Fidelity Low-Priced Stock Remains Legendary

The following is our latest Fund Analyst Report for Fidelity Low-Priced Stock K FLPKX

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A legendary investor’s disciplined approach combined with low fees and Morningstar’s enhanced ratings methodology underlie the upgrade of Fidelity Low-Priced Stock's Morningstar Analyst Rating to Gold from Silver for its K share class. The fund’s no-load and K6 share classes remain Silver.

Lead manager Joel Tillinghast’s cool-headedness has been key to the success of this strategy, which boasts one of the finest 30-year track records of any fund in the small- or mid-cap Morningstar Categories. As a long-term investor, he looks for resilient companies with staying power and doesn’t chase fads. He tries to avoid firms that lack an enduring competitive advantage, steers clear of those loaded up with too much debt, and scrutinizes their leadership’s integrity and prowess.

The fund stands out for its sprawling portfolio of 700-plus stocks drawn from across the globe and market-cap spectrum. Once solidly small-cap-focused, the fund now orients toward mid-caps but distinguishes itself from that category by owning an above-average stake of large caps (33% of assets) and small caps (25%). Its generous helping of European and Japanese firms, which have tended to enhance the fund’s risk-adjusted returns, also sticks out. Altogether, foreign stocks regularly soak up more than 35% of the portfolio, typically the highest share in the category. Tillinghast’s partiality for high-quality fare reveals itself through the portfolio’s average returns on equity, which are far higher than the Russell Mid Cap Value Index’s, and its aggregate debt/capital ratio, which is consistently lower.

Tillinghast’s risk-conscious approach has helped produce reliable gains over time and consistently helped preserve shareholder capital during drawdowns. For example, during the Russell Mid Cap Value Index’s 73 money-losing one-year periods since 1990, the fund outperformed four fifths of the time and generally did so by a wide margin.

The fund’s ability to maintain its edge, despite its massive asset base of more than $24 billion, underscores its advantages.

Process | Above Average This fund earns an Above Average Process rating for its patient and disciplined approach.

Tillinghast looks for sturdy, underpriced businesses. Stocks selling for less than $35 or with an earnings yield (12-month earnings per share/share price) at least as high as the Russell 2000 Index's median are considered to be potential bargains. But his "low-priced" mandate isn't steered by stinginess. As a long-term investor, Tillinghast wants to own resilient companies with strong profitability, little debt, a defendable market niche, and capable leadership. He often finds what he thinks are excellent opportunities overseas but reserves serious consideration for foreign markets with democratic institutions and the rule of law.

The fund owned more than 700 stocks at last count, with a large tail of tiny positions. Its huge asset base (more than $24 billion as of April 2020) makes breadth a necessity, as Tillinghast can't take big positions in the small- and mid-cap names he favors without exceeding ownership limits. In that regard, the fund’s size is a constraint. Its average market cap is more than 4 times the Russell 2000 Index's, but it has remained squarely in mid-cap territory. In recent years, the fund landed in the mid-blend category but most recently moved to mid-value. This doesn't reflect a change in process but rather where the fund's holdings have skewed in recent years.

Despite a sprawling portfolio, the fund has avoided becoming bland or benchmarklike. It has long distinguished itself through a sizable stake in foreign stocks: Its 41% stake as of January 2020 is extraordinary in the mid-cap category, where the average peer invests 2%-4% overseas. (The fund can't buy more non-U.S. stocks once the stake reaches 35%, but they can appreciate beyond that.) Tillinghast works closely with a few analysts who source non-U.S. ideas, including one stationed in Japan, a country that takes up 9% of assets.

The fund has long favored the consumer discretionary sector--25% of assets versus the Russell Mid Cap Value Index’s 9% share--where Tillinghast is better able to find firms with compelling competitive advantages. Its roughly 12% financials stake is well below that of relevant benchmarks and peers, driven by Tillinghast's avoidance of complex banks with leveraged balance sheets. The portfolio tends to hold 7%-10% of its assets in cash, which has acted as a drag on its total returns over the past decade.

