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Market Update

8 Stocks Top Managers Have Been Buying

Managers from Dodge & Cox, Diamond Hill, Oakmark, and BBH bought energy companies, an online retailer, and a premium spirits producer--among others--last quarter.

After a fabulous start to 2019--the S&P 500 notched an 8% gain in January, its best January in three decades--the stock market's fourth-quarter 2018 performance may be just a distant memory to some investors.

Here's a reminder for those with short memories: The S&P 500 lost more than 13% during the fourth quarter of 2018.

The stock-market slide opened up some buying opportunities for value seekers--including the top-notch active fund managers we're profiling here. Given the market's rise this year, their fourth-quarter purchases are not all buys today. But they're likely worthy additions to many investors' watchlists.

The team at Gold-rated Dodge & Cox Stock (DODGX) favors stocks that are cheap on a variety of valuation measures, focusing on companies with strong management, competitive advantages, and solid growth potential.

During the fourth quarter, the team increased the portfolio's energy exposure as valuations in the sector fell. As they explain in their latest shareholder letter, they believe long-term supply-and-demand fundamentals point to higher prices. More importantly, though, the team is looking more closely at company fundamentals relative to valuation rather than macro factors. As such, they increased their stake in, among others, exploration and production company Occidental Petroleum (OXY).

"Occidental's stock price declined in the fourth quarter with the broader oil universe on macro and oil oversupply concerns, despite its solid underlying business fundamentals," they note. "Occidental operates a free-cash-flow generative business with an attractive growth profile and low-cost assets in the Permian basin and the Middle East. In addition, it has a pristine balance sheet, 5% dividend yield, and proven management team."

Morningstar doesn't believe Occidental has established a moat. The company's Permian resource segment will likely generate a large portion of its future growth and may be capable of sustainable excess returns on capital (in other words, it may be moat-worthy). However, that segment accounts for only a third of the company's current output, notes senior analyst David Meats. The firm's other assets don't hold the same promise, he adds.

This high-uncertainty name is fairly valued today according to our metrics.

Chuck Bath and Austin Hawley, who skipper the Gold-rated Diamond Hill Large Cap (DHLRX), hunt down companies trading below a forecast intrinsic value that considers estimated cash flows, normalized earnings, and an appropriate growth rate. During the fourth quarter, the pair picked up insurer American International Group (AIG).

"We believe AIG now has one of the best management teams in the industry and is nearing an inflection point in its turnaround," they argued in their latest shareholder communication.

We agree that AIG has made significant progress since the financial crisis, focusing on risk-adjusted returns and operational efficiency, says senior analyst Brett Horn.

"We don't see any structural issues with AIG's business and think the franchise can earn adequate returns under capable management, although the process will take time," he adds.

AIG's shares are trading in 5-star territory as of this writing, suggesting that they're undervalued by our metrics.

The Diamond Hill Large Cap duo also picked up shares of General Motors (GM) last quarter.

"Global automobile manufacturer General Motors has a strong product mix and cash flow driven by its truck and SUV programs," they explain. "As the mix of auto sales trends more towards crossovers, SUVs, and trucks, we believe GM is well positioned."

We think GM's car models are of the best quality and design in decades and believe the company's earnings potential is "excellent," says sector strategist David Whiston. Further, we argue that the automaker has more economies of scale to realize as it consolidates manufacturing down to five global architectures over the next decade.

GM's shares are undervalued as of this writing, trading in 4-star range.

And like the team at Dodge & Cox, the Diamond Hill Large Cap co-managers also picked up an energy name last quarter: oil and gas producer Noble Energy . They explain:

"We initiated an investment in oil and gas exploration and production company Noble Energy, as we believed a wave of uncertainty had been overly discounted in the valuation and that the market was underestimating Noble Energy's free cash flow potential. Investors were primarily concerned with an unsuccessful November ballot initiative that would have restricted Colorado drilling activity. There was also concern about near-term pricing risk in the Permian Basin from a lack of secure transportation agreements, but we believed this would be solved by late 2019."

Indeed, Noble has significant production in several markets and a long track record of exploration success, notes Meats. Onshore, the firm is generating strong returns; offshore, Noble will allocate a significant portion of its capital budget to the eastern Mediterranean, particularly to Leviathan. The projected economics of this offshore natural gas field are impressive, but spending may consume the first few years of cash flows, adds Meats.

Shares of Noble are about fairly valued today.

Bill Nygren and Kevin Grant, who comanage Gold-rated  Oakmark (OAKMX), buy companies trading below their business values; the duo wants managers who behave like owners and who can improve per-share value. They use a variety of valuation methods that go beyond traditional price multiples.

