Ultimate Stock-Pickers' Top 10 Buys and Sells
Top managers continue to find opportunities for new-money purchases (albeit fewer than in past periods), while taking full advantage of a rising stock market to book some gains.
By Greggory Warren, CFA | Senior Stock Analyst
As we noted in our last article, the U.S. equity markets finished 2014 on a high note, with the S&P 500 TR Index notching an overall gain of 13.7%. This was in spite of elevated levels of geopolitical tension (both in the Middle East and in the Ukraine), a growing crisis in the European Union (ahead of the Greek elections), and concerns about the economic future of Europe and China. A steep drop in crude oil prices--from $91 per barrel at the end of the third quarter of last year to $53 per barrel at the end of the fourth quarter--gave the U.S. economy, which already posted better-than-expected GDP growth of 5% during the third quarter, an additional boost, with household consumption increasing at a 4% annualized rate during the fourth quarter. It also led to a spike in the stock prices of firms in non-oil-related industries that are affected by changes in energy prices, which not only offset the drop in the prices of oil services stocks but contributed to a 5% increase in the S&P 500 during the final three months of 2014.
While the ongoing rally in the U.S. equity markets has benefited the portfolios of most investors, it has limited the options for our Ultimate Stock-Pickers, many of whom continue to struggle to find ways to put new money to work. The U.S. economy started out 2015 on much better footing, as consumers have benefited from lower energy costs (and lower inflation overall), as well as a job market that continues to improve, the S&P 500 increased another 3% during the first two months of the year, making their task all that much harder. That said, the continuation of the geopolitical tension seen during the fourth quarter, as well as the prospect of a rise in interest rates in the near-to-medium term, could increase the level of volatility seen in the markets; as we noted in our last article, this could create some short-term dislocations that provide buying opportunities for our top managers. Most of our Ultimate Stock-Pickers remain steadfast, though, in their desire to keep investor capital safe should things go awry, making valuation a much more critical aspect of their buying and selling decisions.
From the discussion we've already had on the high-conviction and new-money purchases that made up the bulk of our last article, our top managers were able to use some of the market volatility during the fourth quarter to purchase high-quality names that most of them had previously seen as overvalued--with wide-moat United Technologies (UTX) being the best example of this. Not only was the company's common stock purchased by five of our Ultimate Stock-Pickers during the period, but two of the purchases were new-money buys, and four of the five purchases were made with high conviction. As you may recall, we think of high-conviction purchases as instances where managers make meaningful additions to their existing holdings (or make significant new-money purchases), with a focus on the impact that these transactions have on the manager's portfolio overall. Comments from Steve Romick of FPA Crescent (FPACX), who noted that the market provided him with "a reasonable entry price to a wonderful collection of businesses" when talking about his fund's purchase of United Technologies during the fourth quarter, summed up the view of many of the other managers that were buying the stock during the period.
The buying and selling activity of our Ultimate Stock-Pickers continues to be well off the pace that we've seen in previous periods, highlighting a trend of fewer and fewer meaningful purchases that started midway through 2013, and which has been difficult to shake off as the U.S. equity markets have moved higher. However, we saw a bit more overlap in the trading activity that was reported for the fourth quarter. We also were surprised by the lack of purchases and/or sales of energy stocks, given what happened with oil prices during the fourth quarter. Although wide-moat Berkshire Hathaway (BRK.A)/(BRK.B) did make some headlines by eliminating stakes in wide-moat Exxon Mobil (XOM) and narrow-moat ConocoPhillips (COP), as well as selling off one fifth of its holdings in narrow-moat National Oilwell Varco (NOV), there was not the same level of selling across our top managers. The one exception was the portfolio at Alleghany (Y), which eliminated narrow-moat Chevron (CVX) from its holdings, and significantly reduced its stakes in wide-moat Williams Companies (WMB), and narrow-moat Occidental Petroleum (OXY) and Noble Energy (NBL), during the fourth quarter.
What these two managers have in common is the fact that their equity portfolios are an extension of their insurance operations, which likely influenced their decisions to whittle down their Energy sector exposure. Unlike their peers in the mutual fund business, the portfolio managers at insurance companies are not affected by investor redemptions during poor market environments, but have to be mindful of the volatility that could affect their investment holdings. In most cases, they will lessen their exposure to a particular asset class (or sector of the market) when they regard the risk/return tradeoff as being less tenable than it might have been in previous periods. That said, Berkshire still had 2% of its equity portfolio invested in energy stocks at the end of the fourth quarter (and actually increased its stakes in narrow-moat rated Suncor Energy (SU) and Phillips 66 (PSX)). Alleghany had 13% of its stock portfolio dedicated to energy, having made a meaningful addition to its stake in Schlumberger SLB, which has a wide moat around its operations.
