Our Ultimate Stock-Pickers' Top 10 Buys and Sells
We saw a higher level of trading by our top managers in the most recent period.
By Greggory Warren, CFA | Senior Stock Analyst
The end of the third quarter and start of the fourth quarter of 2010 were exemplified by strong equity market performance, with the S&P 500 Index (SPX) posting one of its best returns for the month of September in the last 85 years. This compares to the seesaw of returns posted by equities during the five months prior to September 2010, with the market dropping more than 8% in May, and another 6% in June of this year. The market rebound was driven by solid second-quarter earnings results in the face of the European credit crisis, and its potential impact on the global economic recovery.
It was against this backdrop that our Ultimate Stock-Pickers were reviewing their portfolios, making purchases or sales that would prepare them for what they believed would be the next stage of the market. Much as we saw in the second quarter, our top managers continue to have a reserved attitude about the markets and the economy, unlike the first quarter of the year when they were imbued with a sense of cautious optimism.
As we were sifting through the holdings, purchases and sales of our Ultimate Stock-Pickers, we were intrigued by the dichotomy that continues to exist among our top managers. While most have been taking measured steps to invest in companies that have relatively stable revenue, sound balance sheets, and increasing cash balances that can be used for debt repayment, dividends, or share repurchases, a few continue to focus on more cyclically sensitive firms. As we sifted through our Ultimate Stock-Pickers' holdings, the best description of the current market environment that we could find was exemplified by the managers at the Jensen (JENSX) fund, who said the following in their third-quarter commentary:
"The economy seems to be in a state of malaise, and investors' sentiment has been marked by reactions to daily headlines rather than business fundamentals. In this environment, we live with a certain amount of "expectation risk" in our portfolio companies. As such, positives don't tend to result in stock prices being marked up significantly, but negative news drives stock prices down. Fundamental business performance�is generally good and improving. Companies are taking advantage of cheap credit, and using the proceeds to refinance debt, buy back shares, and pay growing dividends. The growth prospects in the U.S. and developed Europe will likely remain low for some time, yet the outlook for many emerging economies remains bright, allowing global companies�to pursue attractive opportunities for growth. We believe that valuations are compelling and, in many cases, disconnected from�earnings and cash flows�"
Ultimate Stock-Pickers' Top HoldingsStar RatingFair Value UncertaintySize of MoatCurrent Price ($)Price/Fair ValueNo. of FundsExxonMobil (XOM)4MediumWide69.230.815Brkshr Hthwy (BRK.B)3MediumWide79.760.8911Johnson & Johnson (JNJ)4LowWide62.300.8113Coca-Cola (KO)2LowWide64.111.1211Microsoft (MSFT)4MediumWide25.250.7914Wells Fargo (WFC)5MediumNarrow26.650.6810Occdntl Petrlm (OXY)3HighNarrow87.650.957Procter & Gamble (PG)4LowWide62.130.8112American Express (AXP)3HighWide42.270.7810Wal-Mart (WMT)3LowWide53.740.9013
Data as of 11-26-10. Fund ownership data as of funds' most recent filings.
Even with the changes made to the Investment Manager Roster at the start of the year, there haven't been any significant changes in the top ten stock holdings of our Ultimate Stock-Pickers over the last seven calendar quarters. Only three of the top ten highest conviction holdings of our 26 managers, ExxonMobil (XOM), Occidental Petroleum (OXY), and American Express (AXP), were not on the list at the end of the fourth quarter of 2008. Looking at the three names that fell off the list--Burlington Northern Santa Fe, ConocoPhillips (COP), and Pfizer (PFE)--each fell off for completely different reasons. As you may recall, all of the outstanding shares of Burlington Northern were acquired by Ultimate Stock-Picker Berkshire Hathaway (BRK.A) / (BRK.B) during the first quarter of this year. Pfizer, meanwhile took a tumble down the list after Fairholme (FAIRX)dumped what had been a rather substantial holding in the health care firm. While ConocoPhillips has been the target of selling activity by Berkshire over the last seven calendar quarters, it wasn't a seller during the third quarter. Instead, it was a major sale by Alleghany (Y) that finally pushed it out of the top ten holdings.
