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By Laura Lallos | 05-01-2013 11:00 AM

Same Process, Different Portfolio at Dodge & Cox

Dodge & Cox managers Diana Strandberg and Charles Pohl explain how the firm's long-term, bottom-up process led to tech, health care, and financials names over the last decade.

Laura Lallos: Hello. I'm Laura Lallos, a fund analyst here at Morningstar.

We have with us today guests from Dodge & Cox, Charles Pohl and Diana Strandberg. Thank you very much for coming.

Diana Strandberg: Hi, Laura.

Charles Pohl: Hi, Laura.

Lallos: I was hoping we could start off talking about technology, because your portfolios represent a pretty broad range of tech names, from Hewlett-Packard to Google. Could you talk about how such different picks fit into your process?

Pohl: Well, I think those two names are a good illustration of the nature of our process, because our process involves a very thorough bottom-up fundamental analysis of companies. We're looking for companies that have good potential for growth in earnings and cash flow, looking for companies with strong business franchises, and companies with high-quality management teams that are oriented towards creating shareholder value. So that's one half of the equation. And the other half of the equation for us is valuation. And so the process of decision-making is a weighing of those fundamentals against the valuation that we see in the marketplace.

In the case of Google and Hewlett-Packard, the equation is a little different. In Hewlett-Packard you have very low valuation relative to what we think the long-term earnings power of the company is. But some of the fundamentals are a little weaker than in a company like Google, where we think you've got some very strong fundamentals, and a little bit higher valuation. But in each case, when weighing both sides of it, we think that they're attractive situations.

Lallos: Hewlett-Packard is currently the largest holding in your domestic stock fund, Dodge & Cox Stock, and that's, I assume, because the valuation is so compelling.

Pohl: Yes. Hewlett has an exceptionally low valuation. We think that the long-term earnings power of that company is $3.50, maybe $4 a share. It's trading at a little less than $20 a share, and so a very low multiple of what we think the company potentially could earn. But the company also has some attractive fundamentals, particularly the printer business, we think, is a business with a lot of barriers to entry; they have very large market shares. And even in some of the other businesses--PC is certainly under a lot of pressure now, as are their other services businesses--but those are fundamentally pretty good businesses for the company, as are the server and storage businesses.

So a reasonable set of fundamentals. We think the management situation there has been greatly improved over the last year or so since Meg Whitman came in and some of the changes she made throughout the organization, and you saw some of the effects of that in the first quarter. So we have an improving management situation, some reasonably attractive businesses, and a very low valuation, and those things combine to make it an attractive investment for us.

Lallos: Overall your exposure to technology, as well as media names and telecom, and also health care, have increased dramatically since 1999, and I was hoping you could talk about why these are areas that are attractive today.

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