Ultimate Stock-Pickers' Top 10 Stock Holdings (by Investment Conviction)Company Name Star Rating Fair Value Uncertainty Moat Rating Current Price (USD) Price/Fair Value Market Cap (USD mil) # of Funds Holding WellsFargo WFC 3 Medium Narrow 54.79 1.05 282,581 15 Microsoft MSFT 3 Medium Wide 43.85 0.95 358,103 15 Google GOOG 3 High Wide 558.4 0.93 368,750 15 P&G PG 3 Low Wide 85.13 0.95 229,085 13 Oracle ORCL 3 Medium Wide 43.82 1.04 191,904 12 AIG AIG 3 High None 55.33 0.92 77,866 5 BankAmer BAC 3 High Narrow 15.81 0.88 169,789 8 Wal-Mart WMT 3 Low Wide 83.93 1.01 272,136 11 BerkHath BRK.B 3 Medium Wide 147.41 0.94 345,133 8 PepsiCo PEP 3 Low Wide 98.98 1.04 146,710
Data as of 02/27/15. Fund ownership data as of funds' most recent filings.
Even with the changes that were made to the Investment Manager Roster, our top managers remain underweight in Energy, Utilities, Communication Services, and Real Estate relative to the weightings of these same sectors in the S&P 500. That said, our Ultimate Stock-Pickers continue to hold overweight positions in the Financial Services, Consumer Defensive, and Basic Materials sectors, but have pulled back on their Health Care exposure (which is only modestly overweight the market, much like their exposure to Consumer Cyclical stocks). What was even more interesting to note was the shift to an overweight position in Industrials, aided by a lot of new-money purchases of companies that might benefit from lower energy prices--like the airlines and shipping/logistics firms--as well as a drop in the share prices of wide-moat industrials, like United Technologies and wide-moat Deere (DE). We also saw a slight reduction in our top managers' exposure to Technology stocks, as positions in top 10 holdings from the third quarter--wide-moat rated Microsoft (MSFT) and narrow-moat Apple (AAPL)--were whittled down in the face of a 20%-plus gain for the sector last year.
Our top managers' overall buying and selling activity during the most recent period also slightly affected the list of top 10 holdings of our Ultimate Stock-Pickers, with wide-moat rated Wal-Mart (WMT) replacing narrow-moat rated Apple. While Wal-Mart did not make our list of top 10 purchases, a number of managers added to their existing positions in the retailer. As for Apple, we actually saw two high-conviction sales--by Parnassus Core Equity Investor (PRBLX) and Alleghany--and trimmings by three other managers during the period. Todd Ahlsten and Benjamin Allen noted the following about their sale:
Apple had a strong year: its shares rose 37.7% to $110.38 from $80.16 and boosted the NAV by 62¢. Apple continues to demonstrate the benefit of owning the most valuable brand in the world, as evidenced by its successful iPhone 6 launch during the third quarter. We think the company can generate massive cash flows for many years to come based on its device ecosystem, innovative culture, potential new product categories and loyal user base. We sold about 40% of our Apple position during the second half of 2014 in response to the increased price, but still held some stock at year-end.
Given that the shares have risen another 15%-plus since the start of the year, one has to wonder if the timing of the sales was prudent. That said, Apple did rise in value from $101 per share at the end of September to a quarterly high of $119 on Nov. 26, 2014, before tailing off to $110 per share at the end of December. Trading at $128 per share at the end of last week, Apple is now slightly overvalued when compared with our analyst's fair value estimate of $120 per share (which was increased from $100 per share at the end of January following a blowout quarter for iPhone sales). While Apple may have fallen off our list of top 10 holdings by investment conviction, its remains just off the cusp and could return to the list by the end of the current quarter.
