Shrinking shares outstanding plays a big role in $9.7 billion
Oakmark Fund's strategy.
Paired with the high-quality companies the fund pursues, even
if they have mediocre sales and earnings growth, an evaporating
share base can add greatly to value, the fund managers say.
The fund's 33.92% gain over the 12 months ended May 31
outperformed 94% of its large-cap blend rivals tracked by
Morningstar Inc., which averaged 27.25%.
And over the past 15 years the fund's 6.10% average annual
gain topped 83% of its peer group, which averaged 4.71%.
Manager Bill Nygren is among the industry's dwindling ranks of
marquee managers. He has been with Harris Associates, investment
adviser to the Oakmark Funds, since 1983. He and Kevin Grant have
been co-managers since March 2000.
Nygren, 54 years old, and Grant, 48, talked about their fund
from their offices in Chicago.
How does this large-cap fund differ from others?
We consider our universe to be big businesses, in the top half of
the S&P 500 in sales, net income and book value. We look at
business size, not market cap size.
And we like economies of scale, broad geographic exposure,
companies with large sales forces, better outlays on R&D.
You've said that you look for companies whose executives act like
owners. Why is that?
We want management that think and act like owners, who allocate a
business's capital as if it were their own. We look for managers
who measure every expenditure against the return they could get
from some other investment. We like managers that own a lot of
their own stock. We do the same. Oakmark funds are our largest
You like some share buybacks more than others. Why?
We want managements that understand if their business is selling
at a discount. If it is selling at, say, a 30% discount, that's
like buying $1 for 70 cents.
So when a company is undervalued, we prefer management to
rebuy shares instead of paying a dividend. You don't get that
undervalued asset benefit with a dividend.
Bill, you added to your stake inOmnicom (
) the past two quarters. What do you like there?
Omnicom generates a lot more cash from operations than they can
put back into their business. It is one of the most unappreciated
positives in the market. A company like that can make
acquisitions, pay dividends, reduce their share base. Omnicom in
the past three years has cut its share base by an average of 4% a
A lot of investors are concerned that its earnings per share
are slowing somewhat vs. a strong period for advertisers in the
But if the business can grow 5% a year and the share base
decreases 4%, you get a 9% growth rate.
It also pays a dividend, (yielding) about 2.5%. So even if
they don't have growth, you get income exceeding what you'd get
in an intermediate-term Treasury. The market hasn't been like
this since the 1950s.
One last point: A lot of people worry that this transition to
new advertising venues hurts Omnicom. People mistakenly think
this company is too tied to traditional advertising. But they're
not only a leader in print and TV, they also a leader in Internet
So combining income with moderate growth in business and a
moderate decrease in the share base, that makes for an attractive
You've added toOracle (
) three of the past four quarters. The stock has struggled this
year. What's your take?
Like a lot of tech companies, this was selling at nosebleed P-E
multiples a decade ago. Now Oracle sells for about 14 times this
year's earnings. That's not quite as high as the S&P 500's
average multiple. So if you believe Oracle is merely average, it
deserves a higher multiple. If you believe it is superior, it
deserves even more.
Secondly, Oracle's maintenance revenue stream is as dependable
and persistent as any company could hope to have.
Third, Oracle generates lots of excess cash. Fourth, its share
base is down 8% from three years ago.
In contrast to tech companies a decade ago, which had share
creep (upward) from options issuance, Oracle buys more shares
back than it issues in options. That magnifies its growth
) earnings grew just 4% and 8% the past two quarters. But the
stock is trending higher. What's your thesis?
Microsoft sells at 12 times estimates for 2013. It's sitting on a
tremendous amount of excess cash. About 20% of its price is
represented by excess cash on its balance sheet. Its dividend
yield is about 2.7%. And its share base is going down every year,
which compounds its EPS growth rate.
Many investors see Microsoft as shut out from the shift to
tablets from laptops. But with its most recent releases of
Windows, Microsoft has a product that can compete in that
And its strength in the corporate (desktop) world makes it
unlikely the business is going to disappear any time soon.
A decade ago this company was priced at 50 times earnings. It
had to grow fast to merit that multiple. Today it sells at 80% of
the S&P 500's multiple. So it if grows only as fast as the
average company in the index, that (extra 20% of growth) is not
priced into the stock.
That's what we try to do. We try to get something for
The auto parts industry looked like a car wreck recently. What's
your play inDelphi Automotive (
For all practical purposes the whole auto parts industry went
bankrupt several years ago. It was saddled with expensive labor
costs. It was simply bending metal for auto manufacturers, which
forced price reductions to the point where they could not make
But through bankruptcies, the industry shed businesses. It
shifted labor costs to low-cost countries. And it improved its
business mix to the point where its intellectual property has
value. It's no longer just a bunch of metal benders.
And with auto production being done globally, manufacturers
want the same parts makers to follow them around the world to
Delphi sells at under 12 times this year's earnings. The
market sells at a multiple of 15. So it's priced below the
average. And too many investors are too focused on the depressed
cyclicality of Europe.
So a company like Delphi has the tail winds of growing auto
demand, more reliance on intellectual property and pricing below
the market average.
And, guess what, like other companies we've discussed they're
reducing their share base at the same time they're growing their
business faster than demand for auto is increasing, so their
below-market-multiple is not warranted.
And Walt Disney (
What we've liked about Disney, to be blunt, is ESPN. It's a
hidden gem. It's where most of the stock's value came from.
Is the housing recovery the driver forHome Depot (HD)?
The primary reason we own Home Depot is valuation and the
improvements management has made. They're improved cost
structure, supply chain, labor model and merchandising.
During the housing downturn, their improvements were masked.
But in recent quarters we're starting to see how it will all
look. That's why shares have performed well this year.
Also, they're taking share fromLowe's (LOW) . There was more
upside potential in Home Depot, and that's how it's played
What do you like aboutPrincipal Financial (PFG)?
This is a misunderstood business. Insurance is only one-third of
its business. What's undervalue is its retirement plan
administration and asset management business. Those are higher
quality, higher returns. And they've used their cash flow to
reduce their share base. This business sells at 10 times (next
year's) earnings. With the quality of this business, that should
be closer to the market multiple of about 15.
You are value-oriented investors. How do you apply that to buys
We spend time trying to understand the intrinsic value of a
business. We try to buy companies we like when they're trading at
60% to 70% of their fair value. We sell when they reach 90% to
100% of fair value.