Great Companies' Stocks On Sale
Why buy stock in mediocre companies when you can invest in top-notch companies at the same prices relative to their earnings?
To ask that question, says Bill Nygren, co-manager of Oakmark Fund (symbol OAKMX) and Oakmark Select (OAKLX), is to answer it. So he has filled his funds with tech stocks, such as Apple (AAPL), Intel (INTC) and Oracle (ORCL), that normally trade at rich valuations but today sell at close-to-bargain prices. Indeed, Nygren has about 20% of each fund’s assets in tech stocks.
What makes this development so noteworthy is that when tech stocks were going wild in the late 1990s, Nygren wouldn’t touch them.
Back then, tech stocks and, more generally, large-company growth stocks changed hands at stratospheric price-earnings ratios. But things have changed dramatically. In most cases, the outlandish PEs of the ’90s are history, and many, if not most, stocks of all kinds today sell at similar valuations -- regardless of the quality of their businesses. That’s simply nuts. “Investors aren’t favoring companies that demonstrate superior growth,” says Nygren, 52.
Take Apple. At $349.31, it trades at 15 times the average of analysts’ earnings estimates for the next four quarters (essentially, calendar 2011). Standard & Poor’s 500-stock index sells at about 14 times analysts’ 2011 estimates. So the market is valuing Apple -- arguably the most innovative company in the world -- as if it were a so-so company. Plus, the company has $50 a share in cash on its books. Whether or not Steve Jobs -- the visionary CEO and founder who is now on medical leave -- recovers his health, Nygren contends that Apple is dirt-cheap. (All share prices and related data are through March 1.)
Nygren’s funds have proved their mettle. Over the past ten years, both Oakmark Fund, which Nygren co-manages with Kevin Grant, and Oakmark Select, which he co-manages with Henry Berghoef, returned about 5.5% annualized, placing them in the top 10% of funds that focus on stocks of large companies with a blend of growth and value attributes.
Though they often own many of the same stocks, the two funds are hardly identical. Oakmark Fund typically invests in 50 to 60 large companies; Select usually owns about 20 stocks, including some midsize companies. Select can put as much as 15% of its assets in a single stock.
That last bit of freedom is one that Nygren -- and Select’s shareholders -- could have done without. Going into what would become the great financial crisis, Nygren had 15% of Select’s assets in the shares of Washington Mutual, one of the financial institutions that blew up in 2008. “It was the biggest mistake I ever made,” Nygren concedes.
He argues, however, that concentration did not prove to be fatal for Select. “Washington Mutual was a disaster, but it didn’t knock us out of the game,” says Nygren. Still, Select took a nasty hit during the 2007–09 bear market, losing 58.1%. The more diversified Oakmark Fund didn’t do much better, dropping 54.9%. Standard & Poor’s 500-stock index surrendered 55.3%.
Forget the New Normal
Nygren isn’t a believer in the “new normal” -- the notion, popularized by Pimco’s Bill Gross and Mohamed El-Erian, that mammoth debt levels in the developed world will retard economic growth for years to come. But even if economic growth is tepid for a prolonged period, Nygren argues, stocks should still post handsome returns.
Just because the economy grows only 2% a year after inflation (a possible outcome of the new-normal scenario) doesn’t mean that stocks will return only 2% annually, he says. Corporate balance sheets are awash in cash. Companies this year are expected to retain about 75% of the cash they generate, Nygren says. Sooner or later, that mountain of money will be put to work -- companies will buy back shares, make acquisitions or boost dividends. They may undertake some combination of these actions, all of which can turbocharge returns.
After the last bear market, many managers who had focused single-mindedly on picking stocks decided they could no longer ignore the big economic picture. “We disagree,” says Nygren. “If you buy good companies that are cheap, you’ll do well.”
His current favorite stock is Discovery Communications (DISCK), the operator of about 100 cable-TV channels. Nygren has stashed almost 9% of Select’s assets in Discovery. “Companies that produce content that consumers demand will continue to grow,” he says. At $37.32, Discovery trades at 17 times estimated earnings of $2.23 per share for 2011. Nygren notes that the K shares are about $5 cheaper than the A shares. The only difference between the two classes is that holders of the K shares don’t vote on corporate matters.
The stock market remains beset by worry -- two years into a fierce bull market. Investors continue to pile into gold and other supposedly safe havens. In Nygren’s view, investors are doing what they usually do: extrapolating the recent past into the indefinite future. “People are pulling money out of stocks at the bottom to put money into bonds at the top,” he says.
I’m not as sanguine as Nygren, and it makes me a little nervous that he ignores the big picture. But if you’re looking for a terrific, patient stock picker with whom to invest your money, Nygren is one of the best there is.
Of the two funds, Oakmark Fund is the better choice. Long-term returns have been roughly the same as Select’s -- but Oakmark Fund has delivered them with less volatility.
Steven T. Goldberg (bio) is an investment adviser in the Washington, D.C. area.
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