Our Ultimate Stock-Pickers' Top 10 New Money Purchases

By Brett Horn | Associate Director of Equity Research

As many of you may recall, aside from looking at the top holdings, purchases and sales of our Ultimate Stock-Pickers, we also like to dig a little deeper into the purchases that our top managers have been making, honing in on both high-conviction purchases and new money buys. We believe that looking at new money purchases give us the most insight into what our Ultimate Stock-Pickers think are the most attractive buying opportunities right now, as managers typically put money to work in new names only when their purchase decision carries a very high degree of conviction. That's not to say that managers do not make high-conviction additions to their existing holdings. They do, and we track them with the same intensity as we do with new money purchases. It's just that we believe that it is far easier for managers to put money to work in holdings that they are already comfortable with than it is for them to make a bet on a new name.

With about three quarters of our Ultimate Stock-Pickers having reported their third-quarter holdings, we've been able to glean some of the higher-conviction new money purchases that were made by a fair number of our top managers during the most recent period. When looking at these new money purchases, it pays to remember that the stock buys we are looking at were made during a prior period, so the prices managers paid for these securities are likely to be different from where they are trading today. This is particularly relevant right now, given the run-up we've seen in the markets over the last couple of months. With the S&P 500 Index gaining nearly 4% in value since the end of the third quarter, and up about 14% from the low point reached during the third quarter, our top managers were likely putting money to work at much more attractive prices than investors can realize today.

Top 10 New Money Purchases by Our Ultimate Stock-Pickers

Stock Price and Morningstar Rating data as of 11-12-10

As you can see from the table above,  Hewlett-Packard (HPQ) was the most-purchased new money name to be acquired by the Ultimate Stock-Pickers who have reported their holdings.  Parnassus Equity Income (PRBLX) and  Mutual Shares (TESIX) both picked up more than 3 million shares of the computer hardware firm, making their new money purchases extremely high-conviction buys for their portfolios. The third buyer, insurer  Alleghany , picked up 25,000 shares, a less meaningful addition for its portfolio, which remains heavily weighted towards energy stocks, with more than 70% of its total value invested in just four stocks-- ExxonMobil (XOM),  Occidental Petroleum (OXY),  ConocoPhillips (COP), and  Hess Corporation (HES).

Looking at  Anheuser-Busch InBev (BUD), the stock was purchased with gusto by both  FPA Crescent (FPACX) and  Hartford Capital Appreciation (ITHAX), with the former picking up more than 1 million shares and the latter acquiring more than 2 million during the period. These represented meaningful purchases for both managers, albeit more so for FPA Crescent where Anheuser-Busch accounted for close to 4% of its stock portfolio at the end of the third quarter. FPA Crescent also established a nearly 2% stake in  Kraft Foods (KFT) during the quarter, joining  Aston/Montag & Caldwell Growth (MCGIX) in making new money purchases in the packaged foods firm.

 Medtronic (MDT), meanwhile, was the recipient of new money purchases by both Mutual Shares and  Yacktman (YACKX). The managers at Yacktman noted that the small position the fund took in Medtronic was part of a broader move to increase stakes in existing healthcare equipment holdings  Johnson & Johnson (JNJ),  C.R. Bard ,  Becton Dickinson (BDX),  Stryker (SYK), and  Covidien . These six stocks accounted for 14% of Yacktman's portfolio at the end of the third quarter. The manager funded some of the cost of acquiring Medtronic and the other healthcare equipment firms by trimming its stake in  Pfizer (PFE), which accounted for 5% of the fund's stock holdings at the end of the quarter.

Both  Columbia Dividend Income (LBSAX) and  Davis NY Venture (NYVTX) established positions in  Schlumberger (SLB) during the most recent period, while RS Capital Appreciation  (formerly Oak Value fund) was the sole acquirer of shares of  Tiffany . Having owned shares of Tiffany several times over the last decade, the managers at Oak Value/RS Capital Appreciation had developed a pretty good understanding of the business and, assuming that they purchased it at or near the stock's lows of the third quarter, they made a decent return on their investment, given that the stock is more than 50% off of those lows.

 American Express (AXP), meanwhile, was a significant new money purchase for Aston/Montag & Caldwell Growth, which dedicated 3% of its stock portfolio to the name during the quarter. The fund managers believe that American Express has experienced a rapid recovery in its credit-loss rates, slowing shrinkage in its loan portfolio, and more robust levels of capital and funding. They also expect it 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.

 FMI Large Cap (FMIHX) took an equally large stake in  Devon Energy (DVN), believing the management team to be outstanding and the stock very attractively priced (during the third quarter) due to the depressed environment for natural gas. While they admit that Devon's core business is fairly volatile, they firmly believe that the time to buy commodity-related businesses is when supply is adequate and pricing is depressed, which is what they were seeing in the natural gas market during the quarter. They also believe that Devon has the added value of being an inflation hedge.

