The Evolution of Value Investing

Editor's note: This week's installment of The Long View with Christine Benz and Jeff Ptak features a conversation with Bill Nygren, portfolio manager at Oakmark Fund, Oakmark Select, and Oakmark Global Select. In this video excerpt from the interview, Nygren discusses his distinctive approach to value investing, whether concentrated value strategies can work, and where he thinks his team's "circle of competence" lies.

Christine Benz: You talked a little bit about, and we've discussed it already, this idea of traditional value managers are maybe in a crisis of their own making, and how at Oakmark and Harris Associates you use a different interpretation of value, where you're focused on intrinsic value. Can you talk about how your strategy is maybe a little bit of a high-wire act and that you're forecasting cash flows far out into the future? Does it inherently impose a little more risk?

Bill Nygren: Well, I think to argue that anybody's investment philosophy is not to some extent a high-wire act is probably a false argument. Sometimes you can get comforted by a cheapness statistic like low price-to-book value, and then retailers that are on their way out of business that look very cheap compared to book value still go bankrupt because they don't get the useful life out of the assets that the accountants depended on when they decided on what number book value should be.

So, I don't think there is necessarily more risk in straying from the low P/E, low price-to-book value metrics. I think it's just a natural step that as the economy has changed to more asset-light business models that more and more of the assets are not things that you can touch and feel and say, "We'll have a seven-year life," so you depreciate it over that time. The way gap accounting works is if you can't touch or feel something, it's basically expensed immediately.

So, R&D expenditures are all going straight through the income statement. Customer acquisition costs all go straight through the income statement. That can really present an unfair presentation of what a company is accomplishing in a given year. So, I don't think it's any less disciplined the way we look at things--trying to identify business value, demand a significant discount to that, look for management teams that are aligned with the outside shareholders--than it is for picking a favorite metric and then doing all of your work based on that metric.

Jeff Ptak: You don't buy the argument that some make that there aren't enough fat pitches to swing at as value investors anymore for focused investing to work.

Nygren: Well, as an aside, I'm probably one of the few portfolio managers who still has an email address that's out there that any shareholder can email if they want to ask a question. Some of the late-night emails get kind of interesting, I'm assuming people have had their bottle of wine or something, but I've been asked why at Oakmark we don't start a bottom-30 fund. The Oakmark Fund has 50 names in it. The [Oakmark] Select Fund has 20. The reality is, for the past five years, the 30 names that we didn't think were good enough to make it into the Select Fund have actually outperformed the 20 that were our favorites.

It's frustrating. I can assure you it annoys me more than it annoys any single shareholder, but it's very hard to conclude you can add value as a stock-picker if over long periods of time your rank-ordering of ideas either is useless or even inverse. So, I think the problem is that most investors just don't have the time frame that's truly long enough to get as much benefit out of a focused approach as they would need to have.

Ptak: We're going to shift a bit and talk about circle of competence, so to speak, and learning new tricks in the spirit of continuous learning. I was just curious. A type of forecast you and your team had maybe concluded you're not capable of making, just maybe through the years you've learned that it's really hard to pull a certain type of forecast in a certain area of the market or a certain type of company off, and then maybe the inverse of that where you've come to feel more comfortable forecasting certain types of outcomes in the future that perhaps maybe without the advent of technology you wouldn't have been as comfortable making in the past. How has that changed?

Nygren: First, in the area where we've gotten less comfortable because we don't think we've been very good at it, I would say would be in the areas where you think a stock is so cheap that you can tolerate a management team that you'd rather not be invested with. We've learned the lesson too many times about how much damage a management team can do that's not focused on what's best for the shareholders. So, rather than trying to make that a question of what price would we be interested in investing with management teams that are subpar, we've made those more off limits.

The area where we've grown more confident I would say would be in areas that are often called technology, but maybe like Alphabet or Netflix. They're companies that are using technology in a more traditional industry, where they've developed the scale that you're quite comfortable forecasting out what the business might look like seven years from now.

When I started at Harris in the '80s, we had to consider most of the technology companies off limits because they hadn't developed a scale yet that had created a safety net. There's always the story of two high school kids in a garage potentially disrupting a leader in the computer industry. That's not going to happen today to a Netflix, an Alphabet, a Texas Instruments. Those companies have developed a scale that you don't have to worry about a newcomer completely disrupting them.