10 High-Conviction Purchases by Our Ultimate Stock-Pickers
Increased investor inflows and portfolio reshuffling (driven in part by a fairly valued market), has added breadth to the high-conviction and new-money purchases we've seen so far from our top managers.
When we relaunched the Ultimate Stock-Pickers concept more than four years ago, one of our primary goals was to be able to uncover potential investment ideas that not only reflect the most recent buying and selling activity of top investment managers, but would be timely enough for investors to get some value from them. We believe that this can best be achieved by cross-checking the most current valuation work and opinions of Morningstar's own stock analysts against the actions of some of the best equity managers in the business. With more than two thirds of our Ultimate Stock-Pickers having already reported their first-quarter holdings, we've scoured the trading activity of these top managers to get an early read on how they have been putting money to work.
Looking at the purchases that our Ultimate Stock-Pickers make in any given period, we hone in on both high-conviction purchases and new-money buys. We believe that managers send signals about their level of conviction in a position by how much of their portfolio (on a percentage basis) they're willing to commit to a given name at any point in time. For example, we can generally assume that the managers at FMI Large Cap(FMIHX), which had 5.8% of its stock portfolio invested in wide-moat-rated 3M(MMM) at the end of the March quarter, compared to just 2.1% in non-rated Willis Group Holdings (WSH), have a higher degree of conviction in 3M than they do in Willis Group. That said, position size can sometimes be influenced by how much a portfolio manager wants to commit to a particular sector (especially when there are only a few truly investable ideas in that sector). It can also be influenced by large legacy positions that have become difficult to unwind over time.
At Morningstar, we define high-conviction purchases as instances where managers make meaningful additions to their existing holdings, or make significant new-money purchases in names that were not in their portfolio at the end of the previous quarter, with a focus on the impact these transactions have on the portfolio overall. We believe that new-money purchases provide us with the most insight into what our top managers think are the most attractive buying opportunities, as portfolio managers tend to put money to work in new names only when their purchase decision carries a high degree of conviction. This is based on the belief that it is far easier for investment managers to put money to work in holdings they are already comfortable with than it is for them to make a bet on a name representing a new addition to their portfolio.
When looking at all these different stock purchases, however, it pays to remember that the decision to buy these securities was made during a prior period. This means that the prices our top managers paid will likely be different from today's trading levels, increasing the importance that investors assess the current attractiveness of any security that they might be considering for purchase by looking at some of the measures that our stock analysts' research regularly provides us, like the Morningstar Rating for Stocks and the price/fair value estimate ratio.
Top 10 High-Conviction Purchases Made by Our Ultimate Stock-Pickers
Unlike many of the previous quarters we've covered since relaunching the Ultimate Stock-Pickers concept, the first quarter and early part of the second quarter of 2013 have produced a unique mixture of increased buying activity and outright sales. Given the amount of capital that flowed into actively managed U.S. stock funds during the first quarter, the buying activity was not too surprising. After all, according to data provided by Morningstar DirectSM, the first quarter of 2013 (with $2.1 billion in total inflows) went down as the first period of positive flows for actively managed U.S. stock funds since the first quarter of 2011, and was only the third calendar quarter in the last five years to experience positive flows (with the second quarter of 2009 being the other). While not all of our managers experienced positive flows during the period, those that did were not only putting money to work in existing holdings, but were dedicating capital to new names. We also saw a fair amount of portfolio reshuffling going on, as managers traded out of holdings that were fully valued to ones where they expected to generate higher returns. This was also not that surprising to us, given that Morningstar's stock coverage universe has traded above our analysts' estimate of fair value for much of 2013.
Looking over the list of top 10 high-conviction purchases we've seen so far, it is interesting to note that seven of the 10 names received attention from at least two of our top managers. Also of note is the fact that two of the high-conviction purchases-- Apple(AAPL) and CH Robinson Worldwide(CHRW)--were also new-money buys for at least two of our Ultimate Stock-Pickers. Of these two, narrow-moat rated Apple stands out, not only because it saw four high-conviction purchases (two of which were new-money buys) during the period, but because the name was also sold with a high degree of conviction by two of our top managers. Looking more closely at the purchases, both Diamond Hill Large Cap(DHLAX) and Parnassus Equity Income(PRBLX) made high-conviction new-money purchases of Apple, while Oakmark(OAKMX) and Alleghany(Y) made meaningful additions to their holdings in the technology giant. Of their purchase of Apple, the managers at Diamond Hill Large Cap--Chuck Bath, Bill Dierker, and Chris Welch--noted the following in their quarterly commentary:
We initiated a position in Apple after the stock declined in January following disappointing earnings and management provided guidance that was below analysts' expectations. We believe the competitive and market saturation concerns are more than reflected in the current valuation and that the stock trades at a meaningful discount to our estimate of intrinsic value.
