Thursday, May 5, 2011

Yacktman on "Old Tech"

The Yacktman Funds just released their 1Q 2011 Letter.

The fund managers at Yacktman are worth highlighting for their very solid long-term track record with equity investments combined with low turnover in the portfolio.

Some portfolio managers are in and out of stocks so quickly that it is difficult to gain much meaning from what they own at the end of each quarter.

One of the nice things about modest turnover, beyond the obvious benefit of lower frictional costs, is that the primary driver of Yacktman's long-term results is the ownership of great businesses, bought at fair prices, held for a long time.

Outperformance comes from the underlying economics of the businesses and the prices paid relative to those fundamentals instead of some unusual ability to trade in and out of securities at just the right time.

Based upon the most recent letter, the two Yacktman portfolios continue to be dominated by consumer staples, media, and healthcare.

A key theme highlighted in the letter is what they refer to as "old tech":

Microsoft (MSFT)
Hewlett Packard (HPQ)
Cisco (CSCO)
Intel (INTC)

Last quarter, Microsoft, HP, and Cisco all declined. In the last 12 months, Microsoft, HP, and Cisco are all down even though the S&P 500 is up more than 15%. We used the declines in these stocks to increase our weighting to this group of companies and add a small position in Intel in The Yacktman Fund only. We refer to this group of four companies as "old tech".

Investing is largely about what you buy and what you pay for it. Today, with the "old tech" positions in the funds, we think we are getting good businesses at fire sale prices. A little more than a decade ago, these same stocks were overvalued, causing the returns for many previous shareholders to be poor even though the businesses produced strong results.

Today, this "old tech" group is now so disliked it sells at less than ½ the multiple of the S&P 500 even though the companies in this group exhibit business characteristics that we believe are superior to the average company in the S&P 500. The "old tech" balance sheets are some of the strongest around.

More recently, since 2007, the underlying businesses of our "old tech" basket have performed well and vastly outperformed the S&P 500, yet the stocks have dramatically underperformed. Each of the four companies in our “old tech” basket sells at less than 10 times our projection of 2011 earnings, net of the cash on the balance sheet. As long as the businesses on average do not go into unpredicted, sudden, and rapid decline, our investments should do well over time.

Maybe the fact that they are thought of as "old tech" explains part of the valuation disconnect as the name alone implies decline. Of course, in the long run what matters is underlying business performance. So while ugly headlines and poor stock price performance reinforce the "old tech" image the underlying business performance in recent years has actually been more than solid.

If their underlying businesses continue to perform reasonably well, sooner or later, the voting that goes on in the short run will be superseded by the weight of underlying economics.

In any case, nothing spectacular is needed as far as business performance goes at these valuations.

Given the unpredictable competitive dynamics, I happen to think technology stocks should always be purchased with a larger than average margin of safety. Current valuations seem to offer just that. A margin of safety and then some for those familiar with the risks and opportunities in front of these businesses.

To me, some of these appear to be above average businesses selling at valuations implying some kind of imminent collapse or soon to be ruined economic moat.

It's worth noting that although Yacktman speaks favorably of "old tech", among technology only Microsoft is a top ten holding in the Yacktman Fund and Yacktman Focused Fund. So apparently they like these "old tech" stocks but not enough to give them the same kind of weighting as their favorite consumer staple, media, and healthcare holdings.

That weighting makes sense to me even at these seemingly reduced valuations.

Adam

Accumulating, or planning to accumulate, small long positions in the above stocks as they (hopefully) drop further in value.
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