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A Contrarian Masterpiece

Gold-rated Dodge & Cox Stock proves that low-cost active management can still add value.

The following is our latest Fund Analyst Report for Dodge & Cox Stock DODGX. Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

Ample resources, a valuation-driven process, and an excellent track record earn Dodge & Cox Stock a Morningstar Analyst Rating of Gold.

The strategy is in good hands. The firm’s talented, 10-member U.S. equity investment committee includes veteran leaders such as chairman and CIO Charles Pohl and director of research Bryan Cameron, as well as January 2019 appointee Ben Garosi. Garosi isn’t green, though: He has been an analyst on the firm’s global equity research team for a decade. The firm also lined up successors for Pohl and Cameron in early 2019 in accord with its history of careful, gradual transitions, though neither leader’s retirement is imminent. A team of 24 other managers and analysts provides further support. The equity team shared the honor of Morningstar Allocation/Alternatives Fund Manager of 2016 with their fixed-income colleagues for their work on Dodge & Cox Balanced DODBX, a strategy that draws upon the team’s work here.

A contrarian instinct drives the team’s intensive, collaborative process. The managers look for cheap stocks using various metrics, often seizing on bad news or economic weakness to build positions. Thorough, bottom-up research gives the managers confidence in their picks. The analysts seek businesses with competitive advantages, good growth potential, and capable executives. The managers can be patient with such firms, sticking with picks for three to five years or longer. They have made mistakes (such as poor financials bets during the 2007-09 financial crisis), but they’ve responded well. Additions to their risk-monitoring capabilities in recent years should help.

The track record speaks for itself. From Pohl and Cameron’s 1992 start through May 2019, the strategy’s 11.1% annualized return outpaced the S&P 500’s 9.3% and the Russell 1000 Value Index’s 9.6%. It also bested the typical large-value Morningstar Category peer’s 8% gain. Given its investment style, returns can be volatile. Yet patient investors have been rewarded, even when adjusting for risk. Low fees only add to its luster.

Process Pillar:

Positive | Tony Thomas 06/25/2019 Intensive research, collaborative decision-making, and a patient contrarianism earn a Positive Process rating.

Dodge & Cox analysts do thorough, bottom-up research. They seek businesses with competitive advantages, good growth potential, and talented executives. A 10-member U.S. equity investment committee vets analysts’ ideas and manages the portfolio. The managers look to pick up stocks on the cheap, often taking advantage of bad news or a tough economic environment to start or add to positions. The committee constantly reassesses, challenges, and defends holdings.

With so many against-the-grain picks, the managers give ample time for investments to play out. They aim to hold stocks for three to five years, but they are often more patient than that. Annual turnover averaged 16% in the five years through 2018, and 36% of the March 2019 portfolio was in names first bought before 2011. The managers generally stick to their valuation discipline, selling when holdings get pricey, fundamentals deteriorate, or better opportunities come available. They’ve made mistakes, getting burned on American International Group AIG and Fannie Mae in the 2007-09 global financial crisis. More recently, they’ve stuck with battered energy stocks such as Schlumberger SLB or the scandal-ridden bank Wells Fargo WFC. But they’ve been right more often than not.

Bottom-up research on individual companies shapes the equity managers’ distinctive portfolio. They typically hold 60-90 stocks with market caps above $3 billion each. The portfolio can concentrate in a few sectors: As of March 2019, more than 75% of its assets were in information technology, healthcare, financials, and communication services stocks. The latter included two of the portfolio’s top 10 holdings: Comcast CMCSA and Charter Communications CHTR. Financials and healthcare were its largest sector overweightings relative to the S&P 500. The healthcare stake included non-U.S. drugmakers Novartis NVS and Sanofi SNY.

Given the team’s attention to valuation and its interest in companies facing setbacks, the portfolio looks cheap on key metrics. Its average price/earnings ratio was 15.6 in March 2019, below the S&P 500’s 18.9, and its average price/book value was also relatively low. The managers’ interest in temporarily troubled firms dented the portfolio’s profitability metrics, too. Its average returns on assets, equity, and invested capital have historically lagged the index.

True to their contrarian style, the managers added to their energy stakes after oil prices collapsed in 2014-15. Most have weighed on performance even as oil prices rebounded from 2016 lows. Stocks such as Schlumberger SLB and Apache APA languished from January 2016 through May 2019.

