7 Value Investing Observations
CIO-US Equities at value-focused Harris Associates, Bill Nygren, shares his insight on value opportunities for the reopening, value’s recent outperformance, inflation, and the importance of a long-term investment horizon.
When might equities be back to “normal” pre-pandemic levels?
With the disruption in 2020, we immediately went to a severe recession scenario, thinking that we wouldn’t see any recovery until the second half of 2021 – in hindsight, we weren’t too far off, maybe a little bit too pessimistic – and that by 2022 we’d be back to normal levels. Forecasting out five to seven years from now that the world will be normal typically doesn’t give much of a macro-overlay tilt to our portfolios. The view that we would get back to normal relatively quickly, in say, less than five years, gave us an outlier projection – the result of which was that our portfolios were heavily oriented toward business reopening.
What value trends are you identifying?
We also think the new normal is going back to work. For most businesses, collaboration and collegiality is an important part of corporate culture, and it’s difficult to maintain those elements via video conferencing. We think industry’s leaders in commercial real estate, and even something in consumer products like single-serving coffee machine distributors, are well positioned.
We believe the ultimate beneficiaries are some quality financial sector companies. The move to online banking is going to allow them to have a permanently lower expense ratio than they had pre-Covid. Because some of these stocks are cheap at single-digit price-to-earnings, we think it’s the most attractive area in the stock market. We are very much looking for a modern-day version of the Roaring Twenties to match what happened in the 1920s after the Spanish Flu pandemic.
What are your thoughts on value outperforming?
We think that value’s underperformance has been historic, and that we’ll be in a good position to benefit from any reversion in that growth outperformance. We believe that the fundamentals should dictate a continuation of value outperformance. Valuation extremes are very similar to what we were facing back in 2000, and if I’m right on that, then this value run has a good distance left to go.
Are you concerned about inflation? Could it impact portfolios?
Our oil stocks have benefited already this year with the fear of inflation’s return. That’s because hard assets do pretty well against inflation and people will stop talking about $70 per barrel being an unsustainable price for oil.
What do you look for in a company before investing in it?
Clearly, stock selection is the strength we bring to the table. We are not market timers in any way and, in order to maximize the impact our stock selection has on the portfolios, we run focused portfolios, generally between 20 and 70 names. Compare that to a typical mutual fund today that owns somewhere between 100 and 150 names. Each stock that we decide to own has a much bigger impact on our performance than it does for our peers.
We invest for a very long-term time horizon. If you have something that is undervalued and the value’s growing at least as fast as other companies – and management is aligned with outside shareholders – it gives us the luxury to think really long-term.
How long is your time horizon?
Many private equity firms typically buy poorly managed companies where they have to change out the management teams. We differ from them by trying to identify well-managed companies where we want to partner with the existing management teams. This helps us avoid getting into a situation where there could be somewhat of a race against time of the team destroying value while we try to change out management.
How did your high conviction approach help you during the Covid crisis?
That thinking has always been a big part of our process at Harris Associates, but it became even more important last year when our world turned upside down due to Covid. Suddenly, all our forecasts for our companies were completely off. There were some businesses whose growth was going to accelerate because of Covid, and there were others that faced a couple of really tough years. I was really proud of our analyst team who, in about a week and a half, went from expecting normal growth in the economy to expecting a recession that would take a couple of years to exit.
We didn’t think 2021 would be a normal year, we thought that would take until ’22, so we had analysts roll out their detailed forecasts through 2022, and we very quickly had an approved list that re-ranked the attractiveness of each of our companies. I think this quick reaction was one of the biggest reasons we were able to significantly outperform our value peers in the six months after March 2020 – before value really started to rebound.
Disciplined Value Approach
Value isn’t just a style of investing at Harris Associates – it’s the only way of investing. Since its founding in 1976, Harris Associates has had an unwavering focus on value investing. Their consistent, research-driven approach to finding quality companies around the globe that can be purchased at a significant discount to their true business value has been effective though the years. Every member of the investment team at Harris Associates follows the same three investment tenets when considering companies to add to focused portfolios:
- Price: businesses trading at a significant discount to the estimate of their intrinsic value
- Growth: companies expected to grow per-share value over the long term
- Management: executive teams that think and act like owners
We seek to invest in businesses that are priced at substantial discounts to our estimate of intrinsic value. We think this approach provides us with a ‘margin of safety,’ which reduces risk and allows for above-average returns over time.”
~ David Herro
CIO-International Equities, Harris Associates
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Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods.
The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 US large-capitalization stocks representing all major industries. It is a widely recognized index of broad US equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.
The Russell 1000® Value Index measures the performance of the large-cap value segment of the US equity universe. It includes those Russell 1000® companies with lower price-to-book ratios and lower expected growth values. This index is unmanaged and investors cannot invest directly in this index.
Inflation is the steady increase in the price of goods and services over time. It devalues units of currency resulting in consequences like higher cost of living. Structural inflation is inflation that results from changes in the structure of demand and supply.
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