Comanagers run around 5% of assets, which usually include more than 100 unique names. Half of that stake is overseen by three sector-based managers, with the remainder split between a quantitatively driven subportfolio and a sleeve featuring global stocks. The crew manages its respective slices with discretion but always under Tillinghast's philosophical guidance.

People | High Tillinghast became this fund's first manager in late 1989. He's posted one of the industry's best long-term records during his tenure, with the fund's High People rating based on his insights and experience. The fund's performance is all the more impressive considering its $24 billion asset base--a huge sum, particularly for a fund that features small- and mid-cap stocks.

Tillinghast has access to Fidelity's 100-plus global analyst team, which includes teams stationed in the United Kingdom and Japan--important markets for this fund.

Five comanagers fishing in discrete small- and mid-cap ponds independently run assets that in aggregate amount to roughly 5% of the fund’s total. John Mirshekari exclusively picks financials stocks. Shadman Riaz concentrates on energy, materials, and utilities. Morgen Peck covers tech and telecom. Sam Chamovitz invests globally across all sectors. Salim Hart brings a quantitative approach: Using as his investable universe all stocks endorsed by either a Fidelity analyst or this fund’s other managers, he gauges companies’ relative attractiveness by sifting their fundamentals, valuation ratios, and trading patterns, among other data points.

There has been some turnover on the comanagement roster in recent years. Mirshekari and Shadman Riaz joined the team in 2011. The others took over for managers that either retired or departed in 2016 and 2017.

Parent | Above Average Fidelity earns an Above Average Parent rating because of its ability to stay ahead of its competition.

The firm's successful stock-picking mutual funds fueled its rise to prominence, and it has adapted well to investor preferences that have shifted markedly over the past two decades. Index funds and ETFs have garnered most of the industry’s flows as money has gushed from actively managed products--Fidelity’s included. Yet overall, the asset management division has continued to achieve positive organic growth by introducing or maintaining aggressive pricing on its own suite of passively managed funds and expanding its menu of client-demanded investment structures, such as managed accounts and collective investment trusts. These moves are made possible by the firm’s strong distribution network, scale, established brand, and willingness to tolerate losses on some products in pursuit of broader strategic objectives.

Fidelity continues to invest heavily in its active managers’ analytical and technological resources. It is home to a handful of the industry’s most talented equity managers and boasts a topnotch fixed-income division. Across asset-class teams, elevated levels of turnover within its leadership ranks bear watching. Overall, though, the firm has served fundholders well through its competitive capabilities and costs.

Performance The fund has consistently posted excellent absolute and risk-adjusted returns over the past three decades.

From its 1989 inception through May 2020, the fund gained 12.4% annualized, among the best showings of any surviving fund in the mid- or small-cap categories. It exhibited lower volatility than relevant benchmarks and the average mid-value and mid-blend fund (its current and former category, respectively) despite an above-average foreign-equity stake. The fund has also consistently preserved capital better than its rivals during stress periods. For example, during the Russell Mid Cap Value Index’s coronavirus-induced bear market (Feb. 21-March 23), the fund dropped 36.6% versus the index’s 43.7% loss.

The fund’s resilience and steady gains have reliably made for outstanding risk-adjusted returns, despite its at-times less-than-thrilling total returns. The fund gained only slightly more than the index over the past decade but did so with an ample cash cushion and steadier returns.

The fund’s girth does make outperformance more difficult than in the early years; Tillinghast cannot invest as easily in the small- and mid-cap fare that he favors. He's had to manage through outflows in recent years, which he's funded through cash and trimming liquid large-cap positions. He's done better at his smaller, more nimble fund used exclusively in Fidelity's target-date series.

Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category's cheapest quintile. Based on our assessment of the fund's People, Process and Parent pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Gold.