10 Conviction Buy Ideas from Our Top Managers

By Greggory Warren, CFA | Senior Stock Analyst

With over two-thirds of our Ultimate Stock-Pickers having reported their third-quarter holdings, we've been able to glean some of the higher conviction purchases made by our top managers during the most recent period. Much as we had noted last quarter there was a fair amount of buying going on in the health care sector, with at least 19 different securities purchased by our Ultimate Stock-Pickers during the quarter. It wasn't too surprising to see large-cap health care names like  Pfizer (PFE) and  Johnson & Johnson (JNJ) pop up as conviction purchases. However, given the impact that near-term concerns over a government-sponsored health-care plan have had on the stock prices of firms in this sector, it was interesting to see a couple of non-traditional names see new money purchases as well, namely  DENTSPLY International (XRAY) and  Patterson Companies (PDCO), both of which are focused on dental products.

Our Ultimate Stock-Pickers were also putting money to work in the industrial materials sector, which is another unique Morningstar sector designation that encompasses everything from producers of farm equipment and agricultural products (like  Deere (DE) and  Monsanto ), to aerospace firms (such as  Boeing (BA)) and waste haulers (like  Waste Management (WM)). Our top managers bought 22 different names in the sector, with  Republic Services (RSG) being the one name that was bought with the most conviction. As you may recall from one of our more recent articles,  Oak Value Fund  made a significant new money purchase of Republic Services, the nation's second-largest non-hazardous solid waste company behind Waste Management, during the third quarter (contributing greatly to its designation as a high conviction purchase during the period).

10 Recent High Conviction Purchases by our Ultimate Stock-Pickers

Stock Price and Morningstar Rating data as of 11-12-09

What is interesting to note, though, is that despite all of the buying that went on in the health care and industrial materials sectors, which aside from the consumer goods sector had the most buying interest during the quarter, the list of top 10 high conviction purchases by our Ultimate Stock-Pickers (so far) is spread out a bit more evenly across the different sectors of the market. Of these 10 names, only  Comcast  and  Procter & Gamble (PG) are, however, trading at prices where our analysts would consider them to be buyable. In fact, most of them continue to trade at or around our own fair value estimate(s), much as they did during the third quarter, with  Berkshire Hathaway (BRK.A) (BRK.B) being the one exception. The stock also stands out because one of the high conviction purchasers during the quarter was Bruce Berkowitz, whose  Fairholme (FAIRX) fund has been a net seller of Berkshire the last couple of years.

As we had noted in a recent article, Fairholme had completely eliminated its stake in Berkshire's Class B shares before June of last year and sold off the remainder of its Class A shares by the end of November of 2008. But according to the fund's latest 13-F filing with the SEC, Fairholme has bought back more than $500 million worth of the Berkshire's shares, making the insurer one of the fund's five largest holdings at the end of the most recent period. An odd move for Berkowitz, considering that just one year ago he had said the following about Berkshire:

"We have tremendous respect for Warren Buffett but we have to listen to the man who believes that he's going to do a couple of points better than the S&P 500 and given [Berkshire's] size, I would not disagree with that comment. He also has companies that are subject to the same problems that today's economy are presenting [and] significant contracts on puts on the S&P. I mean Berkshire Hathaway traditionally has suffered with most companies during difficult period[s]. But in the past, it has gone up much faster than the S&P during a turnaround. So we felt that given our size we should still have the ability to do better than a couple of points [over] the S&P [and] it was time to dramatically lighten the load."

Then again, his move to unload his Berkshire shares were rather timely, and if he truly believes that "in the past, [Berkshire] has gone up much faster than the S&P during a turnaround," then he may just be ensuring that he's on board again before the Buffett Express leaves the station.

10 5-Star Stocks from Recent Purchases of our Ultimate Stock-Pickers

Stock Price and Morningstar Rating data as of 11-12-09

Lacking truly actionable ideas from the 10 highest conviction purchases made by our top managers during the latest quarter, we decided to dig a bit deeper in order to put together a list of 10 higher conviction purchases that are currently trading at prices where our analysts consider them buyable. While the list is dominated by health care names, which is not too surprising given the fact that 18 of our 51 current 5-Star stocks are from that sector, there are a few names, like  Genzyme  and  Stryker (SYK), which haven't garnered as much interest as the more traditional health care names like Pfizer and Johnson & Johnson.

 Comcast 
Comcast was literally a new money purchase for the  Yacktman (YACKX) fund over the last two quarters, as its weighting in the stock jumped from less than 1% at the end of the first quarter to 5% by the end of September.  Harbor Large Cap Value (HAVLX) also made a significant new money purchase in the name during the third quarter. Besides being the largest domestic cable provider, Comcast is also a significant provider of Internet and telephone services. Our analyst Michael Hodel believes Comcast's competitive advantages stem from the fact that no other company can match it ability to offer multiple services over one connection within the territories it serves.

