Investing Tips From All-Star Managers
Shareholder reports offer a wealth of free stock ideas.
It's 2007, and we are turning once again to the mutual fund world for a little free advice. Every quarter, mutual funds are required to publish lists of their holdings--and at the end of the year, fund managers offer their ideas on the performance and direction of their funds. They often drop tidbits of investment advice that we can use for our own benefit. We love to read the shareholder letters of managers we respect as we hunt for opportunities.
This quarter, we examined the shareholder reports for 15 mutual funds and found a wealth of information. As we discussed last quarter, each quarter we focus on managers who, like Morningstar's equity analyst team, search for stocks that trade below their estimates of intrinsic value and provide a margin of safety. While we are not endorsing these mutual funds, these managers follow the examples set by Ben Graham and Warren Buffett. We would encourage you to read the letters for yourself, and the links to them are in the following table. We should warn you, however, that some opportunities might have already come and gone, as it takes a few months for mutual fund managers to report their holdings and write their letters.
|Shareholder Letters from All-Star Managers|
|Ariel (ARGFX)||John Rogers Jr.|
|Gabelli Asset (GABAX)||Mario J. Gabelli|
|Fairholme (FAIRX)||Bruce Berkowitz|
|Legg Mason Value (LMNVX)||Bill Miller|
|Longleaf Partners (LLPFX)|| O. Mason Hawkins |
G. Staley Cates
|Oak Value (OAKVX)|| David R. Carr Jr. |
Larry Coats Jr.
|Oakmark Select (OAKLX)|| Bill Nygren |
|Olstein Financial Alert (OFALX)||Robert A. Olstein|
|Selected American Shares (SLASX)|| Christopher C. Davis |
Kenneth C. Feinberg
|Sequoia (SEQUX)|| Robert D. Goldfarb |
|Third Avenue Value (TAVFX)||Martin J. Whitman|
|Torray (TORYX)|| Robert E. Torray |
Douglas C. Eby
|Tweedy, Browne Glob. Val. (TBGVX)|| Christopher H. Browne |
William H. Browne
|Weitz Partners Value (WPVLX)|| Wally Weitz |
|Yacktman (YACKX)|| Donald A. Yacktman |
Mixed Emotions About the Future
Most of these mutual fund managers started by reminding readers that the market, as measured by the Dow Jones Industrial Average, reached record highs in the fourth quarter of 2006. All were a little hesitant, not really believing the rally could last. Selected American's (SLASX) Christopher Davis and Kenneth Feinberg went so far as to state that it is "highly probable that we are in the midst of a very low-return decade for stock investors."
A common complaint seemed to be the lack of bargains in this environment, a statement echoed by Morningstar's analysts. Good buys are not as abundant as they once were, but some digging still uncovers opportunities. As of this analysis, Morningstar had 122 5-star stocks--shares we would consider buying at their current prices--out of the 1,900-plus companies we cover. ( click here to see our current list of 5-star stocks.) Yacktman's (YACKX) Donald and Stephen Yacktman agreed that opportunities still exist, saying "there is plenty of value in our portfolios even though the market has reached new highs." However, the only truly optimistic managers among those we focused on seemed to be Robert Torray and Douglas Eby from Torray Fund (TORYX), who said that earnings for their portfolio were expected to grow by 12.5% annually over the next five years.
More and More Media
Media stock plays figured into the majority of the mutual fund letters. As Morningstar's domestic mutual fund managers of the year, O. Mason Hawkins and G. Stanley Cates of Longleaf (LLPFX), said, "the media related companies that Wall Street despised in 2005 became heroes in 2006, although the business landscape changed very little." We commonly saw names like Comcast (CMCSA), Liberty Capital (LCAPA) and Disney (DIS) among the Buffett-inspired funds' top 10 holdings.
In the past, we have talked a great deal about Liberty Capital, which many top value-oriented mutual fund managers have been enthused about. Liberty Capital is one piece of a four-company breakup that took place two and half years ago and was aimed at realizing shareholder value. John Malone took control of Liberty Capital and is considered by many money managers to be a very smart investor himself. Mario Gabelli of Gabelli Asset Fund (GABAX) is a big fan as well--he mentioned it in his most recent Barron's roundtable appearance.
It looks like these managers' hopes are finally playing out. According to Donald and Stephen Yacktman, News Corporation (NWS) agreed to swap its 39% ownership of DirecTV (DTV), three regional sport networks, and some cash for Liberty Capital's 18% of News Corp's stock. This tax-efficient transaction is great news for Liberty Capital, and with DirecTV's stock up 77% in 2006, the deal has been excellent for several of our value-minded managers as well. We believe that the transaction was also a good deal for wide-moat News Corporation. While News Corp currently has a 3-star Morningstar Rating, indicating that it's trading at or near our fair value estimate, we applaud its efficient use of capital.
