Sat, 4 May 2013
Equities may not be significantly undervalued but still look good relative to the paltry returns available in the fixed-income market, says Don Yacktman.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. We're here at the Value Investor Conference in Omaha, Neb., ahead of the Berkshire Hathaway Annual Meeting. I'm sitting down with Don Yacktman of the Yacktman Funds. We want to get his thoughts on stock valuation and also get his take on the Berkshire Hathaway succession.
Don, you're obviously very well-known bottom-up buy-and-hold investor, as is Warren Buffett. But his lieutenants have been trading a lot more frequently than Buffett would in his core portfolio. Do you think this is a sign that buy and hold is going out of fashion, that it's in trouble in some way, or do you think that's still the best way for investors to approach equity investing?
Don Yacktman: Well, I think time horizon is a big difference, and I think the true investor has a much longer time horizon. We have a lot lower turnover rate than most funds. Most mutual funds, I think, turn over about 100%, ours is about 20%. But we'll turn over some. I think, the secret is really, I think, to be objective and in effect, look at stocks as though they were bonds and look at them as though everything you buy, every asset you buy is based on risk-adjusted forward rates of return. And so it becomes like a bond portfolio, and then you can objectively make decisions.
Glaser: So if you're thinking about stocks as bonds, does that mean that you're kind of doing a credit analysis, making sure that those are companies that are going to be there for the long haul, or is valuation more important than kind of business quality?
Yacktman: It's a combination. I mean, what you're basically doing is you're buying future cash flows, and the predictability of the cash flow is certainly one of the elements that determine what the future rates of return are. And nobody can predict the future with absolute certainty. So you have to, I think, by that very definition, have to have a range of outcomes and then establish probabilities to that range of outcomes. So the more financial or operating leverage a company has, or the less predictable the products are, the business model in effect, means that the outcomes are going to have a wider array of potential outcomes. So you have to take that into account.
Glaser: Let's take a look at valuations then. [On May 3], the Dow hit a new record, over 15,000. Is this a sign that valuations are generally stretched across equities? Are there areas that you're finding better opportunities right now?
Yacktman: Well, we're, as you know, bottom-up, one-at-a-time investors, and so we still have a fair amount of money invested, but less invested than we had certainly a few years ago. The dilemma, to put it simply is, if you look at the long-term Treasury rate, it's about 3%. Traditionally the long-term Treasury has provided about a 3% real rate of return, while inflation, the Fed's trying to get inflation around too, that's pretty skimpy. So I think the long-term bond, because in effect it's overpriced, means that equities start to become very good relative to that, at least the kinds of equities we like. But they're not great values in absolute terms.
Glaser: Let's take a look at one of your big holdings right now, Procter & Gamble. It's a company that's had a few stumbles here and there over the last few years. What are your thoughts on your outlook for P&G?
Yacktman: I think people continue to use Tide and Pampers and Gillette blue blades and on and on, Duracell batteries. I think what you have, and it's typical of a lot of the companies we own, is you have a very profitable company, but a low-unit-growth company, gradually shifting more of their volume to an international position. So I think roughly half of Procter & Gamble now is overseas.
Glaser: How about News Corp? That's another top holding of yours.
Yacktman: News Corp.'s a little different. I think it's little more dynamic. Clearly the secret of News Corp. has been the amount of transition to basically a cable news network, where now they have a bigger market share than MSNBC and CNN combined, and it's moving more toward a fee-based model versus just an advertising model or one that's more subject to economic changes. So I think it's a great model that they have, and it's been very dynamic if you look at that one segment. Now there are other segments in the company, whether it be Fox, Fox Financial, Fox Sports, movies and on and on. Clearly, the newspaper businesses is sort of, you might call it an ice cube, particularly with classified ads having dropped off the charts basically in the last five to 10 years. So they're going to spin that off and create a new entity.
Glaser: You mentioned that stocks look attractive on a relative basis to Treasuries. But a lot of investors are still looking for yield, and they're turning to dividend-paying stocks. Do you think that's something that makes sense?
Yacktman: Well, I think that's because of where the rates are is why people are looking at that. A company's cash flow is divided into two pieces generally: one is the dividend, the other is the reinvestment rate. But when you have the dividends on several of these large, profitable businesses equaling the 30-year Treasuries, that's what I'm saying is you have, on a relative basis, a very compelling relative case. But on an absolute case, I'm not saying it's all that great.
Glaser: Do you think most of the companies that you own, do you think the management teams are returning enough capital to shareholders, or are they hoarding too much cash? Those cash hoards have kind of grown on the corporate balance sheets. Do you think that most management teams are handling that appropriately?
Yacktman: I think the central tendency is that most managers don't grow up in the companies with their first business experience being capital allocation. And suddenly they're thrust in the role of the CEO, and that's a huge role and one of the very important roles of companies. So I think there's a central tendency for the really profitable businesses to probably not be as aggressive as they could be in giving money back either in the form of dividends or a share repurchase.
Glaser: Does that extend to Berkshire, or do you buy Warren Buffett's argument that it would be better to sell off portions of your Berkshire stock versus getting a dividend directly from the company?
Yacktman: I think Buffett is incredibly objective and recognize that there is a frictional cost to taxpaying shareholders when a dividend is paid. So the secret, though, if you're going to go to the repurchase route, which is the alternative route, or acquisitions, is to be very, very disciplined and do it at the right time. Buffett has clearly demonstrated that that's the kind of way in which he's going to behave. But I think he's like a human computer and looks at things. Clearly, as he's gotten bigger, I think it's been more difficult for him, but I think he is very objective.
Glaser: Do you think when his successor takes over, that calculus will change a bit, that there will be more of a pressure to pay that dividend? Or is that too speculative to say?
Yacktman: I just think that rather than speculate on it, let's see what evolves. I think that the avalanche is getting bigger and bigger. I mean, the one book on him is called The Snowball, and the snowball is just getting enormous. That is a real challenge. I think the question is not only that one, but will the next person be as hands-off as Buffett is, really being as decentralized an operating person? That requires a certain sort of mentality that not all managers seem to have. I mean, compare him with somebody like [former General Electric CEO] Jack Welch, who is pretty much the other way.
Glaser: Well, Don, I really appreciate you taking the time today.
Yacktman: You bet, happy to be here.
Glaser: For Morningstar, I'm Jeremy Glaser.