Our Ultimate Stock-Pickers' Top 10 New Money Purchases
Several high conviction purchases by our top managers are still attractive.
By Bradley Meeks | Stock Analyst
Despite the dramatic run-up in the markets over the last year, we've still been able to find a few investable ideas among the holdings, purchases and sales of our Ultimate Stock-Pickers. As you may recall from our last article, our top managers seemed to be putting an equal amount of conviction into more defensive sectors of the market, like Consumer Goods and Health Care, as they were in (relatively) riskier areas, like Financial Services and Energy, with their most recent purchases. Given that we are in the midst of what we believe to be a true stock picker's market, where winners will be found only by sifting through each sector of the market in the pursuit of undervalued stocks, we decided to take a much deeper look at the new money purchases made by our managers during the most recent period.
We continue to believe that portfolio managers send signals about how they feel about a particular stock by the amount of money they're willing to commit to it at any given time, which is why we focus on not only the holdings of our Ultimate Stock-Pickers, but also on their purchases and sales. As much as we assess the relative attractiveness of an individual security by how many funds are currently holding it, regardless of whether their managers have been adding to or subtracting from these positions, and the percentage that each security makes up of a portfolio, we also like to look at new money purchases and outright sales, which we feel offer additional insight into the thinking of managers about their holdings.
When looking at all of the new money purchases made by our Ultimate Stock-Pickers during the period (which includes data through the end of January for some of our managers), the sector with the most money flowing into it was the financial services sector, followed by health care. Our top managers continue to overweight financials, with the sector accounting for 19% of their aggregate holdings (compared to 14% for the broader market) at the end of the most recent period. Financials have long been an overweighted sector for many of the value investors on our list, an addiction which cost some of them dearly during the collapse of the credit and equity markets in 2008, so it is interesting to see a handful of them starting to make higher conviction purchases in the sector.
Ultimate Stock-Pickers' Top New Money PurchasesStar RatingFair Value UncertaintySize of MoatCurrent Price ($)Price/Fair ValueCitigroup (C)3Very HighNone3.960.72Qualcomm (QCOM)4MediumWide38.880.79Bank of NY Mellon (BK)4MediumWide29.620.85Aon (AON)3MediumNarrow40.970.87Merck (MRK)4MediumWide36.670.80Clorox (CLX)3LowNarrow62.350.92Barrick Gold (ABX)3HighNone38.750.78Vodafone (VOD)3MediumNarrow22.470.86Pfizer (PFE)5MediumWide17.150.66OccidPetroleum (OXY)3HighNarrow81.970.96
Stock Price and Morningstar Rating data as of 03-10-10 unless otherwise noted.
The two largest new money purchases within financial services were made in shares of Citigroup (C) and Bank of New York Mellon (BK). Morningstar Fund Manager of the Year (as well as Manager of the Decade) Bruce Berkowitz believed Citigroup was so undervalued that he put roughly 6% of his Fairholme (FAIRX) fund in the stock (after selling off a significant portion of the fund's holding in Pfizer (PFE)). Berkowitz noted in a recent interview with our fund analysts that "Citigroup has spent a good amount of time with the U.S. government and many of its financial regulators, going through every liability and asset in the books," which means that by now they've been able to "count [all of] the cockroaches" that might be out there. While he believes that it will still take some time before the bank is back on its feet, Berkowitz thinks that much of the dilution that was going to happen to shareholders has already taken place, and that the valuation was conservative enough for him to buy the stock.
While Fairholme may have been one of just three funds holding Citigroup at the end of the period, Berkowitz was not alone in his buying, with Columbia Value & Restructuring (EVRAX) making a meaningful new money purchase in the name and the managers at Sound Shore (SSHFX) increasing their stake in the bank by more than sixty percent. Meanwhile, Bank of New York was the recipient of new money purchases by both Parnassus Equity Income (PRBLX), which established a 4% position in the name, and the Yacktman (YACKX) fund. At this point, nine of our top managers have holdings in Bank of New York.
Within health care, we saw both Merck (MRK) and Pfizer being bought with conviction by some of our managers. Aston/Montag & Caldwell Growth (MCGIX) built a more than 4% stake in Merck, while both Columbia Dividend Income (LBSAX) and Hartford Capital Appreciation (ITHAX) added to existing positions in the name. Meanwhile, Pfizer was a new money purchase for both Amana Trust Growth (AMAGX) and FPA Crescent (FPACX), with Amana Trust Income (AMANX) and the Yacktman fund both adding to existing positions in the pharmaceutical firm.
Morningstar's Take on these New Money Purchases
Due to the amount of time that typically has passed since our managers made trades in their portfolios, the top purchases of our Ultimate Stock-Pickers don't always translate into investable ideas. We've been able to alleviate some of this time lag by including managers who report their monthly holdings, which allows us to generate more timely commentary and investment ideas. Still, we're always going to be fighting an uphill battle. So it didn't come as too much of a surprise for us to note that out of the top ten new money purchases made by our Ultimate Stock-Pickers, only one is currently rated 5-Stars (with three others priced in 4-Star territory).
That said, many of the stocks on the list actually traded at lower prices during the period in which they were bought. It should also be noted that our Ultimate Stock-Pickers could have different margins of safety attached to these securities, which would prompt them to buy at different prices than our analysts have targeted. Curious to know what Morningstar's stock analysts were currently thinking about these top ten new money purchases, we sifted through their most recent commentary and walked away with the following conclusions:
With Bruce Berkowitz putting more than $400 million (equivalent to 6% of Fairholme's total stock holdings) into Citigroup during the most recent period, we were interested to see if our analyst, Jaime Peters, felt comfortable with his assessment. While she has noted that North American consumer credit losses have been stabilizing and that international consumer credit losses continue to improve, she believes that years of bingeing on growth and failing to properly integrate acquisitions may have finally caught up with Citigroup. In her view, the firm's future remains difficult to predict, with questions still lurking over what will happen to Citi Holdings, how the government will exit its investments in Citigroup, and whether or not the proposed TARP tax will impair Citigroup's earnings power. Because of all of the uncertainty surrounding Citigroup, a larger margin of safety is necessary in Jaime's eyes before recommending the stock.
