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Hotchkis & Wiley's Strategies and Top Picks: JPM, HPQ, RDS.B, COP, WFC

June 22, 2011 | About:
Henry Tan

Henry Tan

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Hotchkis and Wiley Capital is an investment management firm located in Los Angeles, Calif. The firm is led by George H. Davis Jr., a career investment professional who started his career with Hotchkis and Wiley in 1988. Davis is a graduate of Stanford University, receiving both his BA in Economics and his MBA from the institution. In addition, Hotchkis and Wiley boasts of the utilization of 13 CFA charter holders on their primary investment team, all with a rich history of experience and contacts in the industry.

The stated vision of the firm is to “place clients’ interests above all else by promoting a disciplined investment approach and superior service.” In order to execute this objective, the firm utilizes four primary principles: a disciplined philosophy, commitment to independent research, the expertise of an experienced team, and an uncompromisable independence that, all in conjunction, seeks the best results for their client first and foremost. These four principles serve as the foundation to the institutional strategies offered at Hotchkis and Wiley.

From the six primary institutional strategies utilized at Hotchkis and Wiley, six funds are derived: Large Cap Fundamental, Large Cap Diversified, Mid-Cap, Small-Cap, High-Yield and Value. The aforementioned order of the funds also lists the totality of assets under management in a descending manner. Although each fund has a different area of focus and specialty, the fundamental investment process at Hotchkis and Wiley for each fund is as follows:

A. Idea Generation

B. In-Depth Evaluation

C. Recommendation

D. Portfolio Construction

E. Portfolio Review

Initially, a financial database is quantitatively and qualitatively screened under set parameters to yield a list of potential securities. Adjustments may be made for specific sectors due to possible underlying characteristics unique to that sector. Screened equities are then reviewed for specific fund and firm favored characteristics. To do so, due diligence is conducted with a focus on earnings, profitability, capital intensity, free cash flow and leverage. Meetings with company management are arranged in order to clarify key issues, and to receive a “hands-on” understanding of the company’s business model. A stress model is also incorporated to ensure the probability of survival in times of distress with inputs derived from historical financial volatility.

Finally, a three-stage dividend model is used, with a 15-year horizon for the terminal input rates. In all of the aforementioned stages, co-analysts and managers at Hotchkis and Wiley cooperate to ensure the validity of the models, assumptions and projections.

In terms of performance, the large cap fundamental fund serves as a representative basis of comparison against the benchmark due to its size. Before fees in 2009 and 2010, the fund returned 36.28% and 20.82%. For the same period, the S&P returned 26.46% and 15.06%, yielding an excess gain of 9.82% in 2009, and a gain of 5.76% in 2010 for the firm. However, between 2006 and 2008, the fund underperformed the S&P successively year after year. In terms of aggregate performance, the large cap fund has returned 13.27% annually since its inception, vs. the benchmark’s return of 11.33%.

As can been seen in the following tables and charts, the firm’s investments are well diversified in a broad range of sectors. The largest sectors of investment at Hotchkis and Wiley are the financials and consumer service sectors at 27.30% and 14.50% respectively. In terms of change, utilities saw the largest increase in weight, from 5.50% to 8.30%. On the other hand, industrials saw the largest decline, dropping 3.30% to 10.80%.

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As shown in the following tables, the firm manages $17.90 billion in approximately 144 equities. The top five holdings comprise approximately 16.90% of the aggregate fund. This data parallels the broad range of diversification seen in the wide range of sectors invested into at the firm.

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JP Morgan Chase (JPM)


JP Morgan is an international banking firm offering a variety of financial services to both small- and large-scale clients. They are trading at $40.91, with a market capitalization of $162.56 billion. An average price of $38.86 was paid per share of JPM, yielding a capital gain of 5.2%. JPM is the largest holding of the entire firm’s portfolio, comprising 3.51% of the aggregate portfolio. From fourth quarter 2010 to first quarter 2011, JPM’s position in Hotchkis’ portfolio was reduced by 8.65%.

JP Morgan has a P/E ratio of 9.09, a P/B ratio of .94, and a P/S ratio of 1.56. Revenues for the year totaled $63 billion, with a net income of $17 billion, yielding a 16.91% margin. Earnings were reported at $4.50 per share, with a dividend yield currently at 2.44%. On an annual basis, over the last 10 years, JP Morgan has grown its revenues and book value by 4.8 and 9.9% respectively.

JP Morgan recently announced the settlement of an SEC inquiry that will cost it $153.6 million in penalties due to CDOs that the firm sold. JP Morgan’s dispute with federal regulators isn’t over however, as the NCUA is suing the company due to the sale of bonds backed by risky mortgages.

GuruFocus rated JPM with the business predictability rank of 1 star.

