Don Yacktman - "Viewing Stocks as Bonds"
These are the notes taken in the talk given by Don Yacktman at
the Value Investor Conference in Omaha on May 3.
Savers wish they could put their money in a mattress and leave it there. In real world that's not possible. There are two reasons: inflation dribbles capital away. This year is anniversary of reserve system. In 1913 dollar compared to what it's worth today is a nickel. In last 50 years, dollar has declined to 13 cents. At that pace, a dollar will have to decline to a penny. In a paper society, inflation is inevitable. At 2% of something in that area. Insidious thing is to be protected from. Our goal is to protect clients from dumb decisions and inflation.
Second thing is equity investors and shoot for double digit return. The other thing is over a 10-year period, one market peak to peak, want to beat S&P 500.
Overview of managers investment group - this is the performance. Numbers speak for themselves. There are going to be periods of time when we look smarter or dumber than we really are. Our goal is not to beat S&P all the time. We know what we're doing right to the minute because of the internet. You can see the numbers are all over the map. In 1999 they think we're pretty dumb, now they think we're brilliant. Depends on the time. Toughest comparison is to compare peak to peak is the fairest . The problem in this business is to find people ahead of when results show up, and what makes that unique. I've been in the business over 40 years, I ran Selective American for 9 years before starting firm. One of the dilemmas is when you look at the results, in the mutual fund business, when you see those kind of results peak to peak, the fund manager may move on to a new category. Fortunately my sons have been in the business 20 years, and are incredible investors. I'm pretty humble about having a couple of guys who are so dynamic. I talked to manager when we made this deal with AIG, I feel like Mosses with his arms being held up. They're really great.
We are managing about 24 billion. Had a lot of growth in last years.
Investment process: intrinsic value and all these other things. Focus on three parts of investing we see: pricing model. Almost always about the price. Second is business model. Third is management model.
Pricing model. We do it a little different than most value investors. Most have market price and want to buy at a discount. That works, it's not wrong. We just feel we can add additional objectivity by flipping equation and looking at adjusted compounded rates of return and including risk. So when I think of an investment as if it were a bond portfolio, so no matter what I'm buying, it all looks the same whether bond or building or stock. I do have a problem looking at art of violins or gold, I have a hard time valuing things like that. Doesn't mean you can't buy them, but I'm just telling you how I look at it. Ultimately when you buy a stock the cash flows tend to be divided into two components: dividend. Second piece is dividend is reinvested, historical experience on reinvesting. So wild card in investing is looking at future cash flows being reinvested for you by management. That is why it becomes more difficult in analyzing individual equities than bonds. Because nobody can predict the future with certainty, one needs to create a range of outcomes. Depending on the business model, range of outcomes can be narrow or wide. After that, you may have to normalize those cash flows on cyclicality or leverage. And then assign probabilities to various outcomes. And try to come up with objective way to value company.
Now don't assume we're sitting there churning out data every day. That's not how we do it. In reality we can do this simply. But being objective. Really getting key variables in process correct. In other words, I'd rater be generally right than wrong to the fourth decimal. Very hard to predict in the future many years. I can't tell you what kind of phone I'll have in my pocket 10 years from now. But I bet you high percentage of detergent will be made by Procter & Gamble ( PG ). So think about those types of things.
So that's the pricing model. We're trying to find the best risk adjusted rates of return and put our portfolio in line. The market will in general go in line. As an example, today you've got this kind of an experience where the bell curve of outcome because the market tends to be less jittery, whereas in 08 or 09, tend to have a long tail, which creates opportunity. So our turnover rate will be higher in that kind of a period. I think it was around 70 pct. Which now I think it was less than index fund.
Business model we look at - years ago - I tend to think in pictures, and came up with this idea - if you put up a grid and on one side have economic sensitivity, some may be more complicated and have to centralize it because they're diversified. Some are diworsified. We have one, called Dell ( DELL ). But anyway, this gives you an idea of where you can plot a business. What we're looking for is conceptualize and understand business. Btw, Jason, Steve and I were all on the board of 1-800-contacts, so we've seen a co on inside and outside as well. Can see the pressures that go on inside the company.
Going to be difficult for companies to get good directors and retain them.
