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Investing Specialists

Top 10 Buys and Sells from Our Ultimate Stock-Pickers

Most managers are positioning themselves for the next stage of the market rally.

By Greggory Warren, CFA | Senior Stock Analyst

Given the run-up in the markets during the second and third quarters, we weren't too surprised to see relatively few new investment ideas coming out of the top holdings, purchases, and sales of our Ultimate Stock-Pickers. Many of the stocks in these portfolios have converged on our analysts' fair value estimates. That said, our managers were still fairly active during the third quarter, either adding to or subtracting from their existing positions, building positions in new names, and selling some holdings outright. Based on some of the commentary we've seen so far from our Ultimate Stock-Pickers, it looks like many of them have adopted the habit of continually reevaluating their holdings as the equity markets (and prospects for the companies in their portfolios) move around during the early stages of the economic recovery. This has allowed them to more quickly make adjustments to their holdings whenever they see an opportunity to either lock in a gain, or put money to work in either a new name or an existing position.

Many of our Ultimate Stock-Pickers also noted that they continue to see opportunities in health care, something we not only highlighted during a review of second quarter holdings but saw further evidence of in some of the conviction purchases we noted in an early read of our manager's holdings for the third quarter. Health care stocks have been under pressure for much of this past year over concerns about the impact that a government-sponsored health-care plan would have on the industry's profitability. The question for investors, though, has been whether or not these near-term issues would derail the long-term positive impact that the aging of the baby boomers is expected to have on the industry overall. Judging from some of the more recent conviction purchases by our Ultimate Stock-Pickers, the answer still appears to be no. In fact, health care was one of the five areas where our managers were overweight the market, with slightly more than 14% of their aggregate holdings in the sector at the end of the third quarter, versus less than 13% for the S&P 500 Index . The other four areas were business services (at 7% versus 3% for the market), consumer goods (17% versus 11%), financial services (20% versus 14%), and media (5% versus 2%).

We've also seen a lot of commentary about how the rally off the bottom has been led by primarily (in the words of the managers at  Chase Growth  fund) by "low quality, higher beta, more cyclical stocks and, in particular, those stocks that were down the most during the market declines of 2008 and early 2009." The expectation being that as the bull market matures--that is, if this is more than just a "major cyclical rally within a secular bear market"--that we'll start to see more pronounced leadership from higher-quality blue-chip stocks (especially those with strong balance sheets).

Blue Chips Attract More Greenbacks
Looking at the top ten stock holdings of our Ultimate Stock-Pickers at the end of the third quarter-- Berkshire Hathaway  / ,  Microsoft ,  Johnson & Johnson ,  Wells Fargo ,  Coca-Cola ,  ConocoPhillips ,  Procter & Gamble ,  Burlington Northern ,  Pfizer , and  Wal-Mart , respectively--it looks like that continues to be the game plan for most of our managers. Every single one of these holdings saw additional capital being put to work in them during the period, with several of them seeing new money purchases by some of our managers. Of the new money purchases, Berkshire Hathaway stands out from the group, because the most significant buyer during the quarter was Bruce Berkowitz, whose  Fairholme  fund has been a net seller of Berkshire the last couple of years. Berkowitz paid for his purchases in part by completely eliminating his stakes in  American Express  and  General Dynamics , as well as trimming positions in  UnitedHealth Group ,  WellPoint ,  Boeing , and  Forest Laboratories .

Meanwhile, Microsoft saw two significant new money purchases (by Chase Growth and  Sound Shore ), as well as additions to existing positions by five of the sixteen managers that owned the stock at the end of the third quarter. Johnson & Johnson, the only 5-Star name among our managers' top ten holdings, saw additions by five of the fifteen funds owing the stock, while Well Fargo had three managers (including Berkshire Hathaway, the largest shareholder amongst our Ultimate Stock-Pickers) adding to their positions. Coke received attention from five of our managers, with two meaningful additions and a new money purchase, while ConocoPhillips saw additions by four of the eleven managers holding the stock. Procter & Gamble, which had been a 5-Star stock through much of the first ten months of 2009, had five managers putting additional money to work, with the  Yacktman  fund making the most meaningful increase.

Burlington Northern saw two funds,  Aston/Montag & Caldwell Growth  and  Parnassus Equity Income , putting additional capital to work during the period, which we can only assume paid off handsomely given Berkshire Hathaway's $100 per share offer for the company in early November. The stock had traded in a range of $68 to $86 per share from the end of June through the end of October. Meanwhile, Pfizer, which had also been a 5-Star stock for much of the first ten months of 2009, was purchased by two funds ( Columbia Dividend Income  and Yacktman) during the recent period. Wal-Mart, though, saw the most activity with one new money purchase and seven additions by the sixteen managers that held shares of the retail giant at the end of the third quarter.

Ultimate Stock-Pickers' Top Purchases

 Star RatingFair Value UncertaintySize of MoatCurrent Price ($)Price/Fair ValueNo. of Fund OwnersMicrosoft 3MediumWide29.830.9316Berkshire Hathaway 4MediumWide32910.7514CncoPhllps 3MediumNarrow51.170.911Republic Services 3MediumNarrow28.470.982Precision Castparts 3HighNarrow107.891.172Wal-Mart 3LowWide54.440.9116PepsiCo 3LowWide62.760.928P&G 4LowWide62.560.8113General Electric 4HighWide160.647TJX Companies 3MediumNarrow37.311.076

Data as of 12-03-09. Fund ownership data as of funds' most recent filings.