Both Parnassus Equity Income and Sound Shore made meaningful new money purchases in Qualcomm during the most recent period. The semiconductor firm is the innovator of the Code Division Multiple Access (CDMA) wireless standard, which is used in some 2G and all 3G technologies. The company has leveraged its CDMA expertise into the semiconductor market, where the firm is a key supplier of chips to wireless handset makers. It also generates royalty revenue by licensing its intellectual property. Qualcomm's licensing business brought in more than $3.6 billion of revenue in both 2008 and 2009, and analyst Brian Colello expects strong revenue growth in the next few years as 3G networks gain further adoption around the globe.
Bank of New York Mellon (BK)
Our analyst Michael Kon likes the changes Bank of New York has gone through over the last five years, believing they will entrench the firm as a prime service provider to other financial institutions, and make it one of the largest behind-the-scenes players in global capital markets. The move by Bank of New York to exchange its retail banking operations for J.P. Morgan Chase's (JPM) corporate trust business back in 2006 effectively traded a non-core division for greater scale in the firm's bread-and-butter trust operations. Further, the merger of Bank of New York with Mellon Financial in 2007 made excellent strategic sense, as it filled holes in each firm's offerings and provided ample opportunities for cross-selling.
Morningstar analyst Bill Bergman believes that Aon has produced very good returns for its shareholders in recent years, after facing a barrage of scrutiny over its accounting and contingent commission practices earlier in the decade. In his view, the tough times bred valuable humility at the firm, with Aon's new management developing a foundation for more profitable growth and higher cash flows. While the slow economy and soft insurance pricing have weighed on the brokers in recent years, Bill doesn't believe these factors will be long-lived. He is further encouraged by the fact that the largest publicly traded insurance brokers have reached "restated agreements" with various state regulatory authorities, allowing them to once again take contingent commissions, a practice that has been banned since 2005.
While not the most undervalued health care name currently covered by Morningstar, our analyst Damien Conover thinks there's plenty of upside for Merck. The firm's acquisition of Schering-Plough positions Merck for long-term growth as it revived the company's product pipeline and should provide over $3.5 billion in realized cost synergies. Unlike its main competitor, Pfizer, which is electing to reinvest a substantial portion of the cost savings that are expected to be achieved from that firm's purchase of Wyeth, Damien believes that a greater portion of Merck's cost savings should fall to the bottom line.
Clorox is not only a company that Morningstar analyst Erin Swanson likes, but is one that Josh Peters, the editor of our Dividend Investor newsletter recently purchased for his Dividend Builder portfolio. While the company will always face competition from private-label brands, Erin believes that the firm's product portfolio--which includes such well-known brands as Clorox, Kingsford/Matchlight, Brita and Burt's Bees--and expansion potential have positioned it to generate substantial cash flows and returns for shareholders over the longer term.
Barrick Gold (ABX)
With gold prices surging over much of the last year and a half, many gold mining companies saw their stock prices skyrocket. Morningstar analyst Joung Park believes that some of the demand tailwinds that bolstered pricing in 2009 may prove unsustainable in the long run, meaning that gold prices could be extremely volatile going forward. As such, he continues to advise investors to focus on low-cost producers capable of generating economic profits even in weak pricing environments. While Barrick Gold may not be the lowest-cost producer in the industry, it enjoys some relative cost advantages given its geographically diversified portfolio.
While Vodafone is the world's largest wireless phone company by revenue, Western Europe accounts for about three fourths of the firm's reported revenue and profits. Our analyst Allan Nichols believes that Vodafone's scale in Europe gives it an advantage over competitors, allowing it to not only source equipment at lower prices, but also develop products in one country and then roll it out to others at minimal additional expense. Vodafone was a significant new money purchase for recently added fund manager FPA Crescent, which made the stock a top ten holding in its portfolio during the most recent period.
While Bruce Berkowitz may have made a fairly big statement by selling Pfizer, the company is still a top ten holding for our Ultimate Stock-Pickers and is the only 5-Star name on our list of new money purchases. Morningstar analyst Damien Conover continues to like Pfizer even after the firm lowered its long-term sales and earnings guidance on its last earnings call. He believes that the lower projections will increase the credibility of management's long-term outlook (which is still a bit of a stretch in his eyes), and may finally get investors interested in the name again. Damien believes that Pfizer's recent acquisition of Wyeth should help boost top-line growth enough to help offset upcoming patent losses, and that the cost synergies derived from the deal should enhance margins as well.
Occidental Petroleum (OXY)
Occidental Petroleum built its business around the acquisition of legacy assets and the utilization of enhanced oil-recovery techniques to increase production and build reserves. Morningstar analyst Allen Good believes that the continuation of this strategy in the United States, along with recent discoveries in California and projects in the Middle East, should help fuel the company's growth well into the future. One of the biggest buyers of the stock during the most recent period, Alleghany (Y), actually blew out positions in Devon Energy (DVN), EOG Resources (EOG), Petrobras (PBR), and XTO Energy (XTO) in order to put money to work in Occidental Petroleum, ExxonMobil (XOM) and Hess Corporation (HES).
Disclosure: Bradley Meeks does not own shares in any of the companies mentioned above.
The Morningstar Ultimate Stock-Pickers Team does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.