Alleghany is also the reason that ExxonMobil has made such a meteoric rise up the holdings list. The insurer started buying shares of the energy giant aggressively in the fourth quarter of 2009, as it eliminated the final 1 million shares it held in Burlington Northern in the wake of news that Berkshire would be buying the railroad. Alleghany had been a longtime holder of Burlington Northern stock, with shares in the railroad accounting for 36% of the insurer's equity portfolio at the end of 2008. Almost all of the proceeds from the sale of Burlington Northern shares went into energy stocks, with ExxonMobil being the largest recipient. The energy giant made up 46% of Alleghany's stock portfolio at the end of the third quarter of 2010, with the insurer adding another 1 million shares to its existing 6 million share stake. Alleghany has funded most of its purchases of ExxonMobil this year with sales of other energy stocks, like ConocoPhillips, Devon Energy (DVN), and Williams Companies (WMB).
Looking at the trading activity among the other top ten holdings, our managers were net sellers of Berkshire Hathaway's common stock, with Mutual Shares (TESIX) making the most meaningful sale during the period. Johnson & Johnson (JNJ), meanwhile, was the recipient of a meaningful new money purchase by FPA Crescent (FPACX), which when combined with the other buying activity by our top managers, was enough to overcome significant sales by Jensen and Parnassus Equity Income (PRBLX). While making no mention of the reason behind its complete sale of the health care firm, Parnassus was adding to positions in Medtronic (MDT), its fourth-largest holding, during the period. The manager also made significant new money purchases of Hewlett-Packard (HPQ), Cisco Systems (CSCO), and Spectra Energy (SE), several of which were discussed in a previous Ultimate Stock-Pickers' article.
Unlike during the second quarter, Coke (KO) was not the recipient of any high conviction purchases in the most recent period. It should also be noted that Alleghany, which made a significant purchase of Coca-Cola shares during the second quarter, unwound those same 500,000 shares in the latest quarter. Wells Fargo (WFC) also saw a significant sale during the period, with Fairfax Financial (FRFHF) whittling down a stake it had started to build during the fourth quarter of 2008. Offsetting this sale was a meaningful new money purchase by Matrix Advisors Value (MAVFX) and a significant addition by Berkshire Hathaway, which we highlighted in last week's article. Microsoft (MSFT) was also the recipient of several meaningful additions from Jensen, Oakmark Equity & Income (OAKBX), Parnassus, and Yacktman (YACKX), as well as a new money purchase by FPA Crescent.
New to the top holdings list this quarter, Occidental Petroleum was purchased in earnest by Alleghany, FPA Crescent, Aston/Montag & Caldwell Growth (MCGIX), and Parnassus. The managers at Aston/Montag & Caldwell noted that they had added to their stake in Occidental when the stock weakened after the energy firm reported an "operationally poor quarter" and negative press arose about CEO compensation. Believing that these issues would be transitory, and that continued modest economic growth would likely "drive steady to moderately higher oil prices," the managers increased the fund's share position in Occidental by nearly 50%. Aston/Montag & Caldwell also made a meaningful addition to its stake in Procter & Gamble (PG), helping to offset sales by Berkshire and Matrix Advisors Value during the period.
Winding down the list, American Express was the recipient of a meaningful addition by RS Capital Appreciation (RCAPX) (formerly Oak Value fund), as well as a new money purchase by Aston/Montag & Caldwell. Of its purchase of American Express, the managers at Aston/Montag & Caldwell noted that American Express has experienced a rapid recovery in its credit-loss rates, has slowed shrinkage in its loan portfolio, and seen more robust levels of capital and funding. They expect the firm to be a beneficiary of new regulations for interchange rates on debit cards, making it an ideal time for the fund to step into the name. This echoed thoughts from RS Capital Appreciation, which noted that "American Express's performance during the recession and its emergence as a stronger company demonstrate the power of its competitive, structural and economic advantages."
As for Wal-Mart (WMT), there were a few managers adding to their positions, but the group as a whole was a net seller given the significant reduction that Aston/Montag & Caldwell made to its stake in the retail giant. Unlike many of their other transactions, the managers at Aston/Montag & Caldwell made no comments on their sale of Wal-Mart during the period. They did, however, talk in length about their outright sales of Charles Schwab (SCHW), Research in Motion (RIMM), and Hewlett-Packard. According to manager Ronald Canakaris, the fund sold Schwab in reaction to continued reductions in 2011 earnings estimates, the likelihood that interest rates will remain low for an extended period of time, the possibility of reduced market activity, and the potential for lower assets under management. Canakaris eliminated the position in Research In Motion after the disappointing launch of its Torch 9800 smartphone. And, contrary to moves made by some of our other top managers, Aston/Montag & Caldwell dumped Hewlett-Packard following the unexpected departure of the CEO Mark Hurd, convinced that the leadership uncertainty at Hewlett-Packard, in combination with the weakening economic trends, was enough for the fund to exit the position.
