Reading Between the Lines at the Morningstar Conference

This year's Morningstar Investment Conference was held, as always, here in Chicago, and I have to tell you it was one of the best ever. While I wasn't able to catch everything, I did make it to panel discussions featuring value investing superstars Mario Gabelli, John Rogers, Mason Hawkins, Chris Browne, and Marty Whitman. And I caught a fascinating keynote speech by Bill Miller.

I always learn something from hearing successful investors speak, and this year was no different. That said, I noted a few, er, inconsistencies during the various rounds of seminars and speeches. In general, these were of the "do as I say, not as I do" variety. Here are some of them.

Mason Hawkins on Michael Eisner
Hawkins, who comanages the  Longleaf Partners (LLPFX) and  Longleaf Partners International (LLINX) funds, has a great long-term track record. One criterion Hawkins looks for in a stock, besides the obligatory 40% discount to intrinsic value, is a shareholder-oriented management team. At least that's what he says.

During a panel discussion, Hawkins talked a lot about the importance of evaluating management before buying a stock. Yet one of Hawkins' largest holdings is  Walt Disney (DIS), a company with a highly suspect management team. Here's what Morningstar senior stock analyst Jonathan Schrader has to say about it:

"Disney has historically been the poster company for poor corporate governance and excessive management compensation. It's widely believed that 'board' and 'independence' were never mentioned in the same breath in Burbank. Recently, the most independently minded, shareholder-friendly directors (especially Stanley Gold) have been marginalized to satisfy the Securities and Exchange Commission's new 'independence' requirements. One of the more egregious acts: filling CEO Michael Eisner's coffers with an average of $122 million in annual compensation between 1998 and 2003, while the stock declined about 5% annually during the same period (according to Forbes). The compensation committee has been known to lower performance targets midstream so that bonuses can be paid out."

Hawkins response, when asked about this: "It's too complicated to explain in a few sentences, but the bottom line is, I think Eisner is paid what he's worth." Translation: "The stock is so cheap, I don't care about the executive excess." So why not just come out and say that? This is just speculation on my part, but I think Hawkins' access to Disney's management would be cut off if he were to criticize Eisner in public. So he won't do it.

Bill Miller's Keynote Address
During his keynote speech,  Legg Mason Value Trust (LMVTX) manager Bill Miller waxed philosophic about human beings' tendency to engage in "rearview mirror" thinking, making judgments about the future based on the recent past. He showed some compelling data on why that's a bad idea, and how he avoids this problem. It was great stuff.

But oddly, Miller proceeded to profess bullishness on the market using some rearview mirror thinking of his own. Apparently, the market has never gone down in the first year after a five-year period of negative total returns, so he was confident at the beginning of 2003 that the market would rise. In other words, what worked in the past (buying stocks at the end of a bad five-year period) will work again. Isn't that rearview mirror thinking? I didn't hear Miller say anything about the future that made him optimistic on stocks; it was all based on what has happened in the past.

Miller on Sony
After extensively talking about his penchant for companies that create economic value over the long term, Miller picked  Sony (SNE), a company that has destroyed billions of dollars in economic value over time, as his most compelling idea. Sony's returns on invested capital are in the single digits, and its return on equity is well below 10%.

Okay, so the stock doesn't create economic value, but maybe it's so cheap, that doesn't matter? I'm not sure how one would come to that conclusion on Sony, though; the stock's price-to-peak earnings ratio (a favorite Whitman valuation measure) is about 18, based on 1997 earnings per share of $1.83. Its average P/E ratio over the past five years is 72, and it sells for 45 times Wall Street's March 2004 earnings estimate. If that's cheap, what's expensive?

Boring Stuff
There's a saying that goes something like "give a man a fish, and he'll eat for a day. Teach him to fish, and he'll eat for the rest of his life."

During the conference, I was reminded that many people would rather have a few fish handed to them than learn how to fish for themselves. In other words, investors want "actionable" ideas. During the panel discussion I moderated, I started out by asking Hawkins, Whitman, and Browne various questions about their general investment philosophies. I shied away from asking about specific stock picks because I am firmly of the opinion that when fund managers talk about a stock, it's usually one they have stopped buying (or have started selling). Thus, the value of these picks is often pretty low. 

But when I asked the panelists about their specific stock picks, people sat up in their chairs and started taking lots of notes. Oh well--I'll keep that in mind for next year's conference.