) is celebrating its 20th anniversary this year, but when we sat
down with John and new portfolio manager Timothy Fidler, the two
focused on their investment strategy and favorite themes--not the
fund's track record of success.
The fund's amassed an impressive track record since its
inception. What's the secret to your success?
We are a value-oriented firm that has always focused on buying
companies when they're out of favor. For patient investors with a
long time horizon, it pays to invest in the small and midsized
companies that the market kind of hates.
What differentiates us from other value funds is that we
concentrate on a few industries and relatively few names. We
believe what Charlie Munger talks about every year at Berkshire
Hathaway's (NYSE: BRK.A) annual meeting; you want to stay within
your circle of competence and become an expert in the industries
and companies that populate your portfolio.
We often buy stocks when something isn't quite right at a
company--for example, it faces a temporary problem or a subsidiary
causes trouble--but we think it will ultimately overcome these
hurdles and become a higher-quality name. We're willing to look out
two to three years and bet that once things get back to normal
these companies will be able to outperform.
We're patient investors who expect to own stocks for three to five
years. Over that period, management can have an enormous effect on
the direction and value of a business. We spend an enormous amount
of time getting to know each company's management team and sizing
up whether they're good stewards of shareholder's capital.
This approach has led you to some out-of-favor industries,
such as media and commercial real estate. What's the logic
behind these moves?
Last year was the opportunity of a lifetime for value-oriented
investors, though buying stocks at low prices didn't work for a
bit. You'd buy a stock, and it would go down; you'd buy more, and
it got cheaper still. Credit markets froze, so any names with debt
burdens got clobbered. And forced selling by hedge funds created
drama when there really wasn't any, so what was an $18 stock
plummeted to $3. The market abandoned rationality.
Last March we became more aggressive in our purchases because we
knew the economy would recover and wanted to add the names within
our circle of competence that stood to benefit. We picked up some
great stocks that we never thought would sink to bargain
levels--for example, media giant
) and high-end retailer
In times of crisis focusing on your core competencies is
essential to making good decisions; if you lack conviction, you're
more likely to be paralyzed by indecision. Because we knew our
stories well, we were willing to buy when panic reigned.
But media companies are struggling, regardless of the
recovery. How does that sector fit into your thinking on quality?
We spend a lot of time with
) management and believe in what they're doing. But that business
doesn't have to return to its glory days. If it attracts a fair
share of advertising revenue as the economy recovers, aggressive
cost reductions and lower newsprint prices will enable Gannett's
earnings to surprise on the upside.
Analysts have been negative on the sector for so long and aren't
factoring in the benefits that will accrue from any improvement in
the economy. Already a lot of the big retailers are advertising
more aggressively on TV and in print. These days when I pick up my
newspaper I see much more advertising. We're hearing that
advertising rates are improving not only from newspapers but also
from several media companies that we talk to.
Buying quality stocks when there's maximum pessimism has always
made sense because once everyone gives up on a stock, groupthink
takes over and share prices sink lower than they should--people
lose sight of a possible recovery.
Do you have any favorite stocks?
CBS Corp is one of my favorites. The media giant should benefit
from the economy's inevitable recovery and an uptick in
advertising. General Motors' CEO is selling cars on TV, next year
is an election year and advertising prices are on the mend. There's
a lot of positive momentum building, and companies will pay to put
their products in front of the eyeballs that watch highly rated CBS
shows like CSI, Survivor and The Amazing Race.
And investors often forget about CBS' other businesses--for
example, King World Productions, which distributes Oprah, Wheel of
Fortune and Jeopardy. I often joke that I'm the only fund manager
who's been able to perform due diligence on two of these shows; I
was a contestant on Wheel of Fortune in my youth, and I've appeared
on Oprah several times. Showtime Networks is another important CBS
franchise. And CBS operates 137 radio stations, boasts a valuable
programming library and is one of the largest billboard owners in
the US. The company also has a lot of exciting Internet
opportunities on the horizon. CBS is one name that we're going to
stick with for the long run.
Tim: Hewitt Associates
) is the world's leading outsourcer and human resources firm; it's
been around since 1940 and has a tremendous brand. The firm
generates a high level of recurring revenue thanks to a client
retention rate that exceeds 90 percent. And half of the Fortune 500
companies do business with Hewitt. Nevertheless, the market soured
on the company because its business process outsourcing
operations--a small-scale business--was losing money in a dramatic
way. Negative sentiment brought the stock from the mid-$30s to the
teens, at which point we decided to make our move.
If you look at the value of the consulting business, which only
has three other competitors and a well-established market share,
and then look at its outsourcing business, which had some pretty
big competitors walk away from the market, you got the sense that
the market had overreacted to a fixable problem in one business
We scrutinized the company's balance sheet and found that Hewitt
was one of the few names that had a net cash position and was
actively buying back shares. Operating a consulting firm isn't
capital intensive, so the business generated high returns on
capital and high margins.
We've owned shares of
) for almost 10 years, and I've covered the consulting space
throughout my tenure at Ariel; when we took out our stake in
Hewitt, we felt confident in our appraisal of where the company
would be in the next five years.
And from a valuation perspective, Hewitt's shares trade at 10
times free cash flow and 13 times earnings. Right now the stock's
above $41, and we rate its value somewhere in the mid-$50s. Not
only is it cheap on a trading basis, but if you look at the assets
and what acquiring firms have been willing to pay for similar
businesses, you get a stock price that's well into the $50s.
What's your best advice for individual investors?
Stay the course. There's a lot of skepticism about this rally, and
I think people are tempted take profits and err on the side of
caution. But I believe that this economic recovery is going to be
much stronger than people anticipate, and the upside for a lot of
the names that are tied to the recovery is much higher than people
expect. Now's the time to stick with equities for the long run.
This article first appeared in the December 2009 issue of
Louis Rukeyser's Mutual Funds
Editor Benjamin Shepherd is also associate editor of
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