Many fund managers claim to follow the footprints of respected
value investor Warren Buffett, but few actually have the guts to
stick with stocks through the tough times.
Aiming to outperform their benchmarks and attract institutional
investors, they simply can't afford to ride out down markets. But
the managers at Ariel Investments are agnostic to the indexes,
making them able to stick with contrarian value plays regardless of
short-term market fluctuations.
We recently spoke with Charlie Bobrinskoy and Tim Fidler,
(ARFFX), about their Buffett-esque strategy and how that's
contributed to their fund's success as it approaches its five-year
It Pays to be Contrarian
You're both very critical of the fact that so many
analysts are obsessed with quarter-to-quarter estimates. Why
don't you pay much attention to those numbers?
The sell-side analysts and the buy-side community are very
motivated by short-term considerations and often misprice
securities which should ultimately be valued by their long-term
cash flows. We don't see any point in trying to time the market
since it's extraordinarily hard to do. Others trying to do it
create market inefficiencies that we take advantage of.
This is rooted in the Warren Buffet idea of trying to be business
analysts rather than stock analysts. The vast majority of the
effort of the sell-side complex is spent trying to guess next
quarter's earnings and playing an information game.
The way we look at it is that, in the Buffet spirit, we're not
trying to trade paper but buy pieces of real businesses. When you
want to buy a real business, you have to evaluate what the business
can do over the next 5, 10, or 15 years and figure out what those
cash flows are worth today.
That approach flows through not only in our time horizon but
also in the way we do our company-specific analysis since we spend
a great deal of time trying to understand managements' resumes and
capabilities, what makes them unique and gives them a competitive
advantage. We want to look at what kind of growth rate companies
can achieve over the long run because the return of the underlying
business is going to determine the stock return.
But the fact that the investment community will take things that
are temporary in nature and capitalize them into the prices of
businesses as if they're permanent, delivers shocks to the stocks
and creates an opportunity for us as value investors.
You say that you buy value companies without a clear
catalyst in sight. Isn't that a risky proposition?
We don't pretend to know when a stock is going to make a big move,
but what has been absolutely proven over time is if you buy stocks
at a discount to their intrinsic value you will outperform over
time because in the end, a stock's return is based on the cash
flows from the underlying business over the long run.
would be a specific example of that. When we meet with analysts
they usually say that they really like the company but they can't
get excited about it because there's nothing they can see in the
next three to six months to drive the stock price higher.
But if you get back to the idea of buying the right business at
the right price, IBM was a company that we bought at the inception
of the fund that was a very cheap and one that we thought was going
to grow nicely over the next few years. There wasn't any specific
event that people were waiting for with the company and yet the
earnings power has doubled in the past five years and it's still a
cheap stock. The underlying operating performance has been so good
that it has been one of our better performers.
What's your outlook for the next year?
We think that people are underestimating the strength of the
recovery. They're excessively angered over the bad economy we had
last year but we're seeing very consistently that the companies in
our portfolio are recording results that are better than the
estimates. There's been a noticeable change in the confidence of
the managers that are running our portfolio companies.
Before they were talking about how things had stopped getting
worse and now they're saying things are getting better and we don't
think that's fully reflected in analyst expectations for earnings
or the overall market valuation. Again, we aren't good at figuring
out when exactly that's going to change, but it's good to be in
situations in which the market is underestimating the earnings
power of your companies.
Is that what's driving your interest in advertising, a
sector that there doesn't seem to be much confidence in?
These names would go into the category where the market is
underestimating earnings power. The work we're doing indicates that
the media and advertising spend is going to be up in 2010, yet most
of the analysts are estimating flat spend rates this year, which we
think is too conservative.
The best way to characterize our thesis on advertising companies is
that while we've seen a lot of disruption in how media is delivered
and how advertisers are going to market, the advertising firms
themselves are fairly agnostic to that trend and actually benefit
from shifts to digital media.
That's because in a number of ways digital is more profitable
and it also has become more important to advertisers to help
navigate through what is an increasingly fragmented and difficult
environment. That's the longer term case for advertisers.
In addition, we've also gone through a period in which companies
had to cut costs very rapidly and a lot of those cuts were in media
and advertising spend. Right now we're in a period where as the
economy and corporate balance sheets strengthen, advertisers are
going to come back to the market.
) is trading at its lowest valuations in 15 years and it is by far
the world class advertising company.
Interpublic Group of Companies
is a slightly different situation as a company with very powerful
brands in the marketplace with their agency networks but is still
coming out of a period where they've had to turn around operations
that were below peak profitability. So we see a slightly different
stock specific case there but we're pretty optimistic about how
it's going to shake out over the next few years.
What sectors are most attractive to you right
Healthcare is one that we have an outsized weighting in right now.
If you go back through the 27 year history of our firm, we've only
owned healthcare in any meaningful way twice: once was in 1994 and
then again over the last year and a half. I think you'll
immediately see the reason why.
There's been a lot of fear and uncertainty in how healthcare
reform was going to shake out and now that it has passed there's
still some confusion over what the ultimate impact will be on
fundamentals. The market hates any wide scale uncertainty and that
has taken the valuations on some world class leading companies down
to levels that are building in the worst case scenario without
really looking at what should be a positive for them a few years
out in terms of increased volume.
What's interesting is a company like
) is trading effectively for the value of the drugs they have for
sale, giving them virtually no credit for future productivity in
their pipeline and which to us is an incredibly bearish view on a
company that has a very long history of highly productive
They're a tremendous franchise that's trading at 8 times next
year's earnings which just seems overly bearish.
) is another company that's trading at a single digit
price-to-earnings if you look out a year. It's had a few specific
issues in their plasma business but by and large, is a very
high-quality and growing healthcare company.
is another one that we own which doesn't have that much exposure to
healthcare reform since they sell a lot of healthcare and surgical
consumables, low-ticket items that aren't going to see a lot of
pressure from healthcare reform.
Generally what we're seeing is the baby being thrown out with
the bathwater and the whole sector is being hit by investors who
are out of the sector, waiting to see what happens. We're
contrarian value investors so we have to be willing to get in there
and make these investments before the uncertainty is resolved,
because at that point, the market has already moved.
There's obviously a lot of concern about financials and the big
money center New York-based firms are facing concerns about new
financial regulation. We don't discount that because we think there
are new rules coming. But the banks have been pretty good about
dealing with consumer-based regulation in the past and we think
they will be going forward.
There was fear about an end to proprietary trading but that
isn't going to happen. It would be a big deal if all of a sudden
J.P. Morgan Chase
(JPM) couldn't own positions for its own account. The definition of
proprietary trading is going to work itself out and be very
manageable. Right now we think J.P Morgan and
Bank of New York Mellon
(BK) of particularly high quality.
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