These comments echo some of the thoughts put forth by Morningstar analyst Brian Colello, who recently noted that Apple looks attractively priced for long-term investors, especially with much of the near-term risks already baked into the name. While the company has faced many negative headlines this year, Colello still considers Apple to be the world's premier smartphone maker. Even though Apple's days of easy growth might be over, he still sees plenty of opportunities in both developed and emerging markets, and believes that iPad revenue should grow at an outstanding rate as consumers continue to adopt tablets over (or in addition to) PCs. Colello thinks that adoption of these devices could potentially raise the switching costs associated with the iOS platform, driving market share gains in other iOS products. While he is quick to point out that pricing and gross margins for these devices could deteriorate, perhaps stunting the firm's EPS growth in the longer term, Colello notes that Apple should still generate tons of free cash flow in the years ahead.
There were, however, some detractors among our Ultimate Stock-Pickers, with both Hartford Capital Appreciation(ITHAX) and Aston/Montag & Caldwell Growth(MCGIX) making significant reductions in their holdings of the technology giant. Commenting on his sale of 70% of his fund's holdings of Apple, Ronald Canarkis, the manager of Aston/Montag & Caldwell Growth, noted the following:
We had reduced the portfolio's position in Apple after the company issued a range of guidance that fell below analysts' expectations. Earnings guidance appears to be coming down as the strong iPhone launch quarter tends to lead to greater seasonal slowing, while the continued enthusiasm for the iPad Mini put downward pressure on gross margins from a shifting product mix. We further trimmed the position later in the quarter on concerns that the company is not positioned competitively in the smartphone market due to consumers' preference for a larger screen size. The company's production schedule may prohibit it from launching a competitive product until 2014.
Looking more closely at CH Robinson Worldwide, the stock was a high-conviction new-money purchase for Yacktman(YACKX); a new-money purchase for Hartford Capital Appreciation; and a meaningful addition for Parnassus Equity Income, which started building a position in logistics firm during the third quarter of 2012. While none of these managers elaborated on their purchase of the stock, Saul Pannell and Frank Catrickes at Hartford Capital Appreciation, who engaged in an awful lot of buying and selling during the first quarter, noted that they "continue to look for compelling opportunities for capital appreciation across the market cap spectrum," believing that "this is a good overall stock-buying environment."
The managers went on to comment that they remain firmly "focused on company specifics, which will continue to drive the portfolio's overall positioning." It should come as no surprise then to see that CH Robinson Worldwide is just one of five names in our list of top 10 high-conviction purchases that our analysts consider attractive right now. We also note that Devon Energy(DVN), which is the only 5-Star rated stock on the list, was a new-money purchase for at least one of our top managers during the quarter, with Alleghany initiating a 4.5% stake in the energy firm.
Top 10 New-Money Purchases Made by Our Ultimate Stock-Pickers
We don't normally go into much detail on the selling activity of our top managers until we publish our lists of top 10 buys and sells, but we have seen a larger than normal level of outright sales so far this year. While some of this has been influenced by the actions at Hartford Capital Appreciation, which completely eliminated holdings in more than 30 names during the quarter, it should be noted that only three of those transactions actually made their way onto the top 25 outright sales made by our Ultimate Stock-Pickers. Also of note is that fact that only two managers-- Columbia Dividend Income(LBSAX) and Oakmark--were represented more than once on the list of top 10 outright sales.
The managers at Columbia Dividend Income--Scott Davis and Richard Dahlberg--noted that they eliminated stakes in both Diageo(DEO) and H.J. Heinz(HNZ) during the quarter, reducing their exposure to the consumer defensive sector. Of their sale of Diageo, the managers commented that the company's stock "had appreciated significantly and was sold based on valuation." We suspect that this was the case with many of the names that were sold outright during the period, with four of the top 10 sales continuing to trade above our analysts' fair value estimates, and another three names trading in line with the fair value estimates established by our analysts. Of these, Heinz sticks out as a special situation, as it was the only name exited by two of our top managers, Columbia Dividend Income and Oakmark, both of which sold the stock after it was announced in mid-February that Berkshire Hathaway(BRK.A)(BRK.B) and 3G Capital had teamed up to buy the company.
While the managers at Columbia Dividend Income were fairly brief in their rationale for selling Heinz, simply noting that the company had "agreed to be acquired by Warren Buffet and 3G Capital for $72.50 per share and, therefore, its upside is limited," Bill Nygren and Kevin Grant noted the following about their sale of Heinz (which included a link to commentary they had published on Heinz after the sale was announced):
We eliminated two holdings during the quarter: Viacom and Heinz. Viacom's stock reached our sell target despite ratings for its main cable channels that continue to disappoint. Heinz announced its acquisition, and because the stock price immediately matched the proposed acquisition price, we sold all of our shares. We are very pleased with the performance of Heinz management over the many years we owned the stock. For a more complete discussion, read the Heinz piece we posted on our website during the quarter.
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Disclosure: Greggory Warren has no ownership interests in the shares of any of the securities mentioned above. It should also be noted that Morningstar's Institutional Equity Research Service offers research and analyst access to institutional asset managers. Through this service, Morningstar may have a business relationship with fund companies discussed in this report. Our business relationships in no way influence the funds or stocks discussed here.
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