Ultimate Stock-Pickers' Top 10 Stock Purchases (by Investment Conviction)Company Name Star Rating Fair Value Uncertainty Moat Rating Current Price (USD) Price/Fair Value Market Cap (USD mil) # of Funds Buying UnitedTech UTX 3 Medium Wide 121.91 1.05 111,890 5 Google GOOG 3 High Wide 558.4 0.93 368,750 6 TE Connec TEL 1 Medium None 72.13 1.39 28,916 5 IBM IBM 4 Medium Wide 161.94 0.83 163,035 3 Actavis ACT 4 Low Wide 291.36 0.88 79,179 2 Oracle ORCL 3 Medium Wide 43.82 1.04 191,904 3 ExpScripts ESRX 3 Medium Wide 84.79 0.95 63,362 2 Apache APA 5 Medium Narrow 65.84 0.67 24,969 3 Deere DE 3 Medium Wide 90.6 1.04 31,621 3 Schlmbrgr SLB 4 Medium Wide 84.16 0.8 109,876 5
Data as of 02/27/15. Fund ownership data as of funds' most recent filings.
Having spent plenty of time discussing our top managers' purchases of most of the top 10 high-conviction purchases in our last article, which was an early read on the high-conviction and new-money purchases that we were seeing from our Ultimate Stock-Pickers, we thought that we would focus on two names--wide-moat rated International Business Machines (IBM) and Deere--that popped up this time around that weren't on that list. While both names were meaningful additions for the insurance portfolio managers at Berkshire Hathaway, it took additional buying from a few of our other top managers to get them on the list.
Berkshire made waves in the fourth quarter of 2011 when famed investor Warren Buffett made the world aware of his first foray into the Technology sector, having purchased 64 million shares of IBM, equivalent to approximately $10.7 billion or 5.5% of the technology company, during the previous three quarters. Since that time, the stock has decreased in value some 13%, with Berkshire increasing its stake by around 20%--picking up another 13 million shares (half of which were purchased during the fourth quarter of 2014)--with IBM being Berkshire's fourth largest holding at the end of December, accounting for 11% of the insurer's equity portfolio. Buffett was joined in his buying activity during the fourth quarter by Prem Watsa at Fairfax Financial Holdings (FRFHF), where IBM accounted for 14% of the insurance company's equity portfolio at the end of December (Watsa increased his stake in the technology firm by 27% during the period). Chuck Bath, Chris Welch, and Rick Snowdon from Diamond Hill Large Cap (DHLAX) added to their stake as well, but at much lower levels.
Morningstar analyst Peter Wahlstrom believes that IBM holds a defensible position in enterprise software, services, and hardware. While each of these businesses is an industry leader in its own right, he believes that the combination of these products and services provides the firm with a unique solution creation perspective and delivery ability that contributes to its wide economic moat. He notes that IBM is navigating the secular trend toward distributed, open-standards computing by diversifying its hardware platforms, broadening its software portfolio, and building a formidable services organization. While other technology giants have grown faster over the past decade, Wahlstrom notes that few can point to a record of cash flow that is as consistent as IBM's. The firm's free cash flow remains at roughly 14% of sales, with IBM paying a $1.10 per share quarterly dividend (equivalent to a 2.7% yield), which costs it a little over $4 billion per year, and dedicating $13 billion to share repurchases last year. With the stock currently trading at 90% of Wahlstrom's fair value estimate (and trading at a discount for much of the fourth quarter), Buffett was able to purchase shares at a more reasonable valuation than where he first started buying. The Oracle of Omaha even noted recently that the stock has done about what he expected it to do when he first bought it, expecting to see revenue occasionally pressured (both by the competitive environment and by adverse foreign exchange). Buffett believes that any subsequent stock price drops would provide Berkshire with opportunities to increase its stake, by either buying more stock or by having the company repurchase more shares.
As for Deere, we believe that this purchase was likely initiated by Todd Combs at Berkshire, given that Ted Weschler is a bit more of a media investor and Buffett tends to focus his input on positions in excess of several billion dollars. That said, Berkshire's holdings in Deere, which had been excluded from the insurer's third-quarter 13-F filing (as the firm was adding significantly to its stake and received permission to withhold its actions), accounted for close to 2% of Berkshire's holdings at the end of last year, making it a $2 billion-plus holding. Tom Gayner at Markel (MKL) had a similar weighting in the stock, having increased his position by 54% (picking up another 293,000 shares) during the quarter. The managers at Vanguard PRIMECAP (VPMCX), which were recently named Morningstar's U.S. Fund Manager of the Year for 2014, added to their stake as well, but at much lower levels.