As for the remaining new money purchases, Hartford Capital Appreciation took a meaningful position in  J.P. Morgan Chase (JPM) during the quarter, and FPA Crescent joined the growing ranks of Ultimate Stock-Pickers that have holdings in  Microsoft (MSFT). Looking back at the list of ten new money purchases, it should also be noted that six of them--Microsoft, Medtronic, Hewlett-Packard, Anheuser-Busch InBev, American Express, and Kraft Foods--were high-conviction purchases, with more than two funds either establishing meaningful stakes in, or making significant additions to, their holdings during the most recent period.

Market Rally Makes Most Names Less Attractive
With the market rallying 14% off its lowest point during the third quarter, and many of these stocks rallying even more, there are relatively few names from the list of top ten new money purchases during the third quarter that our analysts would still consider buyable. As can be seen in the table below, almost all of the stocks are trading closer to their third-quarter highs than their lows during the period, and some--like Schlumberger and Tiffany--have increased significantly above their third quarter highs.

High and Low 3Q10 Trading Prices for Top 10 New Money Purchases

Stock Price and Morningstar Rating data as of 11-12-10

That said, not all of these stocks have rebounded strongly off their lows, with two names--Hewlett-Packard and Medtronic--still being relatively attractive, given that they're not only trading within their third quarter ranges, but are trading at a meaningful enough discount to our analysts' fair value estimates to be approachable. When sifting through our analysts' current thinking on these names, we came away with the following conclusions:

 Hewlett-Packard (HPQ)
The third quarter was a period of high drama for this tech giant. When news broke in early August that its CEO, Mark Hurd, was resigning in the wake of a sexual harassment investigation, the stock plunged. While the market was very concerned about his departure, our analyst Michael Holt didn't see any cause for major alarm, noting that "although this is an unexpected turn of events for investors, we believe this short-term setback does not upset the strategic positioning of HP's businesses." Our suspicion is that the three Ultimate Stock-Pickers--Parnassus, Mutual Shares, and Alleghany--that established stakes in the name, as well as Yacktman, which made a meaningful addition to its own stake, felt the same and used the event as an opportunity to snatch up shares of this narrow-moat company. The interesting thing to note, though, is that the firm's shares have rebounded only modestly since Hurd's departure. We also think it is interesting that the appointment of Leo Apotheker as CEO, and Ray Lane as nonexecutive chairman in late September, has done little to move the stock price.

Our analyst views these two appointments positively, though, noting that the move "signals a strategic shift toward software for HP," with Apotheker and Lane bringing decades of software industry experience to the leadership roles at the firm. Holt notes that with HP's existing franchises still intact (and easily surviving the departure of Mark Hurd) that any success in building a software business could create additional value for shareholders. While Holt would like to see a larger margin of safety before recommending the company's shares, with any enthusiasm he has for the name tempered somewhat by the fact that he is "skeptical that HP can succeed in transforming into a single-stop hardware and software vendor," investors who share our Ultimate Stock-Pickers' enthusiasm for the name still have an opportunity to buy the stock at a price that is likely comparable to what they paid for it during the third quarter.

 Medtronic (MDT)
This wide-moat medical device company has been left out of the 2010 market rally. While the S&P 500 Index is up more than 5% year-to-date, Medtronic's shares are down about 20%. The stock has rebounded a bit from its midyear lows, but is still trading well within its third-quarter range. The culprit behind the stock's poor relative performance has been the company's poor operating performance of late. Our analyst Debbie Wang is not completely sanguine about the company's near-term issues, and recently reduced her fair value estimate modestly, noting that "Medtronic has been dogged by the erosion in patient volume that has affected many health-care companies." She notes that "in the face of higher unemployment and higher out-of-pocket costs and deductibles for employees, it seems as though patients have been delaying or forgoing nonacute care." Wang believes that if patients remain reluctant to seek care, the challenging near-term conditions for Medtronic will likely continue.

That said, she believes that the company should recover longer term, with Medtronic continuing to innovate, and poised to roll out a number of new products in the cardiac rhythm management and spinal businesses over the next six to 24 months. As we already noted, Ultimate Stock-Picker Yacktman picked up Medtronic as part of a broader move to increase its stake in healthcare equipment firms. The purchase of the stock (as well as its addition to five other names) increased the fund's position in healthcare equipment firms to 14% of the total stock portfolio, with Medtronic accounting for less than 1% of the fund's stock holdings, at the end of the third quarter. While Wang doesn't expect the company to shoot out the lights, she does believe that the marginal rate of growth in the near term will ultimately give way to mid-single-digit growth longer term. With the stock trading at 11 times this year's consensus earnings, and about 9 times forward estimates, even this modest level of long term growth could spell significant upside for patient investors.

Disclosure: Brett Horn does not own shares in any of the securities mentioned above.