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Bill Nygren has been a manager of the Oakmark Select Fund (OAKLX) since 1996, Oakmark Fund (OAKMX) since 2000 and the Oakmark Global Select Fund (OAKWX) since 2006. He joined Harris Associates in 1983 and served as the firm’s Director of Research from 1990 to 1998.
Nygren has received many accolades during his investment career, including being named Morningstar’s Domestic Stock Manager of the Year for 2001.
He holds an M.S. in Finance from the University of Wisconsin’s Applied Security Analysis Program (1981) and a B.S. in Accounting from the University of Minnesota (1980).
Nygren recently did an interview with The Motley Fool, where he discussed how to find value opportunities, how to avoid value traps, and the three things you need on your value investing checklist.
Let’s take a look…
This is an excerpt from the recent interview that Bill Nygren did with The Motley Fool:
Do you use an investing checklist?
Our checklist is brief — just three items — good business, good price, and good management. It is printed at the top of my commentary to shareholders in each quarterly report:
“At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.”
When should a company pay a dividend or repurchase stock?
A company should return capital to its owners when that adds more to per-share value than would reinvestment in the business. With the exception of those few companies that have supernormal growth opportunities, we believe companies should be consistently returning capital to their owners. Our preference for how that capital is returned is repurchase of undervalued shares since that adds more value than a taxable dividend would. If the shares are fully valued or overvalued, then a dividend is preferable to repurchase.
How should value investors try to avoid value traps?
I think the path of least resistance when you are wrong on a stock is to say that the declining stock price has more than reflected the fundamental shortfall. When stocks fall on bad news, the typical analyst response is to say that the stock is a better value now than it was before it fell. We’ve gone back and analyzed stocks we’ve recommended, and we’ve found that companies that start to fall short of our analysts’ fundamental expectations typically continue to fall short both on fundamentals and stock price. Those that meet our expectations are likely to continue doing so. Statistically speaking, the best course of action is to admit the mistake early, sell the stock, and revisit it at a later date. That is much easier said than done.
How do you evaluate a company’s balance sheet? Do you look for particular coverage or debt ratios?
We don’t have targets for debt ratios. As long-term investors, we want to see a balance sheet strong enough to make it highly likely the company can survive for the long term. That can be especially important for cyclical companies that tend to lose money when the economy is weak. During recessions, we typically have confidence the economy will get better but are not confident of when that will happen. So the ability to survive an extended downturn becomes critical.
When we value companies, we value the business separate from the balance sheet. Once we’ve estimated the value of the business, we will add excess cash and other non-earning assets and then deduct claims ahead of the equity investor, such as debt or preferred stock.
We will reduce our normal position sizes to offset a levered capital structure as opposed to making levered businesses off limits.
How do you narrow down your investable universe?
For starters, on the U.S. side of our business, we limit our universe to companies either based in the U.S. or conducting a substantial part of their business inside the U.S. We don’t do that out of xenophobia, but rather out of respect for our peers on the international side of our firm. David Herro manages an outstanding international team for Oakmark that primarily invests in companies headquartered outside of the U.S. For non-U.S. investing, I’d urge you to strongly consider Oakmark’s offerings of international and global funds.
Further reductions in the investable universe depend on goals of each specific fund, but generally revolve around liquidity and suitability. For Oakmark Select, as an example, we want typical position sizes of about 4% of assets because we are targeting a 20-stock portfolio. We also want reasonable liquidity in each position. If we want 4% of our assets in a stock without owning more than 4% of the outstanding shares, that means we can’t buy companies with a smaller market cap than our total NAV. Today we have about $5 billion in Select, so we only look at companies larger than that.
In the Oakmark Fund, we are focused more on risk than we are in Select because many of our investors use it as their sole domestic fund. To keep the risk lower, we only invest in big businesses. Many studies of risk have, incorrectly in our opinion, concluded that large-cap stocks, usually defined as the 250 largest market caps, are the least risky. While often true, at important turning points such as 2000 when overvalued small technology companies achieved large-cap status, investors were hit by the double whammy of risky small businesses combined with excessive valuations. Large-cap investors in 2000 were in a very risky spot.
We believe that the risk reduction associated with “large” is due to business characteristics, not valuations. So we limit Oakmark investments to large businesses as measured by the 250 largest in sales, earnings or book value. These two sets of businesses are largely overlapping; they don’t sum to 750 companies, but more like 300 to 400. Eliminating the ones with below average per-share growth prospects, poor management, or excessive valuations then gets us down to about 100 big businesses on our approved list. About half of those names make it into the portfolio.
We’ve chatted on various occasions. No one has been as generous with his time and knowledge as you have. Is there a question about Oakmark I’ve missed?
Thank you — I enjoy sharing our thinking with anyone who is interested in hearing it. But that isn’t just being altruistic. One of the biggest difficulties in managing money today is that investors have developed very short time frames — much shorter than the five-to-seven-year time horizon we use to evaluate the companies we invest in. I think the main reason investors have become so impatient is they are bombarded with short-term performance data and are encouraged to almost constantly reevaluate their investments. They tend to shoot themselves in the feet buying after a stock or fund has gone up, then selling after it has gone down. Rapid in-and-out trading also increases the cost of managing a fund, and those costs are borne by the fund shareholders.
By sharing with investors and potential investors how we think, rather than just how we’ve performed in the past quarter, we attempt to get investors to understand and believe in our process. An investor who appreciates the thinking that goes into our decisions is more likely to be a long-term investor than a performance chaser. So when you see Oakmark getting awards for industry-leading shareholder communication, know that we believe better informed shareholders are less likely to suffer from self-inflicted wounds. And what is good for our shareholders is good for our business.
To find the full interview that Bill Nygren did with The Motley Fool, you can find it here.
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