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By Jason Stipp | 03-14-2011 11:30 AM

Herro: Hard to Believe Japan Sell-Off Is Real Value Lost

In crisis situations, investors often sell first and ask questions later, says the Oakmark manager.

Jason Stipp: I am Jason Stipp with Morningstar. As the Japanese market continues to be rattled in the wake of the natural disaster that occurred on Friday, we're checking in with David Herro--he is the manager of Oakmark International and was also named Morningstar's Fund Manager of the Decade last year--to get his take on the situation and what he sees for the future.

Thanks for joining me, David.

David Herro: I am very happy to try to help out this morning.

Stipp: So, the first question for you, overnight the Nikkei 225 was down about 6%. There's obviously a lot of concern about the situation in Japan. It's a story that's still developing.

I wanted to get a sense from your perspective--and you do have a good number of holdings in Japan--how much of the selling that's happening in Japan right now is due to a real fundamental loss of value due to the natural disaster that occurred there, and how much is fear right now in the market about what could happen?

Herro: I think when you look at the severe price downward movements, and you mentioned that Nikkei was down 6.18%, the TOPIX was down 7.5%, and the JASDAQ, the smaller companies, was down 9.92%. I think it's hard to believe that the average Japanese company is worth 8% to 10% less as a result of what happened with the natural disaster.

Clearly, it was a bad disaster, and clearly there's going to be damage to the macro economy, but the intrinsic value of a business is not determined by what's going to happen in the next day, week, or quarter. The intrinsic value, especially our belief is, and the fundamental financial sense tells you, the intrinsic value is the present value of all future cash flows.

So you have to look at what a business is going to do, not just over the next couple of weeks but over the next couple of years and decades, in fact, when valuing a company. And when you look at it with that perspective and when you look at the price of Japanese companies, it's hard to believe that most companies have been diminished in value by this 6% to 10%, which the markets are showing.

So, what often happens in these situations is people sell first and ask questions later. And as everyone heads to the exits, what you see is a broad-based and uniform selling that doesn't quite match with what's happening fundamentally.

Stipp: David, it does seem like the story is still developing in Japan, and I know that there are still headlines about concerns at some of the nuclear reactors. Do you think that we'll continue to see more selling there and that we could be in for some more losses as that fear-selling continues on?

Herro: In the short term, it's really hard to say what's going to happen price movement wise. More selling in the short term is certainly possible as the headlines happen. But on the other hand if all of a sudden it looks like things are getting contained at the power plants, and we have a more clear view on the short-term and medium-term damage to physical infrastructure, we get a clearer picture. That is, if there is less uncertainty, you might see people realizing that perhaps the market was oversold and you would see some buying.

So, in the short term it's very hard to judge which of these two forces in this tug of war wins, but it certainly is a possibility that there might be some selling. But on the other hand, if we start seeing some stability and some less uncertainty, you could start to see some buying.

Stipp: David, as you at look at your own portfolio holdings in Oakmark International, I believe you've about 23% in Japan. What sorts of holdings are those and have you made any changes to that position over the last few days, and what sorts of things would cause you to change that position if new news became available?

Herro: What would cause us to change our position? On the positive side, if we saw severe downward price pressure--if the price of the companies were dropping and not at all reflect a drop in the underlying intrinsic value of the business--we'd been inclined to add to those positions. So if it's a case where the value isn't dropping or it's dropping very little and the price, the market price, of the company dropped aggressively, we view this as a sign perhaps to add to positions.

What we have been doing is we've been looking at each and every company to see how they are impacted. For instance Toyota announced they are not going to produce cars in Japan for a couple of days. Now, this is going to have a short-term negative impact, but as we know Toyota produces cars all over the world and sells cars all over the world. Japan production is just one of the areas, and it's only shut for a couple of days. So, in the grand scheme of things, Toyota's production is just shut for a couple of days or even a couple of weeks, it probably is not going to have a material impact on the company's value. However, last night it dropped 8%. I think if it continues to drop, you would see good value there. We thought it was cheap before this happened, and the price has dropped. So, again, our key is to ascertain and to assess the impact this disaster has had on the long-term intrinsic value of the business, and if prices overreacted, then try to take advantage of it.

Stipp: Are there any companies, either in your portfolio or not, that you think would be particularly affected on the value front, their actual fundamental value could be a lot less today than perhaps what it was before the disaster struck?

Herro: As we look at the companies we own, we've not been able to find one that has had a material change in value as a result of the disaster. If we owned Tokyo Electric Power, I think it would be a different story. If we owned some of the insurers, it would be a different story. But from what we own and where their production is based and the spread of their production, it does not appear that any of the names we own have sustained a material hit to their intrinsic value.

Stipp: David Herro, Oakmark International Fund, thanks so much for your time today and giving us some context around the situation in Japan.

Herro: You are very welcome.

Stipp: For Morningstar, I am Jason Stipp. Thanks for watching.

 

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