Fund Holdings, Insider Ownership, Long Only, Value
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Dear Superinvestor Bulletin Follower,
An interesting take from Weitz Value in their second quarter 2017 commentary. The firm has made the decision that in an environment with few stocks meeting their valuation standards.......to lower those standards so that it has more investment opportunities.
Essentially this is a bet that interest rates will continue to stay low for a long time.
With both the equity and bond markets continuing to drift higher, there has been growing interest in the longevity of the now eight-plus-year-old rally. Respected value investor Jeremy Grantham recently grabbed headlines by suggesting higher P/E ratios are likely here to stay, stating matter-of-factly that this upward shift in valuations is in fact “very, very different” (read: sustainable). “The world has changed.” Predictably, Grantham has taken his share of flack for making such a bold claim. But Berkshire Hathaway Chairman & CEO Warren Buffett, too, has suggested he doesn’t see widespread evidence of overextended valuations within the context of today’s long-term interest rate environment. In a February interview Buffett stated “…we are not in bubble territory or anything of the sort…if the 10-year [Treasury Bond yield] stays at 2.3%...for ten years…you would regret very much not having bought stocks now.” What will long term interest rates average over the next 10 years? 0%, 2%, 6%? And where will they be in 2027? No one, of course, knows the answer to these questions.
What we do know is today’s ultra-low interest rates have generally resulted in a less compelling opportunity set. Earnings streams that were routinely offered at P/E multiples of 12-15x over much of the last 20 years now mostly trade for 18-22x. When the typical investor’s alternative is 2-3% 10-year Treasuries or high-grade corporate bonds yielding 3-4%, a broad basket of stocks offering 7-8% hypothetical long-term returns looks attractive (and all the more so when the Federal Reserve stands at the ready with monetary assistance, or promises thereof, at the first sign of equity markets beginning to wane).
In early 2016, we made the decision to lower our hurdle rate for assuming equity risk from 12% to 9%. This was not a decision we took lightly. Cognizant of the risks of skating to where the puck was as opposed to where it may eventually be, we concluded that we had been asking too much of both existing and prospective investments. We had sold a fair number of quality businesses–Texas Instruments, Fidelity National Information Services, Microsoft and Anheuser Busch-InBev, to name a few–at prices we believed still offered low double-digit forward return potential at the time of sale. We also found ourselves passing on prospects we thought likely to produce mid-teens annual returns.
These decisions made less and less sense with cash piling up in the portfolio. The goals of adjusting our “ask” were (and are) to: 1) allow us to hold onto stocks we ought to longer (ideally capturing more return, delaying tax realization and lessening the burden of finding qualifying replacements); 2) encourage us to more regularly consider high-quality businesses offering mid-teen return profiles (recent additions Comcast, Oracle, Amazon, Visa and Thermo Fisher Scientific fit this profile); and 3) gradually lead us toward being sustainably more fully invested. We’d like residual cash to eventually average less than 10% of the Fund’s assets, but we are resolved not to “force it.”
Importantly, while we believe these process tweaks will be additive to the Fund’s performance over time, our underlying investment philosophy has not changed. We continue to spend our time searching for competitively advantaged businesses, studying the industries in which they live, evaluating the quality of their management teams and framing their ability to generate excess cash flow under a host of different scenarios. We demand a healthy margin of safety upon initial purchase and will sell when prospective returns no longer compensate us for the risks we must bear to earn them.
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