What we're looking for is high returns on tangible assets. Reminds me of story of guy went to Harvard business school and came back 25 years later and they said where have you been, and he said I barely got in here and barely graduated, and I went back to little co in Illinois and we used a little product, we make it for a dollar and sell for four, you'd be amazed how that three percent adds up [laughter].
Central tendency is to have businesses with low cyclicality, Coke ( KO ) and Pepsi ( PEP ) and PG fit that to it. Most people can understand that to a certain degree. But the gamble is to get it at a decent enough price.
Coke had its all time high at 44 and a half, still hasn't reached that. Was a good business then and is today. But it was just overpriced. Fast forward and you start to see it at a much better letter. By 2007 had over 10 pct of the fund in Coca Cola, much less now as price went up.
We rarely spend a lot of capital in businesses that have enormous amounts of cyclicality.
Most CEOs grow up in business, and come up to the top, but they aren't capital allocators. They have to go through learning curve, but most wouldn't learn well.
They start to generate excess cash, and the key is what to do with it. They have five options. First is most fruitful, reinvest. Marginal rate of return on incremental units is phenomenal. But they tend to run out of that option. Then acquisitions. But look at companies like Pepsi, they bought Frito Lay, then Tropicana, and Quaker oats, then along the way when FCC was hard on people, they made deworsification acquisitions. But now they have a much better, purer business model. So it can work but need to be synergistic - make sense - and not overpay. Coke overpaid for Russian milk business. I can give you example after example.
Next one is buying back stock. At least then you know the business you're buying. At Harvard they said bankers tend to reach for yield then get caught and nailed with those assets when the market reverses itself. They end up with a lot of business so buy when others are but if they're objective the return can be phenomenal.
Henry Singleton's Intelidyne bought something like 90% of its stock back. Masterful job running.
Paying a dividend. Frictional cost to tax-paying shareholders, but a lot of times better than if they do 2 and 3.
Last is letting it build or reduce debt.
Our two funds - in the mutual fund biz is hard to get shareholders to vote on anything. We love the Focus Fund and created an institutional class for large shareholders to reduce expense ratio when we did the deal with aig. For full disclosure, the four of us, have over 100 million in the Yacktman Institutional Focused Fund. Eating our own cooking.
The stocks we have in those funds [slide].
Wants to answer questions.
Question: you were talking about capital allocation and CEOs having a tendency to want to make acquisitions, and there's a lot of talk about slow growth environment. Do you think CEOs have learned maybe the best thing is you should be buying back your stock. Seeing how Apple has taken a beating here, next six months as a poster child for why aren't you allocating capital better, why letting it pile up. Do you sense CEOs are kind of getting that math in what they should be doing?
Answer: I wish that were the case. It's hard to change people. Either you get it or you don't. The problem again is so many CEOs just don't think in those terms. Don't think enough in capital allocation terms. They think about their basic business and how to make it bigger. Part of it is management teams. If you get more you get a bigger salary. We just think that doesn't do a good job of lining up management with shareholders.
Let me address Apple. Here's my concern with Apple ( AAPL ): Apple has hit like four home runs in a row. Made tremendous investments under Steve Jobs. How many more can they hit, I don't know. But if you take the strategy they have of high profit margins and not reducing price, you create enormous umbrella where people can come. This happens over and over again in technology. Eventually someone can say I can get an Android or Blackberry and start coming in at half the price and 90% of the same capabilities. Why would I continue to objectively keep buying the other one. My kids love Apple. But that's a problem.
To answer your question specifically, I wish that were the case. I'd like to see more objectivity. What I was concerned is that tax on dividends were going to go up and 40% taxes on dividends. I pushed managements and would you be willing to stop giving dividends and issue shares instead. Got a lot of resistant. Historic bent going on there.
Question: if you have this big fund, don't they want to hear what you think?
Years ago the brokerage firms just voted with management and now they can't do it anymore, so management has to go out and get the vote. We don't want to see politics enter the equation. That drives me up the wall if I see it. Management listens and does what they want to do most of the time.
Notice sometimes you use options. Can you talk about when you exit using options and when sell them outright?
Options is a zero sum game as you know. I have another son who has his own mutual fund, and they use options and going to do it a lot more heavily than we will. When you're this big it limits it somewhat. Try to use objectivity. When BP had that problem, and we said if US biz got wiped out at $20 per share we would be willing to buy the stock at $17, that was like free money to us. So we said we'll take that.