The list of top ten purchases for the most recent period includes many of the names we recently highlighted in a piece on high conviction purchases by our top managers (based on the top holdings, purchases and sales of over two-thirds of our Ultimate Stock-Pickers), as well as some new entries. 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 (along with a somewhat smaller purchase being made by Berkshire Hathaway).

 Precision Castparts  saw significant new money purchases by two of our top managers,  Oakmark Equity & Income  and  Sequoia . Despite having nearly doubled in price since the markets bottomed in the early part of March, this manufacturer of complex metal components for aerospace and industrial gas turbines looked attractive enough during the third quarter for these two managers to commit new capital to the name. As for the three other top purchases that we haven't already covered,  PepsiCo  was purchase by three of the eight managers holding the security at the end of the period, with Yacktman making a fairly meaningful addition to its position in the food and beverage giant.

 General Electric , meanwhile, was purchased by three of the seven managers that held it at the end of the third quarter, with  Fairfax Financial  increasing its share holdings by nearly 50% (with General Electric representing 11% of the insurance company's holdings, excluding the impact of its controlling stake in Odyssey Re, at the end of the period). While not quite as dramatic,  TJX Companies , saw three fund managers putting money to work in the name during the third quarter, with Aston/Montag & Caldwell Growth making a significant new money purchase. Of the next five most significant purchases made by our Ultimate Stock-Pickers during the most recent period-- Adobe Systems ,  News Corporation ,  Hewlett-Packard ,  Deere , and  Symantec --all of them are trading at/around our analysts' fair value estimates, leaving us with few investable ideas out of even the top 15 stock purchases by our managers.

Ultimate Stock-Pickers' Top Sales

 Star RatingFair Value UncertaintySize of MoatCurrent Price ($)Price/Fair ValueNo. of Fund OwnersTyco Electronics 3MediumNarrow23.70.955Occidental Petroleum 3HighNarrow80.150.947Petroleo Brasileiro 3V HighNarrow52.121.183IBM 2LowWide127.551.137Moody's UHighWide23.5403Tiffany 2HighNarrow42.51.421Qualcomm 3MediumWide44.630.915Autmtc Data Prcssng 3MediumWide43.190.858Apple 3MediumNarrow196.480.994Apache 3HighNarrow94.90.815

Data as of 12-03-09. Fund ownership data as of funds' most recent filings.

As for the sales, there were four hardware firms-- Tyco Electronics ,  International Business Machines ,  Qualcomm , and  Apple --and three energy companies-- Occidental Petroleum ,  Petroleo Brasileiro , and  Apache Corporation --among the top ten names. While it's always difficult to figure out the true motivation behind a sale absent an explicit statement from the manager involved, we can always infer something from the holdings of the manager doing the selling, or in some cases from the market activity in the stock during the period in question. With the hardware names, it looks like Chase Growth fund was the most active, selling IBM, Qualcomm and Apple outright, with  Dodge & Cox Stock  fund being the largest seller of Tyco Electronics. As all of these names were up dramatically off their lows of early March, it was not too surprising to see some of our managers locking in (either) some (or all) of their gains.

The moves with the energy stocks, though, were far more concentrated with one of our insurance companies,  Alleghany , which made outright sales in Occidental Petroleum and significantly trimmed its position in Apache (as well as an outright sale of  Anadarko Petroleum , and big reductions in  Chevron (CVX) and Global Industries ). That said, the insurance company is still betting big on ConocoPhillips (which made up close to 13% of the portfolio at the end of the period), with energy accounting for more than 60% of Alleghany's total stock holdings at the end of the third quarter (versus 67% at the end of the second quarter and 48% at the beginning of the year).

As for the three other top sales by our Ultimate Stock-Pickers-- Moody's ,  Tiffany , and  Automatic Data Processing --they were all big sales by the managers that were doing the selling during the quarter. As you may recall, we recently noted that Berkshire Hathaway had made meaningful reduction to its holdings in Moody's during the period, although we're not sure if the reasoning for the sale by the insurance firm is the same that Oak Value gave for selling off its entire position during the third quarter. That is, that the fund had concluded that the risk-reward tradeoff for the stock had "shifted in the wrong direction," as increased public scrutiny over the firm's credit rating operations was likely to lead to increased government regulation, as well as open the door to litigation, which "could significantly affect the future of the company and its financial position."

Oak Value was also a big seller of Tiffany, a stock that the fund manager has regularly bought and sold over the years, as the valuation had reached a point where they felt it best to sell the stock. Tiffany had been a big contributor to performance during the last two quarters, increasing more than 120% from its lows in early March to the end of September. Meanwhile, both Chase Growth and  WHG Large Cap Value (WHGLX) were outright sellers of Automatic Data Processing during the period. This is surprising, given that the stock had not run all that much, and the fact that we had several other managers adding to their positions in this provider of human resources administration services.

Disclosure: Greggory Warren owns shares in the following securities mentioned above: Johnson & Johnson and Procter & Gamble.

The Morningstar Ultimate Stock-Pickers Team does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.