The Oakmark Select Fund increased 6% for the quarter, compared to 5% for the S&P 500 Index. Three quarters into our 2014 fiscal year, the Oakmark Select Fund has returned 25%, compared to 18% for the S&P 500 Index. Our best performers in the quarter were Apache and Intel, up more than 20% each, while a couple of our financial stocks, Bank of America and JP Morgan Chase, led the laggards with losses of 11% and 4%, respectively.
During the quarter we added four new positions to the Fund (Amazon, Citigroup, Fidelity National, and Google) and eliminated four others (Cenovus, Comcast, DIRECTV, and Kennametal). While this is an unusual amount of activity for us, it was driven by the attractiveness of the new additions, discussed individually below. As we’ve said before, we don’t manage the Fund to meet artificial criteria such as turnover ratios, sector weightings, or style boxes. Our investment process is to buy a business at a significant discount to our estimate of intrinsic value, where we believe that value will grow over time on a per-share basis, led by management teams focused on maximizing this per-share value. The consistent application of this process is what drives our position changes.
Our bottom-up company analysis is identifying attractive investment opportunities which today can often be classified into one of two categories: great businesses selling for average prices, and financial companies currently mispriced relative to their long-term earnings power. Our four new purchases this quarter each fit into one of those themes.
Amazon.com, Inc. (AMZN)
Amazon is discussed at length in Bill Nygren’s 2Q14 commentary letter. Suffice it to say, we were thrilled the market gave us the opportunity to purchase this dominant business at a lower adjusted price/sales ratio than that of the bricks-and-mortar retailers from which Amazon is consistently taking market share.
Citigroup Inc. (C)
We continue to believe that universal banks are significantly undervalued relative to their normalized earnings power. Citigroup’s global franchise gives it a unique advantage, as the company has more than twice as many country banking licenses and direct local payment network connections as its closest competitor. This asset is virtually impossible to replicate in today’s regulatory environment, and we believe it makes Citigroup one of the only viable choices for multinational corporations looking for a consolidated banking relationship. The company has a large deferred tax asset and significant excess capital growing at a rapid rate; we believe neither of these assets is properly appreciated by the market, as Citigroup hasn’t yet begun to fully utilize them.
Fidelity National Financial (FNF)
Fidelity National is the largest and most profitable title insurer in America. We find the title insurance industry attractive, given its oligopolistic market structure, high barriers to entry, and low customer price sensitivity, and we believe that Fidelity National, with 33% national market share, is poised to significantly expand margins as mortgage origination mix and volumes recover over the next several years. The company’s management team has a long history of operating excellence and smart capital allocation. Selling for less than 10x our estimate of what the company’s EPS would be in a normal operating environment, Fidelity National is being valued at a significant discount to our estimate of its intrinsic value.
Google Inc. (GOOGL)
Google is the world’s dominant Internet search engine, with more than an 80% share of global search advertising revenue. The company has the most data and the best tools to develop effective targeted marketing products, which in turn lead to higher returns on investment for the advertiser. Google’s scale is orders of magnitude larger than any competitor, which makes its business both very profitable and very hard to supplant. Online share of the total global advertising market is growing rapidly, which should provide Google with good growth for many years even as the company reinvests its cash flows into a variety of other businesses, some of which are likely to become big themselves. Adjusting for cash and amortization, Google sells for less than 17x 2015 consensus EPS, and we believe consensus EPS comfortably understates what will be the company’s true earnings power once the business model matures.
William C. Nygren, CFA
Anthony P. Coniaris, CFA