The pair picked up  eBay (EBAY) last quarter. They elaborate in their latest commentary:

"The marketplace business is transitioning to a new payment provider and recently began allowing sellers to advertise on the platform. We believe these initiatives should substantially increase company profits over the next three to five years, even after eBay passes some of the savings back to marketplace participants. We purchased shares of eBay at a multiple that was similar to many brick-and-mortar retailers, which we believe overlooks the company’s higher growth rate and powerful competitive and scale advantages."

We assign eBay a narrow moat but a negative moat trend. Despite platform enhancements and the transition to payment intermediation, we're concerned about eBay's ability to keep occasional users engaged as Amazon (AMZN) continues to strengthen its third-party marketplaces, argues sector strategist R.J. Hottovy.

"We see shares as fairly valued using our base-case assumptions but acknowledge that a combination of core marketplaces acceleration, expense reductions, or the potential portfolio divestitures could present positive catalysts," he concludes.

Nygren and Grant also picked up shares of oilfield services company Halliburton (HAL). They commented:

"The scale of its operations leads the industry and it maintains impressive technical capabilities across a broad array of product lines and geographic markets. The company also has a long history of best-in-class operating efficiency and disciplined, return-focused capital deployment. The global oil and gas industry has endured a multi-year retrenchment of capital investments, and we believe that a significant and sustained increase in spending will now be necessary to satisfy increasing global demand. We believe Halliburton is particularly well positioned to benefit from this recovery, given its dominant presence in the reviving U.S. onshore market, its significant investment in international footprint expansion and its ability to capture increased market share in select high-value product lines. Despite this attractive long-term environment, a combination of short-term concerns have significantly pressured Halliburton’s stock price. The company is currently trading at a single-digit multiple of our estimate of its normalized earnings per share--a very attractive price for a company of this stature."

We think that Halliburton has done a terrific job of delivering high-quality oilfield services and large volumes of shareholder value, says analyst Preston Caldwell.

"The company's status as the number-one wellbore engineering company is nearly a century old, and in the past two decades, Halliburton has built up a drilling and evaluation business second only to traditional leader  Schlumberger (SLB)," he adds.

We therefore assign the company a narrow moat--and a negative moat trend. The firm's focus on shale has certainly been a benefit, but given the intense competitiveness of U.S. shale, we expect its profitability to wither over time, says Caldwell. We think shares are fairly valued today.

Michael Keller, who helms Silver-rated BBH Core Select , looks for profitable cash generators with solid balance sheets trading at least 25% below their intrinsic values. During the fourth quarter, he picked up shares of premium spirts producer Brown-Forman (BF.B).

Keller explains in his latest commentary:

"Brown-Forman's key strategic goals are to maintain leadership in the American whiskey market and to augment that position with additional brands that can improve returns and reinforce profitability in select markets. The company's strategy of brand-driven leadership and scaling through acquisition, brand creation, and broadening distribution have allowed it to be profitable and growing while also improve returns, even in more mature markets like the U.S. and Western Europe. We believe the long-term results of this brand-led approach and broadening distribution opportunity will be attractive rates of revenue and profit growth over full economic cycles. We initiated our position in Brown-Forman in December at a price that offered an attractive discount to our appraisal of per-share intrinsic value."

Brown-Forman's spirits portfolio has generated steady growth and impressive profitability; we've awarded the company a wide moat and stable moat trend. Its brand-driven intangible assets and cost advantages contribute to its moat, says analyst Sonia Vora. While we think that the company's underlying growth prospects remain strong, we think shares are fairly valued as of this writing.

 KLA-Tencor (KLAC) was another fourth-quarter pickup for Keller.

"We built our KLA position in October as investor sentiment towards the semiconductor industry became incrementally more negative in the context of a general market selloff and a view that the negative phase of the industry's inventory cycle was beginning. Our KLAC investment is not predicated on timing the industry cycle, but instead recognizes the company's critical value-add to semiconductor manufacturers and the attendant secular growth benefits that should persist over the long run."

We assign the company a wide moat, given that it dominates the process diagnostic and control segment of the semiconductor equipment industry. We think KLA-Tencor is on track for a strong 2019, despite industry headwinds, says senior analyst Abhinav Davuluri.

"Given its more favorable end-market exposure (logic and foundry) in an overall weaker wafer fab equipment (WFE) spending environment, combined with its technology leadership, we expect KLA to outperform relative to WFE peers in 2019," he says.

Shares are undervalued as of this writing, trading in 4-star territory.

Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.