Top 10 Buys and Sells from Our Ultimate Stock-Pickers

By Greggory Warren, CFA | Senior Stock Analyst

Following the run-up in the markets over the second, third and fourth quarters of last year, our Ultimate Stock-Pickers continued to adjust their portfolios in preparation for what they believe will be the next stage of the market. The more than 60% increase in the S&P 500 Index  from its low point during the first week of March of last year until the end of 2009 puts it right up there among the biggest stock market rallies that investors have seen over the last century. This run-up in the markets led to a 26% gain in the index for the full year (after it had declined nearly 20% during the first two months of 2009), helping to reverse a fair amount of the damage inflicted by the bear market during 2008. Cautious optimism seems to be the most prominent opinion in the end-of-year commentary put forth by our top managers, who remained fairly active during the fourth quarter, either adding to or subtracting from their existing positions, building positions in new names, and even selling some holdings outright.

With more than a handful of our Ultimate Stock-Pickers believing we were due for a bull market correction, which seemed to play out a little bit at the beginning of the year (as the market lost nearly 4% of its value in January), there was a drift towards more defensive sectors. At the end of the most recent period, Consumer Goods accounted for 17% of the aggregate holdings of our 26 managers, with names like  Coca-Cola ,  PepsiCo  and  Clorox  being purchased with conviction since the end of the third quarter. We'd noted this shift a few weeks ago when we did an early read on the holdings, purchases and sales of about half of our Ultimate Stock-Pickers, and it looks like it carried through to the rest of the group. That said (and much as we noted in our previous article), there were also conviction purchases made during the period in money-center banks--namely,  Bank of New York Mellon  and  Citigroup --which, (while well past the calamities that had brought them to their knees in the autumn of 2008) are hardly what we would call risk averse.

Some Changes in the Investment Manager Roster
Before we go any further, though, it should be noted that we've shaken up the Investment Manager Roster a little since we last walked through the top holdings, purchases and sales of our Ultimate Stock-Pickers. As you may recall, when we closed out 2009 we had talked about taking a much deeper look at the funds represented on our list of top managers in the hopes of improving not only the timeliness of the data we were receiving but in an effort to weed out several managers that had been underperforming. When we relaunched Ultimate Stock-Pickers last year we'd stated that we wanted to be more proactive with the Investment Manager Roster than others had been in the past, moving managers off the list and replacing them with better-performing peers whenever we felt that such a move was warranted.

We've also been committed to getting the timeliest information we can get our hands on, which translates into more robust buy and sell lists for investors. In our view, it makes no sense to wait around for a quarterly filing by one manager, when another (with just as impressive a track record of generating strong investment performance) provides us with monthly (or at least more timely quarterly) holdings. With all of that in mind, we've decided to remove  Chase Growth ,  Harbor Large Cap Value ,  Sequoia , and  WHG Large Cap Value  from our list of managers. While there were more than a few reasons for taking each of these funds off the roster, the decision ultimately started with performance, with each of these funds underperforming the broader market by a fairly wide margin in 2009--a year when the market had one of its strongest rallies in the last 100 years.

Of the four funds we're dropping, we'll probably miss Chase Growth the most, given that it was always a big source of buy and sell ideas for The Ultimate Stock-Pickers Team. That said, we'd begun to doubt the conviction behind many of the trades the fund was making, especially as we'd started to see more and more situations where the managers were buying a stock in one period and then turning around and selling it one or two quarters later. Don't get us wrong, we're all for taking advantage of short-term opportunities, but the turnover rate at Chase Growth exceeded 180% last year, which indicates to us that they were having a hard time figuring out where they should be invested. This probably explains why the fund underperformed not only the market (by 1,300 basis points) but the Large Cap Growth category (by 2,200 basis points) during 2009. With a focus on consistently generating high-conviction buy and sell ideas for investors, it was getting harder and harder to keep Chase Growth in the mix.

With four open slots in the Investment Manager Roster, we dug a little deeper into some managers that had been recommended to us by Morningstar's fund analysts, adding the following funds managers to our list:  FMI Large Cap ,  FPA Crescent ,  Hartford Capital Appreciation , and  Columbia Value & Restructuring .

All four funds posted market-beating returns last year, with both Hartford Capital Appreciation and Columbia Value & Restructuring generating returns in excess of 40%. This tells us that these managers have a fairly good sense of what's working and what's not in these markets.

Both FMI Large Cap and FPA Crescent run fairly concentrated stock portfolios, with the latter conservatively shorting stocks in an attempt to lower overall portfolio volatility. While Hartford Capital Appreciation and Columbia Value & Restructuring might run less concentrated portfolios, they're more than willing to take on larger positions in individual stocks in situations where they're convinced the security is significantly undervalued.

Ultimate Stock-Pickers' Top Holdings

*Under review
Data as of 03-04-10. Fund ownership data as of funds' most recent filings.

