Monday, August 27, 2012

Yacktman: Above Average Businesses, Below Average Prices

Here's a good GuruFocus interview with Donald Yacktman and Russell Wilkins of the Yacktman Funds. Check it out in its entirety. 

Some highlights (all excerpts below are Donald Yacktman quotes):

Above Average Businesses, Below Average Prices
"...one of my children said to me once, after dinner when we were talking about investing, 'Now let me see if I have this right, Dad. Basically what you're saying is if you buy above average businesses at below average prices, then on average it's going to work out?' I said, 'Yes, that's basically it.'"

So much for using complex formulas to boost returns.

On Patience
"So many people in this business think in terms of 10 minutes, or 10 hours, or 10 days, or 10 weeks, or 10 months, not 10 years. Very few people have the inner strength or patience to wait it out."

On Focus
"We are focused on a fairly narrow universe of companies we know well."

On Capital Intensity and Cyclicality
The interview includes a useful chart that Donald Yacktman used to demonstrate the business characteristics he and his team find attractive. On the y-axis is capital intensity and on the x-axis is cyclicality from high to low. It's a simple but useful way to think about businesses. As an example, they have consumer staples shown as low capital intensity and low cyclicality.

I'd add that greater cyclicality and capital intensity means that a strong balance sheet is a must. Too much financial leverage can get any business (anyone) in trouble, but excess financial leverage with highly cyclical and capital intensive businesses is just asking for it.

In Mr. Yacktman's view, businesses with both low capital intensity and low cyclicality (Coca-Cola: KO, Pepsi: PEP, and P&G: PG are the specifics mentionedare likely to earn the highest returns.*

Jeremy Grantham has previously described the higher quality stocks as the "one free lunch" in investing.
(Coca-Cola, Pepsi, and P&G are all in the top 25 of the GMO Quality portfolio)

I happen to think that sometimes, even if rarely, a simple insight can trump details and complexity. When it occasionally does, use it. A simpler approach can beat the complex and, in fact, often does.**

Back to the Yacktman interview:

On Valuation
The managers at the Yacktman funds have mentioned the following mantra on prior occasions:

"It's almost all about the price." 

Well, the chance to buy a good business cheap is usually when it is experiencing difficulties. During the interview, Russell Wilkins also points out sometimes a stock gets cheap when prospects for a business seem solid but unexciting.

On Growth
Yacktman points out that many businesses, especially the high growth ones, have difficult to project long-term prospects. That high growth doesn't generally last very long, yet valuations of fast-growers often assume growth will continue for an extended time. 

"...the problem is that the market has a central tendency to overprice things, and put very high multiples on companies that are growing quickly, even if it is for a short period."

Well, when high growth selling at a premium price disappoints, watch out below. 

On Hewlett-Packard, Microsoft, and Cisco
Hewlett Packard (HPQis cheap but its history of doing dumb things with cash (Yacktman specifically mentions the value destroying event that was the Autonomy purchase) and their relatively high net debt has kept it a smaller position for the Yacktman team.

The Yacktman team is more favorable toward Microsoft (MSFT) and Cisco (CSCOconsidering their also cheap valuations but much stronger balance sheets. As a result, both of those stocks are larger technology positions than Hewlett-Packard.

Special situations like Hewlett-Packard have been some of their biggest winners but they recognize that these have a higher probability of not working out. So they tend to keep positions like Hewlett-Packard on the smaller side.

Check out the full interview.

Adam

Long positions in all stocks mentioned

* To me, the shares of many of these businesses are not especially cheap these days even if they have been at times over the past few years. It's worth waiting for a good price then acting decisively when valuation is attractive. Since each is unique, the necessary homework to build some depth of knowledge and understanding can be done while waiting for the right price. These may be lower risk but they're certainly not no risk. Margin of safety still matters. There's no way around the preparation and patience required in investing. After figuring out what's attractive at a certain price lots of waiting is inevitably necessary.
** Some may become bored by the straightforwardness. A few may even choose more complicated, high risk journeys just to enhance the challenge. Long-term Capital Management (LTCM) comes to mind. Charlie Munger said it best in this 1998 speech:

"...the hedge fund known as "Long-Term Capital Management" recently collapsed, through overconfidence in its highly leveraged methods, despite IQ's of its principals that must have averaged 160. Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger's 1998 speech to the Foundation Financial Officers Group

Uncomplicated, understandable, yet effective ways to produce attractive risk-adjusted returns should be embraced. Sophisticated or esoteric methods, especially those involving leverage, should not.

Munger's speech to the Foundation Financial Officers Group - 1998
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