors be in those markets?
Haugerud: Passive commodity indices are not the way to go unless maybe you're looking out 20 or 30 years. But if you're looking for a return in two, five, 10 years, we think you should either hire an active commodity manager or do it yourself. The investment community has convinced everyone that commodities are complicated, but I would argue that commodities are the easiest asset class to understand. Do your own homework, just like you do on stocks, and it's going to be easier, I would say, because a bushel of corn can't commit fraud. It can go up or down in price, and it can't go to zero.
Dave, you've been investing in financial companies for a long time. No sector has been through more drama in the past two or three years. What do you like now?
Ellison: Credit cards are one of the more attractive areas now because the yields on the assets are still very high, meaning you're making credit card loans at 10%, 12%, 15%, 20%. That's a lot better than making a mortgage loan at 4%, especially when you have people strategically defaulting on their debts. So I'd rather get 12% and take my chances on defaults, because I can have a lot more defaults and still make money. I like transaction-oriented companies like Capital One (COF) and Visa (V) and MasterCard (MA), even Discover. The government stabilized the economy, so I don't think transactions are going to fall that much. I'm also a fan of credit collectors like Portfolio Recovery Associates (PRAA). I think we've had north of $3 trillion of loans written off in the U.S. alone since 2007. These companies buy loans at very low prices and then work them out. If the economy improves and jobs come back even a little bit, people will be able to make those payments. Another attractive area would be small, well- capitalized banks that can take advantage of consolidation in the financial sector.
Ellison: You've got Danvers Bancorp (DNBK) in Massachusetts, Washington Federal in Seattle. I'm holding maybe 15 or 20 of those names in my portfolio. I tend to take the group-hug approach when it comes to investing in that class.
Ellison: Firms that have bought a lot of toxic assets. KKR (KKR) is a good example. If they bought those assets at 10¢ on the dollar and sell them for 20¢ on the dollar or hold them to maturity, you can make money that way.
Deshpande: Financials are a broad category. Our portfolio is full of misfit toys, a lot of the wrongly accused and the underappreciated or misunderstood. In financials we found companies that have suffered collateral damage. Bank of New York Mellon (BK), for instance, is mostly a case of mistaken identity. It is not a bank at all -- 80% of the business is actually non-interest-bearing, fee-based revenue, custodial business, and that kind of asset management. Only 20% is net interest income, and that's really corporate trust business. It's not even at-risk business. These business lines are packed with underappreciated earnings power. We're talking about potential normalized earnings of $2.80, $2.90 a share, so the stock is trading for less than 10 times earnings.
Wally, why do you like Liberty Media so much?
Weitz: Liberty has split itself into six or eight different pieces, one of which is Liberty Media Interactive (LINTA), which is basically QVC. It's going to become an independent company, getting out from under the tracker-stock confusion. QVC grew right through the recession. It's doing beautifully. It doesn't have to worry about bricks and mortar. It can change its product mix on the fly, as the presenters are showing their cookware or whatever. We think the QVC business itself, which also does business in Germany, Japan, England, and Italy now, is worth $16 or $18 a share, and it's got another $5 or $6 a share of marketable securities. That adds up to $21 to $24 a share, and the stock's currently at about $15.50. Not only do you have good assets, you have liquid assets that [founder and CEO] John Malone can do something else with.
Then there's Aon (AON), the insurance broker. It was put together through acquisitions. There's new management that rationalized those acquisitions and improved their execution quite a bit. But the stock has been depressed because Aon bought Hewitt and issued a lot of shares, which disturbed some people. More important, we have a soft insurance market, and Aon makes commissions on the policies that it sells. The stock is at 13 times earnings, growing at double-digit rates, and generating tons of cash. There will be a hard market at some point. You don't want to cheer for things like hurricanes, but when people decide they like insurance brokers, they'll probably sell at 14, 15, 16 times earnings. So you get earnings growth, a dividend, and then a shift up in P/E at some point.
Abhay, what other names get you excited?
Deshpande: As value investors, we tend to like dull and boring. While everyone else gets excited about China and Brazil and India, we go for rocks in the ground, companies like Martin Marietta (MLM) and Vulcan Materials (VMC) -- we own both of those. Internationally we own a company called Heidelberg Cement, German listed, probably the biggest aggregates company you've never heard of. The combination of poor operating metrics and poor sentiment equals opportunity for us. In the U.S., aggregate volumes are down about 35%, but pricing's up 20%. Cash flows in 2009 were actually up close to peak. Nobody wants a quarry in his or her backyard, so competition is naturally limited. When you combine pricing power, cost control, and long-lived assets -- aggregates don't decay -- you have the hallmarks of a great business.
Heidelberg owns a controlling interest in a publicly listed company called IndoCement that's got the No. 1 position in Jakarta and is growing 8% a year. Their stake is worth €3 billion. Heidelberg's market cap is €8 billion. On a normalized basis, Heidelberg trades for maybe 12 times earnings. Considering it's got pricing power, cost control, and very long-lived assets, I believe that's too low a multiple.
Weitz: We own Vulcan and Martin Marietta also. One extra layer of comfort you get besides those rocks in the ground: These companies are not going to sell themselves, but I think either of those two could sell themselves at a 50% premium with one phone call.
Jim, what are the specific themes that you like right now?
Swanson: People say the U.S. doesn't make anything. Yet today the biggest market-cap sector of the S&P 500 is -- guess what? IT. And we do make that. We export it. We're good at it. The rest of the world loves this. It's a sector that has doubled and tripled the free cash flow margins and EBIT margins it had 10 years ago when people were paying 40 times earnings. Today that sector is trading at only about 16 times earnings. The growing middle classes of China and India want our smartphones, they want the apps, they want all these devices and the software that comes with them. And these companies are sitting on massive amounts of cash. Either there's going to be dividend increases or mergers, or they're going to buy back their shares. The cash is just sitting there like a time bomb waiting to go off. Valuations are not rich, and yet earnings are spectacular.
Can I get anybody to weigh in on Apple (AAPL) at $320?
Deshpande: Love the products, hate the stock price.
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