Even with the changes in the Investment Manager Roster, there weren't any significant changes in the top ten stock holdings of our Ultimate Stock-Pickers at the end of the fourth quarter. Nine of the names on the list were top holdings at the end of the third quarter, with  General Electric  replacing Burlington Northern  by virtue of the railroad being acquired by  Berkshire Hathaway  /  in November of last year. While all ten names saw additional capital put to work in them during the period, with several of them seeing new money purchases by some of our managers,  ConocoPhillips  and  Pfizer  experienced major sales. Berkshire Hathaway,  Davis NY Venture , and  Sound Shore  all made meaningful reductions to their stakes in ConocoPhillips, with the managers at Berkshire having spent the better part of the last year and a half winding down what had been a significant stake (and one which Warren Buffet has admitted was one of his rare mistakes) in the oil and natural gas firm.

While the sale of Pfizer by Bruce Berkowitz's  Fairholme  fund was significant, with the manager selling off close to 60 million shares of the stock, it wasn't enough to push the company out of the top ten highest conviction holdings of our Ultimate Stock Pickers. Eleven different managers, including Berkowitz (who continues to hold 17 million shares of the stock), held Pfizer in their portfolios at the end of the period. That said,  Wal-Mart  remains the most widely-held security, showing up in fifteen different portfolios, with   Microsoft  and  Johnson & Johnson  being the second and third most widely held, with positions in each name established in at least thirteen different portfolios. Microsoft was also the beneficiary of a meaningful new money purchase during the quarter by Hartford Capital Appreciation. As for the rest of the top ten holdings, several of our managers were making new money purchases in the following securities during the period: Coke,  Procter & Gamble ,  Wells Fargo , and Pfizer.

Ultimate Stock-Pickers' Top Purchases

*Under review
Data as of 03-04-10. Fund ownership data as of funds' most recent filings.

More than half of the list of top ten purchases by our managers reflects names that we recently highlighted in a piece on high conviction purchases by our top managers (based on the top holdings, purchases and sales reported by half of our Ultimate Stock-Pickers). As we mentioned earlier, there seems to be an equal amount of conviction being placed in more defensive sectors of the market, like Consumer Goods and Health Care, as there is in (relatively) riskier areas, like Financial Services and Energy. Given the run-up in the markets over the last year, we believe that we're now in a true stock-pickers market, where the winners will be found by sifting through each of these sectors to find undervalued stocks. We take solace in the fact that legendary investor Bill Nygren, manager of the  Oakmark  and  Oakmark Select  funds has come to a similar conclusion, noting in an interview with our fund analysts that:

"The stock-picking opportunities aren't as obvious to us as they were last year. It is hard to identify a large percentage of the S&P that we believe we can add value by simply avoiding. However, there are always some industries that investors have punished because of uncertain outlooks, and we believe that our long-term investment horizon gives us a big advantage in investing in those industries. Health care, technology and financials would be some examples of industries where we think today's concerns are likely to disappear within our investment time horizon."

It's also interesting to note that two of the stocks Nygren discussed in the interview-- H&R Block and  Comcast  / --were meaningful new money purchases by at least one of our managers during the period. H&R Block (not too surprisingly) was bought by  Oakmark Equity & Income , which, while not run by Nygren, is influenced by the research process at that asset management firm. In its quarterly commentary, the managers of the fund noted that their "only new position was in H&R Block, a company with commanding market share in the tax-return preparation business. Its new management team has slowly been unwinding the company's missteps in the mortgage securities and investment areas and has re-focused on its core business."

While both Harbor Capital Appreciation and  Yacktman  made meaningful new money purchases in Comcast during the most recent period. Oakmark Equity & Income was, quite ironically, a big seller of the cable television firm. The fund was not alone, though, as two other funds unloaded shares in Comcast, with both Oakmark Equity & Income and  Mutual Shares  eliminating the name completely from their holdings. Oddly enough, this move by Oakmark Equity & Income ran contrary to Nygren's addition of the stock to both Oakmark Select and  Oakmark Global Select  during the quarter. Clyde McGregor and Edward Studzinski, the managers at Oakmark Equity & Income, cited credibility concerns about Comcast's management (as the firm pursued the purchase of NBC Universal) and the "long-term growth potential of the cable business in an increasingly Internet world," as the reason behind their decision to sell. Nygren saw the pressure that these concerns were putting on the company's stock price as a reason to buy. While we recognize that there are always going to be buyers for every set of sellers of any given security, it's interesting to note that both parties were in the same house this last quarter.

Ultimate Stock-Pickers' Top Sales

Data as of 03-04-10. Fund ownership data as of funds' most recent filings.

As for the rest of the sales (that is, those we haven't already talked about), both Harbor Capital Appreciation and  Alleghany  were unloading shares in  Petrobras . This seemed to be part of an overall move by these managers to reduce their Energy exposure, as Harbor Capital Appreciation also eliminated stakes in  Halliburton  and OAO Gazprom , while Alleghany blew out positions in  EOG Resources ,  Devon Energy  and  XTO Energy . As for the two Consumer Goods names on the list of top sales,  Oak Value  unloaded its stake in  Cadbury  even as the managers of the fund believed that  Kraft Foods' (KFT) bid for the firm was discounting the candy company's intrinsic value. Sometimes the value you can realize today is far better than the value you can realize longer term (especially if you have someplace more lucrative to stash that cash). As for  Canon , it was a major sale at FMI Large Cap, one of the recent additions to our Investment Manager Roster. Meanwhile,  Chubb  was completely eliminated from Sound Shore's holdings during the period. 

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