During his recent presentation at Natixis, Bill Nygren explained how the growth of passive investing and popularity of low-beta stocks have created attractive value opportunities for active, research-driven investors. Here’s an excerpt from the presentation:
Nygren: In a market cycle like we’re in today, we’re dealing with more passive investors than we’ve ever seen. We’re dealing with industry investors who aren’t thinking about specific companies.
And while that can be frustrating at times, we believe it creates value for a firm like us that does deep company-specific research, because we can find companies that are trading at prices that are dramatically different than what we believe their businesses are worth.
I think today’s market creates a lot of opportunity for a value investor like Oakmark. First, the multiple spread has become very large between cheap stocks and expensive stocks.
And one of the areas that we think investors are overpaying for is what we would call low-risk or low-beta companies, companies whose businesses are quite predictable, are in great demand by investors today.
And we think we are getting paid much more than we normally do to take on some volatility in companies that may go up or down a little bit more than others in the business cycle, or where there are longer-term questions about industry disruptions, such as the auto industry, and prices for traditional businesses are well under market multiples.
In fact, I’d say the biggest opportunity that we have today is buying those out-of-favor businesses that are selling at single-digit P/E multiples.
The S&P 500 is selling at close to a 20-times multiple, and yet the spread between high-priced stocks and low-priced stocks is so large that many of the names that we have in our portfolios are only selling at single-digit P/E multiples. And when our entry multiple is that low, we think that strongly biases the potential outcomes in our favor.
I think today the typical investor views risk as either how volatile your fund is on a day-to-day basis relative to the market, or, over a slightly longer time period, how much your results might deviate from the market.
We think our shareholders are most concerned with growing their capital over a long period of time.
So when we try to mitigate risk, we’re trying to reduce the chance that we lose capital. We’re willing to take on the risk of looking a little different than the index or, on a day-to-day basis, being up or down more than the index when we think the market is paying us more than it should to take on that incremental level of risk.
We might have slightly higher standard deviation today or slightly higher beta than we’ve had historically. Maybe tracking error relative to indexes that’s a little bit higher. But the reason we’ve structured the portfolios that way is we believe the returns are unusually high for being willing to take on that level of risk.
We think investors’ obsession today with trying to reduce the risk level in their portfolios has led to some unusual and hard to justify outcomes, like the electric utility industry selling at a market multiple or higher, or packaged foods companies selling higher than market multiples, businesses that we don’t think for a minute are better than average businesses, and they’re selling at higher than average multiples.
So we believe, at Oakmark, by avoiding those investments we’re able to increase our expected returns.
You can watch the entire presentation here:
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