Ultimate Stock-Pickers' Top PurchasesStar RatingFair Value UncertaintySize of MoatCurrent Price ($)Price/Fair ValueNo. of FundsOccdntl Petrlm (OXY)3HighNarrow87.650.957ExxonMobil (XOM)4MediumWide69.230.815Microsoft (MSFT)4MediumWide25.250.7914Morgan Stanley (MS)3HighNarrow24.700.806Anhsr-Bsch InBev (BUD)3HighWide57.570.993Hewlett-Packard (HPQ)4MediumNarrow43.200.799Stryker (SYK)4MediumWide51.460.714Covidien (COV)5MediumNarrow42.320.637Bank of America (BAC)5HighNarrow11.120.487Cisco Systems (CSCO)5MediumWide19.490.657
Data as of 11-26-10. Fund ownership data as of funds' most recent filings.
With three names on the list of top purchases by our managers already highlighted in the commentary we've made about their top holdings, we thought we'd focus on those names we haven't fully expanded on. Of these seven firms, Anheuser-Busch InBev (BUD), Cisco, and Hewlett-Packard really stand out, as each was the recipient of new money purchases during the most recent period. As you may recall, we believe that managers tend to put money to work in new names only when they have a high degree of conviction behind the purchase. That's not to say, of course, that managers do not make high-conviction additions to their existing holdings, it's just that we believe that is far easier to put money to work in holdings they are already comfortable with than it is for them to make a bet on a brand new name (especially one that had been blown out of the portfolio in a previous period).
Anheuser-Busch was a significant new money purchase for both FPA Crescent and Hartford Capital Appreciation (ITHAX), with the latter noting that the recently merged company has half of its business in fast-growing Latin American and Asian markets, and the other half in mature, but highly profitable, North American markets. The managers at Hartford believe that the synergies from the merger will be higher than the market anticipates, with this disconnect being the driving force behind their purchase. As for Cisco, it was a meaningful new money purchase for Parnassus, with both RS Capital Appreciation and Oakmark Equity & Income making significant additions to existing positions.
Hewlett-Packard was probably the most contentious new money purchase during the period, given all of the drama associated with the departure of CEO Mark Hurd during the third quarter. While Aston/Montag & Caldwell took it as a sign to dump the technology firm, three of our top managers--Parnassus, Mutual Shares, and Alleghany--all started meaningful positions in Hewlett-Packard, with Yacktman nearly doubling its stake in the firm, in the wake of the news. While we lack confirmation from any of these funds, we had speculated in a recent article that these Ultimate Stock-Pickers may have felt that Mark Hurd's departure did not upset the strategic positioning of Hewlett-Packard's businesses, and used the event as an opportunity to snatch up shares of this narrow-moat company. This sentiment was echoed by Dodge & Cox Stock (DODGX) fund in its quarterly commentary:
"H-P's stock performed poorly in the third quarter, primarily due to concerns surrounding a sudden management change. Mark Hurd (CEO for past five years) was replaced by the Board for reasons unrelated to the company's operating performance. We added to the Fund's position in the third quarter following the drop in price and additional due diligence on the company's underlying fundamentals. We concluded that the company's long-term opportunities remained intact, and there was not a significant change to the key risks faced by the company. H-P has a deep management team and strong competitive positions; in fact, it has increased share in many of its markets during the past few years. Management plans to reduce the company's cost structure by several billion dollars during the next four years. H-P has historically made extensive R&D investments and has strong intellectual property assets relative to its peers, which we think should help fuel future growth. The company has a low valuation (eight times forward earnings), healthy free cash flow, and a strong balance sheet. It is inexpensive relative to its history, relative to competitors, and relative to the S&P 500."
