Tue, 13 Sep 2011
The Oakmark manager says the fund is able to pick up quality names at 60% to 70% discounts amid a market that's selling first and asking questions later.
Jason Stipp: So, I wanted to talk to you about volatility, because it does seem, as you're saying, that we've seen a lot of the markets moving in lockstep and a lot of indiscriminate selling in some cases.
... I know it’s kind of hard to get a handle on what's causing it, but it seems like especially in August we saw so many days of triple-digit up and down on the Dow Jones, for example.
What do you think is the big concern here behind some of these sell-offs and then some of the quick corrections and then some of the sell-offs again?
What is it that the people are most worried about, and is there a valid concern right now?
David Herro: I think the biggest worry, and I heard this from one of my friends who is in the hedge fund business in New York, the biggest worry is people don't want to get caught like they were in 2008 and perhaps '09. So they are extrapolating what was the situation in 2008 and 2009, and they are selling first and they are asking questions later.
Despite the fact, what we are seeing in the real economy, despite all these fears, despite all this volatility and market instability in the financial markets, in the real economy we’re not yet seeing what we saw in '08 or '09--nothing like it.
In fact, in August, BMW reported their best August monthly sales ever. And this is after the August we had in the financial markets. So what we are seeing in the financial world is not transferring to the real economy at this stage, and market participants are behaving like the real economy has already adjusted downward 16 notches, when that is not the case. So you have that going on.
Number two, this volatility I think was caused by ... instantaneous information, instantaneous, and people respond and react instantaneously. Now, I think eventually we are going to get to the "boy who cried wolf" syndrome, where people are going to quit instantly responding because they are going to realize that it is erroneous to do so. So maybe this is why BMW sold more cars in August than ever before, because the consumer says, "oh, yeah, that’s the financial markets again."
So ... as investors, how do we utilize this environment? What can we do with the volatile environment? We try to take advantage of it. As an example, besides the financials that have been destroyed in August and early September, lot of the industrials in Europe. You take a company like Daimler. Daimler going into August--and this is one of the largest producers of trucks and commercial vehicles as well as Mercedes automobiles--was trading at nine times earnings and had a dividend yield of about 5%, payout ratio of about a third. So, plenty of room on the dividend, still yielding 5%. Today, the dividend yield of Daimler is probably closer to 6% or 7%, and its P/E is about 6. That is, the stock dropped over 35% in one month. Now, is Daimler worth 30% or 35% or 40% less today than it was in the middle of July? Our view is no, but the markets are so scared they just wanted out of any European industrial, and you could see it across the board. A company like Akzo, which is Dutch company that makes paints and coatings, same thing.
So, we try to take advantage of that. Again, our view is the value of the business is not the next couple of quarters of free cash flow and earnings. It's the next three, five, 10, 15 and into perpetuity, discounted to the present value. That's what makes the business valuable. Mr. Market, unfortunately or fortunately, fortunately because we like to take advantage of it, is concerned about the next couple of weeks, months, and quarters. However, value is derived from today to perpetuity, and that is where a patient long-term investor could profit.
Stipp: So, volatility may make us nervous in the short run, but the upside is you do have those opportunities to go in and get these businesses at good prices. Would you say given the volatility that we've seen over the recent weeks that you've have been more active, potentially, in buying some more of these companies than you had been when the market was a bit calmer?
Herro: Yes. Absolutely. Our trading volatility goes up when market volatility goes up. Why? Because we want to keep our portfolio forward-positioned. Our method of operation is to price a business, determine its intrinsic value, and buy it at least a 30% discount. And today, by the way, you don't even get into the portfolio unless you're trading at least a 60% or 70% discount. That's how cheap we're finding global equities today.
So, if the prices are bouncing up and down like bobbing-head dolls, in order to keep our position size consistent with what we perceive to be the upside of that company, we have to do buying and selling. So, yes, definitely we have been basically selling and trimming those names which haven't been hit to fund those names which we think have had little or no dimunition of value, but a huge drop in share price. So, it really takes effort and focus to keep that portfolio forward-looking.
Stipp: Last question for you, David. Your portfolios have great long-term performance, but have struggled, though, in 2011. I want to get your take on the portfolio's performance this year. Then also more importantly, what do you think is the potential for those holdings that you have in the portfolio right now looking forward?
Herro: It certainly hasn't been a very good year for us. We're down in an absolute and relative sense to our peers. And this is not uncommon in periods where there is severe price distress. As value investors, sometimes we're a bit early. The other types of periods where we underperform are euphoric markets, when we are on the sidelines. This is the exact opposite of the euphoric market. This is a dismal market. But we're in there buying quality that has been trampled upon.
I mentioned in the financials, I mentioned some of the European industrials. It looks today that we are a bit early. I am every enthusiastic that we are able to buy these quality businesses at very, very low prices, and then when the market does come back, when the fear does leave, it will be reflected in the performance of our fund going forward.
Today, our portfolio trades at roughly 43-44 cents on the dollar, which is below where it has traded in typical downturns and a little greater than where it traded in the last, the big downturn, where it was in the mid-to-high 30s. So, we're very, very enthused about the prospects.
One other thing that has hurt us this year: We hedged some of our currency exposure, as you know, and as the dollar has basically weakened quite substantially versus the respective foreign currencies, we have not enjoyed that foreign currency bounce, because we’ve hedged a lot of that back into U.S. dollars.
However, as we've seen in the last week, some of this is changing. The Swiss franc from its highs, probably 15% or 20% below its peak, Australian dollar 7% or 8%, the yen still hasn't moved off its peak, but this hedging, which has been a negative contributor could almost turn on a dime, and will probably be less of a negative contributor going forward as currency values revert to more normal levels.
Stipp: David Herro, Oakmark International, thanks for your take on the European situation today and for joining me.
Herro: Thank you for having me.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.