We would like to mention one quick turnaround at one of the funds. Oak Value's (OAKVX) David Carr and Larry Coats sold their CBS (CBS) position early in 2006 for tax reasons. As the stock got more attractive, Oak Value decided to re-enter the stock in the fourth quarter. We believe that CBS shares are moderately attractive; they currently have a 4-star Morningstar Rating, so they are not far above our $27.80 "Consider Buying" price.
The Importance of Management
In addition to ongoing enthusiasm for the media sector, a lot of these value-minded managers have opined about the need for quality management. Since all of these managers are bargain-hunters, it is common for them to buy slightly troubled companies. These firms often are involved in ugly headlines splashed across the media. As Legg Mason Value Fund's (LMNVX) Bill Miller puts it, "if it's in the papers, it's in the price," presenting a buying opportunity. However, a troubled company needs good management to right itself, and many of the fund managers try to pound this point home. The firms these managers select either have good management already or an expectation that poor management will quickly be replaced.
Robert Olstein of Olstein All Cap Value (OFALX) spent his latest letter discussing the art of corporate turnarounds. He stressed that without capable management, a corporate turnaround was not likely to happen. The key to investing in corporate turnarounds is figuring out if the management is one of the problems or part of the solution.
Excellent corporate managers are out there. As Fairholme Fund's (FAIRX) Bruce Berkowitz put it, "With Warren Buffett at Berkshire Hathaway (BRK.B), Murray Edwards at Canadian Natural Resources (CNQ), Charlie Ergen at EchoStar (DISH), Eddie Lampert at Sears Holdings (SHLD), and other all-star owner/managers, the Fund has never been blessed with so much talent--and we are searching for more." We heartily agree with the importance of strong management. At Morningstar, we rate all of our domestic companies with our Stewardship Grading system. The system is quite strict, with only 90 stocks out of more than 1,900 in our coverage universe earning our top grade.
Views on Dell
Dell (DELL) is another name that appeared in several of the shareholder letters we examined. The stock is out of favor with Wall Street, and it dropped 16% in 2006. Many of the value-minded managers we focused on think the computer maker presents a buying opportunity; in fact, five of 15 managers hold Dell in their portfolios. We agree with these managers, and wide-moat Dell currently has a 5-star rating. However, many managers took the time to say they've been scaling back their expectations somewhat. Selected American's Davis and Feinberg looked at their Dell purchase as a part of their biggest mistake. After following Hewlett-Packard (HPQ) for several years, they failed to take a position in the stock in 2006, and they believe that they didn't foresee how much the firm's new CEO, Mark Hurd, would improve Hewlett's results. More to the point, Davis and Feinberg also underestimated how quickly the reawakening of Hewlett would hurt Dell.
For Stock Junkies
We've also taken a look at which stocks made the most popular holdings among these top value-minded managers; we've listed 18 stocks that at least four of these value-oriented funds held. The list has shrunk from 23 last quarter, but that is most likely due to a slight shift in our list of managers. With recent market fluctuations, almost all of the stocks are in attractive 4- or 5-star territory--only one, Sears Holdings, is overvalued, with a 2-star rating. (Sears is one of those tidbits we missed because of the delay involved in fund reports; it has appreciated by 30% since the middle of 2006.)
Just like the all-star mutual fund managers, our long-term investing time horizon allows us to buy with patience and a margin of safety. While it often requires going against the masses, we think this philosophy offers the biggest long-term rewards.
|Common Stocks Among Our Favorite Managers' Funds|
|Stock|| Morningstar |
|Moat||# of Funds Holding|
|American Int'l Group (AIG)||Narrow||7|
|Tyco International (TYC)||Narrow||6|
|American Express (AXP)||Wide||5|
|Apollo Group (APOL)||Wide||5|
|Berkshire Hath. B (BRK.B)||Wide||5|
|Discovery Holding (DISCA)||Narrow||4|
|H&R Block (HRB)||Wide||4|
|J.P. Morgan Chase (JPM)||Wide||4|
|Liberty Capital A (LCAPA)||n/a||n/a||4|
|Liberty Interactive (LINTA)||n/a||n/a||4|
|Marsh & McLennan (MMC)||Wide||4|
|Mohawk Industries (MHK)||Narrow||4|
|Sears Holding (SHLD)||Narrow||4|
|Time Warner (TWX)||Wide||4|
|Data as of 03-16-07|
Jaime Peters does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.