Of the other four names, Morgan Stanley (MS) and Bank of America (BAC) stand out because they were significant additions for Bruce Berkowitz's Fairholme fund, which has made a big bet on financials, with the sector accounting for more than three quarters of the fund's stock portfolio at the end of the most recent period. While Sound Shore (SSHFX) was the only other manager to add to its stake in Bank of America, the managers at Columbia Value & Restructuring (EVRAX) saw fit to reduce their stake in Morgan Stanley by more than 80% during the period. The last two names on the list-- Stryker (SYK) and Covidien (COV)--also saw meaningful additions from several of the managers holding shares in the companies. Yacktman was a buyer of both stocks, with the managers at the fund noting that it was part of a broader move to increase established stakes in existing healthcare equipment holdings that also include Johnson & Johnson, C.R. Bard (BCR), and Becton Dickinson (BDX). The managers at Yacktman made a new money purchase in Medtronic as well during the period.
Ultimate Stock-Pickers' Top SalesStar RatingFair Value UncertaintySize of MoatCurrent Price ($)Price/Fair ValueNo. of FundsWells Fargo (WFC)5MediumNarrow26.650.6810Comcast (CMCSK)4MediumWide19.130.836U.S. Bancorp (USB)4MediumWide23.970.836Appl'd Mtrls (AMAT)5MediumWide12.530.573Tyco Int'l (TYC)URMediumNarrow37.89N/A6ConAgra Foods (CAG)3MediumNarrow21.620.98-ConocoPhillips (COP)3MediumNarrow60.810.9810Kraft (KFT)3HighNarrow30.300.897Humana (HUM)3HighNone56.791.012Becton, Dickinson (BDX)5LowNarrow78.160.804
Data as of 11-26-10. Fund ownership data as of funds' most recent filings.
Much like the first quarter, when major portfolio changes in Berkowitz's Fairholme fund had a big influence on the list, we saw another manager shaking up its portfolio and having an impact on the list during the most recent period. Significant sales this time around by insurer Fairfax Financial of shares it held in Wells Fargo, US Bancorp (USB), and Kraft Foods (KFT) capped off a slough of selling activity that included a complete removal of all of the manager's holdings in utilities--including Xcel Energy (XEL), Sempra Energy (SRE), PG&E (PCG), Dominion Resources (D), and Duke Energy (DUK). It should also be noted that Fairholme's influence on the top sales by our Ultimate Stock-pickers has not waned all that much, as Berkowitz completely blew out his stake in Comcast (CMCSK) and more than halved his position in Humana (HUM), using the proceeds to fund additional purchases of both Morgan Stanley and Bank of America, as well as a meaningful new money purchase of General Electric (GE).
Looking at the remaining sales, Applied Materials (AMAT) was dumped by both Parnassus and Oakmark Equity & Income. The fund managers at Oakmark also blew out ConAgra (CAG), Avon Products (AVP), and CostCo (COST) during the period, but spent no time talking about the rationale behind these sales. The fund used the proceeds from these sales to beef up stakes in Microsoft, Home Depot (HD), ITT Corporation (ITT), Cisco Systems, and Sara Lee (SLE), and establish brand new positions in Flowserve (FLS), Boston Scientific (BSX), and Mine Safety Appliances (MSA). The managers at Oakmark Equity & Income believe that expertise in natural resource management will continue to increase in importance as emerging market populations become wealthier and increase their consumption, and that firms like ITT and Flowserve are likely to benefit as fluid handling grows in economic significance.
Tyco International (TYC) has not received such favorable treatment, with Matrix Advisors Value eliminating its stake, and Mutual Shares nearly eliminating what had been a significant holding, in the firm. While ConocoPhillips was not sold by Berkshire during the period, it was sold aggressively by Alleghany, which has been bulking up on Exxon Mobil at the expense of other energy names in its stock portfolio. As for Becton Dickinson, it was sold outright by the managers at RS Capital Appreciation, who noted in their quarterly commentary that they had sold the medical products firm "as competition for capital dictated the replacement of one good business for a slightly better one, and at a more attractive valuation (which we assume was the fund's purchase of Tiffany (TIF))." While they like Becton Dickinson's business model and exposure to healthcare categories that generate stable and recurring revenue, they felt that "the company is somewhat challenged to produce new outlets of growth in the current healthcare spending environment."
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Disclosure: Greggory Warren owns shares in the following securities mentioned above: Johnson & Johnson, Procter & Gamble, Becton Dickinson, Kraft Foods and Avon Products.
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.