Performance Pillar:

Positive | Tony Thomas 06/25/2019 A fine risk/reward profile earns this fund a Positive Performance rating.

Since Charles Pohl and Bryan Cameron joined Dodge & Cox’s U.S. equity investment committee in January 1992, the fund’s 11.1% annualized gain through May 2019 beat the S&P 500’s 9.3% and the Russell 1000 Value Index’s 9.6%. It also topped the typical large-value category peer’s 8% tally.

The team’s contrarian style and patience while theses play out have contributed to the fund’s long-term success, albeit with higher-than-average volatility. After poor relative showings in the 2007-09 financial crisis and choppy markets in 2011 and 2015, it rebounded well in 2009, 2012, and 2016. As a result, the standard deviation of the fund’s returns (a measure of volatility) over Pohl and Cameron’s tenure ranked higher than most peers and either index. The managers’ patience helped turn this apparent instability to their advantage. The fund’s Sharpe ratio, a gauge of risk-adjusted return, topped the typical peer and both indexes over the period.

The fund’s middling results since the start of 2018 owed mostly to stock-picking. Microsoft MSFT contributed nicely through May 2019, but longtime holding Schlumberger, an oil and gas equipment provider, slumped 46% in the period. Discount brokerage firm and top-10 holding Charles Schwab SCHW dropped 18%.

People Pillar:

Positive | Tony Thomas 06/25/2019 A deep, talented investment team built with its future in mind earns a Positive People rating.

Dodge & Cox’s 10-member U.S. equity investment committee manages the strategy and helps mitigate key-person risk. Recent minor moves fit with Dodge & Cox’s long-standing, gradual approach to succession planning. Four members each have more than 30 years of tenure at the firm (the group as a whole averages 24 years), including chairman and CIO Charles Pohl and director of research Bryan Cameron. In January 2019, the firm shored up these leaders by promoting committee members David Hoeft and Steven Voorhis to associate CIO and associate director of research, respectively. At the same time, analyst Ben Garosi joined the committee.

The firm draws the investment committee from its deep, stable equity research team. As of May 2019, that unit had 34 analysts and managers, and all but two have at least five years’ experience at Dodge & Cox. A cadre of 27 fixed-income analysts and approximately 25 research associates provide support. Most of the firm’s analysts and managers have spent their entire careers immersed in its investment culture.

The managers’ investment in the strategy is impressive. As of early 2019, nine of the committee’s 10 members each invested more than $1 million in the mutual fund; the other invested $500,001-$1 million.

Parent Pillar:

Positive | 06/27/2018 Dodge & Cox sets a high bar for the asset-management industry. Its many strengths earn it a Positive Parent rating. The San Francisco-based firm, founded in 1930, benefits from a strong investment culture. CEO Dana Emery and chairman Charles Pohl are also lead members of the investment team; they run the firm and its funds with a long time horizon.

But there are no stars here--an intentional and enduring characteristic of the firm. Each fund is run collaboratively by one of five investment policy committees, whose members average more than 20 years at the firm. The analyst ranks are broad and deep, with impressive levels of experience. In all, the firm has approximately 60 managers and analysts, most of whom are Dodge & Cox lifers. Team members rarely leave for any reason other than retirement. The team's financial incentives are appropriately aligned. Portfolio managers invest heavily in their strategies, helping align their interests with investors'. Dodge & Cox is 100% employee-owned, allowing staff to participate in the firm's economic success. Moreover, it has helped Dodge & Cox avoid short-term pressures that often face public firms on Wall Street.

The firm's approach to new strategies is admirable, having rolled out just six in its history. Management has also proved willing in the past to safeguard its strategies by closing funds. All around, Dodge & Cox is a model fund family.

Price Pillar:

Positive | Tony Thomas 06/25/2019 Consistently low fees earn this fund a Positive Price rating.

All assets are in the fund’s no-load share class, which charges 0.52%--a competitive rate that hasn’t changed since 2004. It is well below the 0.88% median net expense ratio for large-cap, no-load peers. This pricing advantage is likely to remain. The fund’s $70 billion asset base favors economies of scale, and the managers’ low-turnover strategy tends to minimize transaction costs.

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