Hewlett-Packard Co. (HPQ)

Hewlett-Packard provides a variety of services and products ranging from software to IT consultancy to their clients. HPQ currently trades at $35.30, with a market capitalization of $73.22 billion. HPQ has an average cost basis of $44.12, yielding a capital loss of nearly 20%. HPQ is the second largest holding of the portfolio, with its overall position increased by 11.83% quarter to quarter.

HPQ has a P/E ratio of 8.66, a P/B ratio of 1.91, and a P/S ratio of .58. A net income of $8 billion was reported upon revenues of $126 billion, yielding a 6.95% margin. Earnings were $4.08 per share, with a dividend yield of 1.36%. In terms of growth rates, over the last five years, HPQ grew its revenues and earnings by 13.1% and 28.8% respectively.

Hewlett-Packard is in the midst of issuing a recall of 162,000 notebook computer batteries due to the risk of overheating batteries. In other developments, HPQ signed an agreement worth $380 million with Healthways Inc. to provide application development and management services to the firm. This agreement will serve to embrace a larger volume of clients and business at Healthways Inc.

GuruFocus rated HPQ with the business predictability rank of 1 star.

Royal Dutch Shell (RDS.B)

The Royal Dutch Shell company is a gas & oil company operating through three primary segments: Upstream, Downstream and Corporate. The Class B shares of Royal Dutch currently trade at $70.94, with a market capitalization of $222.09 billion. Each share of RDS was acquired at an estimated price of $65.61, yielding a capital gain of 8.1%. RDS is the third largest holding of the firm, representing 3.46% of the entire portfolio. From quarter to quarter, the position of RDS was increased by 8.8%.

Royal Dutch Shell has a P/E ratio of 9.32, a P/B ratio of 1.41, and a P/S ratio of .58. Earnings for the year totaled in at $7.61 per share, with a dividend yield of 4.74%. In addition, a margin of 5.56% was yielded upon revenues of $368 billion. Over the course of the last 10 years, RDS.B has grown its revenues and earnings by 20.5% and 2.4% annually.

Royal Dutch Shell announced plans to acquire 254 British gas stations at a cost of $400 million from Rontec Investments LLP. In Iraq, RDS and Mitsubishi Corp. are in the process of embarking upon a $12.5 billion natural gas venture. This project will serve as a key component in the Iraqi power grid, as the current infrastructure has resulted in unmet demands and frequent blackouts.

GuruFocus rated RDS.B with the business predictability rank of 1 star.

ConocoPhillips (COP)

ConocoPhillips is an international energy conglomerate providing services through six segments: exploration and production, midstream, refining and marketing, LUKOIL investments, chemicals, and emerging businesses. Conoco current trades at $73.73, with a market capitalization of $107.34 billion. The estimated cost per share of COP is estimated at $46.46, yielding a capital gain of approximately 59%. The position of Conoco was reduced by 16.56% quarter to quarter.

COP has a P/E ratio of 8.88, a P/B ratio of 1.53, and a P/S ratio of .51. Earnings for the year totaled in at $8.31 per share, with a dividend yield of 3.58%. A net income of $11 billion was earned on revenues of $198 billion, yielding a margin of 5.75%. Growth at Conoco has been largely positive in the last 10 years, with revenues and free cash flow growing at 18.2% and 38.2% respectively.

ConocoPhillips recently signed an agreement with the government of Bangladesh to drill in the deep water of the Bay of Bengal. The area in question spans 1.27 million acres, and is considered a significant investment for the company due to its potential. In other developments, the FTC recently launched an investigation into the oil industry to see whether a conspiracy of manipulation exists.

GuruFocus rated COP with the business predictability rank of 1 star.

Wells Fargo (WFC)

Wells Fargo is an investment management bank that offers a variety of financial services to their clients via their community banking, wholesale banking and wealth/brokerage/retirement divisions. Wells Fargo closed at $27.46, with a market capitalization of $145.24 billion. The average cost per share of WFC is at an estimated cost of $19.92 per share, yielding a capital gain potential of approximately 38%. WFC was reduced by 7.20% quarter to quarter.

WFC has a P/E ratio of 11.33, a P/B ratio of 1.20, and a P/S ratio of 1.66. Earnings for the year ending in 12/10 were $2.42, with a dividend yield of 1.75%. Revenues totaled $52 billion, with a net margin of 14.86%. Historically, over the last 10 years, WFC has grown its revenues and earnings by 10.6% and 4.1% respectively.

Trade Finance magazine recently awarded Wells Fargo with the “Best Trade Bank in the USA” title. In terms of operational changes, Wells Fargo also announced that they were eliminating their origination of reverse mortgages. In terms of business developments, Wells Fargo signed a strategic cooperation agreement with Guodian United to explore new opportunities in the wind industry.

GuruFocus rated WFC with the business predictability rank of 1 star.

For more information regarding Hotchkis & Wiley’s investments and philosophy, please visit:

http://www.gurufocus.com/ListGuru.php?GuruName=HOTCHKIS+%26+WILEY

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