Special Report
The following is an excerpt from Morningstar's Premium Analyst Report for Dodge & Cox Stock (DODGX), a large-value fund that receives a Gold Morningstar Analyst Rating. Morningstar.com Premium Members can click here to see the full Analyst Report. Not a Premium Member? Take a free Premium trial to gain access to this and hundreds more reports.
Process Pillar: Positive | 01/06/2014
This is value investing with a contrarian streak. The fund invests in mostly large-cap stocks that look cheap on a range of valuation measures. Management relies on bottom-up, fundamental research and favors business with good management, competitive advantages, and good growth potential. But these also may be businesses that are under a cloud. When JPMorgan Chase (JPM) stumbled during the London Whale trading scandal, for example, the team took a position believing it to be a well-run institution with strong franchises.
This approach requires patience, which the managers have in spades. (The fund's most recent turnover ratio of 11% is among the lowest in the large-value category.) Hewlett-Packard (HPQ) , in the fund for more than a decade, is emblematic of their willingness to stand in defiance of prevailing wisdom. They sell when valuations get rich, fundamentals deteriorate, or better opportunities become available. If valuations decline, they often take advantage of the opportunity to persistently "nudge" a stake higher when their conviction in a pick remains strong.
While the strategy is bottom-up, picks tend to cluster in sectors. Today, the fund has more than twice as much in technology as its typical peer. It also has more in foreign stocks, favoring blue chips with exposure to emerging markets. Financials have also become a significant sector.
Technology, health care, and financials continue to dominate the portfolio. While Hewlett-Packard had a remarkable rebound in 2013, it remains a top holding, as the managers consider it cheap relative to earnings and cash flow and foresee continued improvements. They believe large pharmaceutical names such as Sanofi (SNY) remain attractive relative to healthy cash flows, and big banks such as Wells Fargo (WFC) are still attractively priced. Banks are poised to benefit in a more normal interest environment, and higher capital ratios required by regulators will not necessarily lead to lower return on equity, because consolidation has increased market share.
While the fund remains relatively underweight in energy, Apache (APA) is a recent addition that was already approaching the top-25 list of holdings at 1.4% of assets at the end of September. This quick ascent is testimony to the team's confidence in the name. (For some perspective, the most recently added top-25 name is Microsoft, first bought in 2011.) The attraction is the value of the company's oil fields in Egypt, which have been unaffected by political turmoil but remain overlooked by the market.
The team has almost entirely avoided consumer staples and utilities for several years for valuation reasons. After their recent relative underperformance, the team is revisiting some of these names, but has not yet added any.
Performance Pillar: Positive | 01/06/2014
The fund continued a dramatic rebound in 2013, landing among the top 2% of funds in the large-cap value category for the second calendar year in a row. A number of longtime holdings, some of them contrarian plays, paid off. Hewlett-Packard is the most notable example, with a 100% return; the partial acquisition of Sprint by Softbank was another vindication. Overall, the managers added significant value with their technology picks, with Microsoft (MSFT) another big contributor. The fund's large stake in financials was an advantage, with Charles Schwab (SCHW) its leading pick.
Now that 2008 has receded into the distance, the fund's trailing five-year returns through December 2013 look as strong as its recent performance, landing in the top decile of the category. However, the fund's extreme losses during the financial crisis should not be forgotten. The fund's above-average Morningstar Risk scores, which emphasize downside volatility, demonstrate that a contrarian approach can lead to big bumps along the way.
The fund is at its best advantage over very long time periods, which is a reasonable perspective to take, as it is run by long-tenured managers with a long time horizon. During the past 20 years through December, the fund's 10-year rolling returns land in the top quartile of its category 78% of the time and beat its benchmark, the S&P 500, 97% of the time.
People Pillar: Positive | 01/06/2014
This fund benefits from a considerable depth of management experience on the nine-person investment policy committee that runs Dodge & Cox's domestic equity strategies. Chairman emeritus Kenneth Olivier stepped off the committee in 2013 and was replaced by Philippe Barret, a financials analyst with nine years of tenure at the firm. However, the average tenure on the committee remains high, at 25 years toward the end of 2013. The other members have between 17 and 41 years of experience. They include former chairman John Gunn, who joined the firm in 1972, and current chairman Charles Pohl, who came on in 1984. They all have significant investments in the fund.
A collaborative approach minimizes key-person risk and produces thoughtful, original research. The funds benefit from continuity of management and consistent hiring practices that bring one or two new analysts into the firm each year, after an extensive interview process to ensure a good fit with the rest of the group. As of late 2013, there were 34 industry analysts and equity managers at Dodge & Cox (in addition to 24 fixed-income analysts and managers).
If history is a guide, nearly all these analysts and managers will spend their careers at Dodge & Cox and work their way up the ranks. They have ample incentive to stick around: Most of the investment professionals become partners in the firm.
Parent Pillar: Positive | 10/31/2013
Employee-owned Dodge & Cox is an exemplary firm. CEO and president Dana Emery and chairman Charles Pohl are also lead members of the investment team, and they run both the firm and its funds with a long time horizon. The average fund manager tenure of almost 23 years is exceeded by only a few companies, and the firm's five-year manager-retention rate is 98%.
There are no stars here; each fund is run collaboratively by an investment policy committee. Ideas can come from anyone but must survive peer review to get into the portfolios. Although the funds have seen outflows in recent years, the firm has continued to build the investment team at a slow-and-steady clip. It now totals more than 55 managers and analysts.
Dodge & Cox has rolled out only five funds since it first opened in 1931. As a natural extension of its international-equity expertise, it is now developing its global-bond capabilities. Since 2009, three of the funds have become available overseas. While the firm has eschewed marketing, it is among the largest mutual fund companies today. Asset growth can hinder execution, but management has proved willing in the past to safeguard its strategies by closing funds.
Managers are heavily invested in the funds and the firm and have ample incentive to serve shareholders, evinced in low costs, clear communications, and a sober long-term approach.
Price Pillar: Positive | 01/06/2014
This fund's expenses are about as low as they come for an actively managed fund sold directly to retail investors. (Among active retail funds in the large-value category, only a few Vanguard offerings come cheaper.) Management's low-turnover strategy has also minimized transaction costs.
Even though this fund and Dodge & Cox overall have seen net outflows since 2007, expenses have not gone up. Shareholders who have stuck around have been able to rely on Dodge & Cox to maintain its low-expense edge.