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By Jason Stipp | 03-11-2010 11:56 AM

Long-Haul Companies Look Undervalued

The long-duration characteristics of high-quality firms are dramatically undervalued in the marketplace, says Smead Capital's Bill Smead.

Jason Stipp: I'm Jason Stipp for Morningstar. After a one-year anniversary of the market bottom in March 2009, and a 60%-plus run up in the S&P 500, investors may naturally be wondering where are the values today? Bill Smead, CIO and CEO of Smead Capital, and also the portfolio manager of the Smead Value Fund, says some of the values are right under our nose in some of the best-known American companies. He's here with me to tell us a little bit more about that.

Bill, thanks for joining us today.

Bill Smead: Thank you.

Stipp: As I'm looking over your portfolio, it reads like a who's who of American companies. There's Microsoft, eBay, Starbucks, Merck, Disney. These companies are very well known, nobody would say that they're under-followed, but you're saying that you're able to pick some of these companies up at good values. So that basically means that you're taking a position that the market seems to not agree with. In your thinking, when you're looking at such well known companies, how do you get comfortable with the fact that you're buying them at a value and that the market is wrong?

Smead: Two things. Ben Inker at Grantham Mayo did some wonderful research that shows that 75% of the intrinsic value of a business comes from cash flows more than 11 years from now. So in a 10-year time period, when the stock market goes down, people have compacted the duration of how long they want to own a stock. And as they compacted the duration, they more and more undervalued the long-durational businesses. You folks do some great work on moats in your stock research and your mutual fund research. Moats are the kind of thing that cause long duration. So long duration characteristics are dramatically undervalued in the marketplace, and if there's a theme in our portfolio, you can see long duration companies.

We think that their earnings leverage going forward from the economy coming back, and then their 20-, 30-, 40-year histories, the intrinsic value today is way above the current stock prices.

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