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Stock Strategist

Is Value Investing Dead?

A roster of some top stock-pickers begs to differ.

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Each quarter, our stock analyst team reviews the holdings and shareholder communications of more than a dozen of our favorite mutual fund managers in an attempt to learn from some of the best investors in the business.

While value investors typically measure results over a period of years, the recent volatility in the markets occasionally made a weekend seem like a long time horizon, leading some of the fund managers we follow, such as Robert Torray of  Torray (TORYX) and Ron Baron of  Baron Asset (BARAX), to update their shareholder communications midquarter.

Despite the turmoil in the stock and credit markets, most of the managers we follow are sticking to their knitting. However, a few missteps early on in the current downturn make it clear that the market sometimes takes even the most experienced and successful investors by surprise.

 All-Star Managers
Ariel (ARGFX) John Rogers Jr.
Baron Asset (BARAX) Ronald Baron
Andrew Peck
Fairholme Fund (FAIRX)

Bruce Berkowitz

Gabelli Asset (GABAX) Mario J. Gabelli
Legg Mason Value (LMVTX) 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
Henry Berghoef
Olstein All-Cap Value  (OFALX) Robert A. Olstein
Selected American Shares (SLASX) Christopher C. Davis
Kenneth C. Feinberg
Sequoia (SEQUX) Robert D. Goldfarb
David Poppe
Third Avenue Value (TAVFX) Martin J. Whitman
Torray (TORYX) Robert E. Torray
Tweedy, Browne Value (TBGVX) Christopher H. Browne
William H. Browne
Weitz Partners Value (WPVLX) Wally Weitz
Yacktman (YACKX) Donald Yacktman
Stephen Yacktman

Even the Best Make Mistakes
The rapid and severe market declines over the past year spared very few value managers, leading more than one publication to mourn the Death of Value Investing. Considering that most of the managers on our list have held up better than the market on a relative basis, we believe that these reports are greatly exaggerated. That said, a number of the managers on our list admitted investment mistakes in the past year, with most related to high profile--and highly leveraged--financial companies. While Bill Miller's  Legg Mason Value Trust (LMNVX) suffered greatly from overexposure to companies like  AIG (AIG) and  Freddie Mac (FRE), several of our managers sold out of some of these positions before the fates of these companies were sealed.  Weitz Partners(WPVLX) Wally Weitz became "concerned that [these companies] might lose control of their financial destinies," while the team at  Tweedy, Browne (TWEBX) became increasingly concerned with the goverment-sponsored enterprises' subprime mortgage exposure and leverage, as well as AIG's derivative book, selling out of these companies before they were ultimately rescued by the government. While  Ariel Fund (ARGFX) managed to avoid the most troubled names, John Rogers acknowledged the need to remain flexible with respect to investment positions, agreeing with survival expert Laurence Gonzales that "rigid people are dangerous people." We at Morningstar agree, and we updated our research methodology early in the year in order to focus on the strongest financials.

Hot Commodities Turn Cold
One bright spot for value investors in the third quarter was their relative lack of exposure to the volatile commodity sector, with some managers likening the recent demand for energy and commodity-related names to the dot-com bubble. While many investors piled into these issues, believing that demand from China and other developing markets would lead to ever-increasing prices for commodities of all sorts, value managers like Robert Torray refused to pay up for rosy expectations, explaining "when the vast majority of investors believe something, it's never long before they're proven wrong." Ariel Fund's John Rogers also highlighted his fund's avoidance of the bubble: "Unlike the first half of the year when our lack of ownership of the booming commodities hurt, this quarter our avoidance of those capricious issues helped as they dramatically fell from unsustainable highs." However, as prices fell during the third quarter, value managers began to nibble in stocks like  Conoco-Philips (COP), owned by three of the managers we follow, as well as Warren Buffett's  Berkshire Hathaway (BRK.B). The team at Weitz Partners has "been doing research on several energy and commodity companies over the years, and it is possible that some will meet [their] investment criteria if their weakness continues." With the overall market continuing to fall in the fourth quarter, and a number of energy and commodity names rated at 5 stars, we wouldn't be surprised to find more of these stocks among the fund managers' year-end holdings.

Valuations Continue to Improve
Since most of the managers on our watch list were bullish early on in the current bear market, it's not surprising that their after enthusiasm has grown after a 50% peak-to-trough drop in the S&P 500 Index.  Longleaf Partners(LLPFX) Mason Hawkins and Staley Cates wrote that "The P/V ratios in all three funds have fallen below 50% as we write this letter, a level seen only once domestically in the last fifteen years." David Carr and Larry Coats of  Oak Value (OAKVX) called valuations "extremely attractive." The stock analyst team at Morningstar agrees, seeing the most compelling valuations since we began rating stocks. With so many values in the market, third-quarter purchases were more diverse than in the recent past, with the only common purchase among more than two funds being  UnitedHealth (UNH). New additions to the list of widely held stocks were limited to health insurer  Wellpoint (WLP) and flooring manufacturer  Mohawk Industries (MHK).

 Widely Held Stocks
Company

Number of Funds Holding

Morningstar Rating

American Express Company (AXP) 8

UnitedHealth Group, Inc. (UNH)

7

Berkshire Hathaway Inc. B (BRK.B) 6

eBay, Inc. (EBAY) 6

Johnson & Johnson (JNJ) 6

Liberty Interactive A (LINTA) 6

Under Review

Microsoft Corporation (MSFT) 6

Cisco Systems, Inc. (CSCO) 5

Citigroup, Inc. (C) 5

Dell, Inc. (DELL) 5

Intel Corporation (INTC) 5

Mohawk Industries, Inc. (MHK) 5

Telephone and Data Systems, Inc. (TDS) 5

Tyco International, Ltd. (TYC) 5

WellPoint, Inc. (WLP) 5

Top Managers Remain Long-Term Optimists
Winston Churchill once said of himself, "I am an optimist. It does not seem to be much use being anything else," a view seemingly shared by all of the managers we follow. As  Third Avenue Value Fund's (TAVFX) Marty Whitman pointed out, "General markets tend to come back strongly in periods subsequent to price crashes! That was the case in 1932, 1937, 1962, 1974-75, 1980-82, 1987, and 2001-02. A comeback also seems likely after the unprecedented crash of 2007-08." Ron Baron devoted a large portion of his quarterly letter to the importance of optimism, quoting Warren Buffett, who apparently learned this lesson early in his career. A young Buffett asked his mentor, Ben Graham, what would happen if the depressed stock market never went back up. According to Buffett, Graham "just shrugged and replied that the market always eventually does. He was right."

Jim Sinegal has a position in the following securities mentioned above: BRK.B. Find out about Morningstar’s editorial policies.