Think of it - either you want to be on the house side of the option, or the speculator. We'd rather be the house side.
Questions on diversification: 1) in your portfolio, when do you say I would like to have and will not exceed this number 2) if managing by yourself, how many would you be comfortable with?
Yacktman Fund is still pretty concentrated, if you add cash, rarely have under 50% in top ten holdings and cash. Focus Fund is more like 70%. We can put more in particularly ones that go beyond 1, 2 and three and concentrate more. We've had I think 15 stocks in last 15 or 16 stocks that we've had over 10% investments in, knock on wood, we've made money on all of them. But we don't treat that lightly. Won't go much over that, but we would. We try to be as objective as we can. Events occur that are unpredictable and one needs to be able to adapt. We've bought REITs, junk bonds... when I started I didn't think well we're probably not going to do those things, but as time goes on you find if you give yourself latitude it really helps. We'll have ten others but they're usually small.
I think you're better off to have 10 or 15 but do the homework. One of the problems in this biz is people like to look at a lot of things, but quantity won't override quality. Better to have few and really know what you're investing in. than to have a lot of them and speculate.
Question: consumer staples stocks you own a lot. Comment on valuation of Coca Cola and PG, they're trading 12 months forward earnings. Why do you buy into them?
Again, our primary goal is preserving and number two growing capital of clients. So tend to have tendency to want to protect client's money. Certain times it works to buy these companies, on a relative basis we think valuations are still pretty good. We're not going to be perfect. Can you make more money in other things? Of course you can. But the question is on a risk-adjusted basis is it worth it? When Dell got below 10, that changes the equation dramatically than when it's at 20. RIMM - do we love RIMM as a biz? I wouldn't say that. But when you look at everything and put it in perspective that was a really good value. But have to take range of outcomes, but at that value it made sense.
Conceptually, think of it this way: a lot of companies, steel or auto, they look like moving sidewalks. Valuation builds up very slow. So you get a one-time revaluation and you move on. We bought Quest bonds in 92, fifty cents on dollar. But behind every Quest bond was a telephone line. Objectively we said, that's a good deal. Almost always about the price. Part of it is the process and the other part is the execution. Good judgment comes from experience, and a lot of that comes from bad judgment. Everyone makes mistakes. If you can come up with a better process, let me know. I don't mean that arrogantly. I really want to know.
The other thing is time horizon. I see a world in which time horizon is way too short. Sixty percent of trades made by computers without any human.
Businesses have slowed. Microsoft was popular in 2000 and today about 60% of where it was. Cisco is about 25% of where it was. So had 13 years of building growth and value, and price declined that much. It shows you how overpriced they were then. Both cases have equation pieces trying to normalize cash flows in the future, we feel more comfortable. Microsoft takes on characteristics of Pfizer ( PFE ). PFE you could look out five years, not much beyond that. But odds of getting money back in that short time was so high, even with patents coming off, you could do that. Same applies to MSFT, RIM, Cisco. Reach a point where you've been doing this enough times that you just say at this price its worth it. There are times when Steve and Jason get excited about something and I say yes, I see it - I don't override them - I just believe in decentralized model of management. But anyway, they'll come and like a homebuilder or our gypsum, and I say I'll hold my nose on this one. I'll say I don't like the long-term investment. They're like slow moving sidewalks, I like the escalators.
Question: recent report from PG, people say they're losing their way. You're long term. But for Stryker and JNJ, they're both facing number of suits for hip implants shedding metal. Is that much of a risk for those? We own both of them.
The other side of the equation is like - that has been through the courts for years and about to get a huge settlement with the patent infringement case. Lawyers are motivated by getting money. One of the Graham books is on dealing with the honey pots, and it's a novel so it's not - but takes into account how lawyers behave. Think of the probabilities and try to be objective about it. Does that make a difference in valuation? It might. So yeah, take it into account.
One more story: a fellow had an assistant who gave talks right after another and after doing it a few times the assistant said, 'I've watched you do this so many times I think I could do this on my own just as well as you.' So they said that would be fun, let's do that. So the assistant did presentation just like the manager. First question out of the box was tough, and manager said you know, that's such an easy question I'm gong to have my assistant answer it.
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