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Finding Refuge in Value

Don Yacktman and Pat Dorsey look for undervalued firms with margins of safety, and they see a lot to like in today's market.

Ryan Leggio, 10/08/2011

“Don Yacktman’s Wild Ride--Fall of a Fund Manager”

 

That was the headline of an article in Kiplinger’s about fund manager Don Yacktman in 2001. While not as famous as Business-week’s cover story on “The Death of Equities” in 1979, it proved just as accurate as a contrary indicator. (To be fair, Morningstar’s track record analyzing Yacktman at the time is mixed.) From 2001 through Aug. 15, 2011, the Yacktman Fund YACKX appreciated by an annualized 11.4%, versus a 1% annual gain for the S&P 500. That showing earned Yacktman one of the five nominations for Morningstars Manager of the Decade award in 2010.

As the 2001 headline suggests, Yacktman’s performance the past decade has been a turnaround of sorts. In the late 1990s, he loaded up on small-cap companies he thought were cheap as the market rewarded large-cap stocks year after year. In 1999, for example, his fund fell 17% as the S&P climbed 21%. Investors, having endured two previous years of underperformance, left in droves, and the fund’s asset base fell from $1.1 billion in assets in 1997 to just $70 million in 2000. Despite a current asset base of $5.4 billion, one thing seems clear: Yacktman’s disciplined, concentrated approach to uncovering the market’s cheapest stocks--along with the manager’s willingness to sit on cash when bargains are scarce--hasn’t changed much through the years.

The same can be said for Pat Dorsey, Sanibel Captiva Trust Co.’s vice chairman and director of research and strategy. Longtime readers will remember Dorsey as Morningstar’s former director of equity research. During his career here, Dorsey helped develop Morningstar’s economic-moat rating--analyst-assigned ratings that gauge a company’s competitive advantages and its abilities to keep rivals at bay and to withstand tough economic times.

We invited Yacktman and Dorsey to discuss where they see bargains today and why both currently favor beaten-down technology stocks such as Cisco CSCO. Our conversation took place Aug. 12 and has been edited for clarity and length.

Ryan Leggio: Don, we’re talking in early August and the markets have been quite volatile recently. [The S&P 500 dropped 6.7% on Aug. 8, one of its steepest single-day drops in decades.] What’s your take on the concerns that are out there and how that is affecting your investments?

Don Yacktman:
I think the situation like we’ve had in the last week or so really creates opportunity for value investors. While I have an opinion on all the economic and political things that are going on, the reality is that it wouldn’t change what we do, because we’re very systematic, and we try to be objective in the way in which we approach things. So, it’s just been a great opportunity, and it certainly has allowed us to do some things that have come to fruition.

Leggio: Are you basically saying that even if Europe’s fiscal situation gets worse, tha it wouldn’t have a big impact on the values of a lot of the companies you own in the fund?

Yacktman: It doesn’t affect the process. It may affect the pricing on individual issues, but what it does is allow us to do things. I think the best way I could reflect that is to go back and look at what happened in 2008 and ‘09. We have, really, three goals. The first goal is to avoid the permanent loss of capital. The second one is to make equity-type returns, double-digit-type returns, over long periods of time. And the third one is to beat the S&P over a cycle, and because cycles vary in length, we use 10 years as our pick, if you will, or our hurdle.

And so, we try to project a forward long-term rate of return, saying, “If we were to buy something and own it for a long period of time, and throw out market fluctuations, what kind of a rate of return would we expect to earn on this?” And then we try to adjust for the predictability of that by using quality standards. In other words, the more predictable the cash flows are, the higher the quality and, probably, the less spread we need in order to make that investment.

Ryan Leggio, Esq., is a fund analyst with Morningstar.
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