Morningstar analyst Kwame Webb believes that Deere's brand name is synonymous with agricultural equipment. He notes that the firm generates 80% of its sales from agricultural equipment, and more than 50% of its sales from the North American farm equipment market. The company's brand is built on industry-leading agricultural R&D spending and an unmatched North American agricultural dealer network. While Deere's brand is decidedly weaker outside of North America, Webb notes that the firm has been aggressively deploying resources into markets such as Brazil, where it accounts for 20% of new tractor sales (compared with 8% a decade ago). He believes that the firm is smartly diversifying its business into new geographies--like Brazil, Russia, India, and China--where Deere can capitalize on a consumer base demanding higher caloric intake (prompting the local agricultural economy to produce more output). Webb also notes that Deere is active in consumer, construction, and forestry markets, which make up 20% of revenue, offering some diversification away from its large agriculture-oriented business. That said, with the shares currently trading at 104% of his fair value estimate, it is difficult to get excited about the name, which had dropped down as low as $80 per share in early October, only to recover to $88 per share by the end of December.
Ultimate Stock-Pickers' Top 10 Stock Sales (by Investment Conviction)Company Name Star Rating Fair Value Uncertainty Moat Rating Current Price (USD) Price/Fair Value Market Cap (USD mil) # of Funds Selling PepsiCo PEP 3 Low Wide 98.98 1.04 146,710 5 Microsoft MSFT 3 Medium Wide 43.85 0.95 358,103 5 BerkHath BRK.B 3 Medium Wide 147.41 0.94 345,133 3 Apple AAPL 3 High Narrow 128.46 1.07 742,969 5 AIG AIG 3 High None 55.33 0.92 77,866 1 Medtronic MDT 3 Medium Wide 77.59 1.08 76,354 4 WellsFargo WFC 3 Medium Narrow 54.79 1.05 282,581 5 Allergan AGN 3 Medium Wide 232.74 1.03 70,358 3 Occidental OXY 4 Medium Narrow 77.88 0.79 61,763 4 Chevron CVX 4 Low Narrow 106.68 0.86 204,571 1
Data as of 02/27/15. Fund ownership data as of funds' most recent filings.
Looking at the list of top 10 sales during the most recent period, there was very little to be discerned by the sectors represented. Three stocks from the Financial Services sector, and two each from the Technology, Health Care, and Energy sectors, were sold, with only wide-moat rated PepsiCo (PEP) and Microsoft being sold outright by our top managers. With regard to PepsiCo, the managers at both Diamond Hill Large Cap and Vanguard PRIMECAP completely eliminated their stakes in the beverage and snack foods firm, while ASTON/Montag & Caldwell Growth (MCGIX), American Century Value (AVLIX), and AMG Yacktman Service (YACKX) reduced their holdings. The managers at Diamond Hill Large Cap noted the following about their sale of PepsiCo:
We eliminated our shares of consumer snack & beverage manufacturer PepsiCo, Inc. during the fourth quarter market sell-off to provide funds for more attractive investment opportunities. PepsiCo shares were very close to our estimate of intrinsic value at the time of sale.
This pretty much echoes what we were seeing in relation to the rest of the names on our list of top 10 sales. In most cases (and where commentary exists), managers were selling as share prices hit fair value estimates, and, in some cases, to eliminate stocks that were the target of acquisitions announced during the period (with wide-moat Allergan (AGN) fitting the bill this time around). With regards to American International Group (AIG), which was sold by Fairholme Capital Management, the largest holder of the name among our top managers, we expect that manager Bruce Berkowitz was selling to keep the positon below 50% of his overall holdings (AIG accounted for 40% of Fairholme's stock holdings at the end of December). As for Occidental Petroleum and Chevron, their position in the list of top 10 sales was heavily influenced by sales at Alleghany, which, as we noted above, redirected some of the proceeds of its sale of several energy names into its existing stake in Schlumberger.
If you're interested in receiving e-mail alerts about upcoming articles from The Ultimate Stock-Pickers Team, please sign up here.
Disclosure: Greggory Warren owns shares in the following securities mentioned above: Procter & Gamble. It should also be noted that Morningstar's Institutional Equity Research Service offers research and analyst access to institutional asset managers. Through this service, Morningstar may have a business relationship with fund companies discussed in this report. Our business relationships in no way influence the funds or stocks discussed here.
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.