 Procter & Gamble (PG)
Procter & Gamble continues to be a top holding for our Ultimate Stock-Pickers, with  Matrix Advisors Value (MAVFX),  Parnassus Equity Income (PRBLX), and Yacktman all making meaningful additions to their positions during the quarter. Our analyst Lauren DeSanto strongly believes that P&G's ability to consistently reinvent itself and refocus on improving its capabilities will serve it well in the current environment, as firms with moats as wide as P&G's tend to have greater resilience with their structural competitive advantages shining through during periods of economic weakness.

 ITT Educational Services (ESI)
The Oak Value fund has been a big buyer in the for-profit education industry over the last few quarters, picking up  Apollo Group  in the second quarter and ITT Educational Services more recently. The managers of the fund believe that while the "education sector is a bit out of favor among investors at this time, owing to fears of the rising student loan default rates that can be expected to accompany rising unemployment," strong demand for post-secondary education should continue to benefit these companies longer term, which only echoes the thoughts of our analyst Todd Young.

 Pfizer (PFE)
Pfizer is another top holding for our top managers, with both  Columbia Dividend Income  and Yacktman adding to their stakes in the name during the quarter. Our analyst Damien Conover believes Pfizer's sheer size provides it with the largest economy of scale in the pharmaceutical industry, and that was even before the Wyeth acquisition was announced. He believes the integration of Wyeth will not only strengthen Pfizer's diverse drug offerings, but offer substantial opportunities for further cost savings for the pharmaceutical giant.

 Novartis (NVS)
Damien also likes Novartis, which he feels derives its strength from a diversified operating platform that includes branded pharmaceuticals, generics, vaccines, diagnostics, and consumer products. In an industry plagued by stagnant growth, Novartis emerges as a juggernaut with diversified operating platforms and an industry-leading number of new potential blockbuster drugs. It's no wonder Novartis remains a top holding for our Ultimate Stock-Pickers, with both Parnassus Equity Income and  Tweedy Browne Value (TWEBX) adding to their stakes in the name during the period.

 Applied Materials (AMAT)
While a relatively small holding among our top managers, Parnassus Equity Income did make a meaningful increase to its stake in Applied Materials. Our analyst Andy Ng believes has unmatched scale and a broad enough product portfolio to continue to drive growth longer term in the semiconductor equipment industry. While severe cyclical slowdowns in the chip and solar equipment markets have been hampering the firm of late, Andy expects Applied Materials to retain its leadership position in the industry, where it remains the closest thing to a one-stop shop for many of its customers.

 Johnson & Johnson (JNJ)
With 15 of our 26 top managers holding the name, Johnson & Johnson is one of the most widely held securities among our Ultimate Stock-Pickers, with both Parnassus Equity Income and Yacktman adding to their stakes during the quarter. Our analyst Damien Conover believes J&J's ability to maintain a diverse revenue base and a robust research pipeline, generate exceptional levels of cash flow, and control the top or number-two spot in 70% of its product lines, has endowed it with a wide economic moat around its business.

 Becton, Dickinson and Company (BDX)
Becton Dickinson has been a favorite of our analyst Alex Mozorov for some time now. The company is the world's largest manufacturer and distributor of medical surgical products, such as needles, syringes, and sharps-disposal units, and also manufactures diagnostic instruments and reagents, as well as flow cytometry and cell imaging systems. Berkshire Hathaway's new money purchase of the name during the second quarter was echoed by a similarly sized purchase by the managers at  Mutual Shares (TESIX) in the third quarter. At this point, 7 of our 26 top managers hold a stake in the medical products firm.

 Genzyme 
Matrix Advisors Value more than doubled their position in this biotechnology firm, which is focused on developing therapies for genetic disorders and other chronic debilitating diseases. Our analyst Karen Andersen believes Genzyme's in-house innovation and smart acquisitions have enhanced its ability to succeed globally. Despite the impact that ongoing supply constraints of two of its leading rare disease therapies have had on results, Karen feels the firm's ongoing manufacturing and strategy improvements should set the stage for a recovery in 2010.

 Stryker (SYK)
Both  Amana Trust Growth (AMAGX) and Yacktman made meaningful new money purchases in Stryker during the third quarter. Our analyst Julie Stralow believes that Stryker excels in several of the orthopedic and medical equipment niches where it competes, and fully expects the firm to continue launching innovative new products to maintain its competitive position. While health-care reform efforts could reduce long-term returns in Stryker's U.S. operations, she believes the firm should still make solid enough returns to continue returning value to shareholders.

Disclosure: Greggory Warren owns shares in the following securities mentioned above: Amana Trust Growth; Becton, Dickinson and Company; Johnson & Johnson; and, Procter & Gamble.