An analysis of Private Capital's philosophy and their top holdings : CA,SYMC,VRX,HPQ,MENT
The stated objective of the value fund is to “achieve long-term capital appreciation by investing in companies that are out of favor, underappreciated or misunderstood, and thereby trades at a significant discount to PCM’s estimation of long-term intrinsic value.” To execute this vision, the firm utilizes a research driven approach to analyze potential equities, typically those trading on North American exchanges, with no particular preference to market capitalization. From time to time, other investment opportunities such as warrants, bonds, and preferred stocks may be utilized. In addition, PCM may hedge their positions to either magnify or protect existing assets to adapt to changing market conditions. However, when analyzing equities, PCM utilizes a genera l 4 step “bottoms-up” approach:
1. Quantitative Screening
The firm first screens for equities under a list of set parameters. Preference may be placed on equities based on referrals and existing in-depth knowledge.
2. Financial Analysis
The next step in the process is to render a valuation of the equity through financial analysis. Adjustments are made to financial statements in response to uncanny footnotes regarding off-balance liabilities, pension plans, and questionable accounting policies. PCM places a heavy emphasis on discretionary cash flow, also known as free cash flow, due to its ability to increase shareholder value in a variety of ways. Once free cash flow is calculated, PCM renders the valuation of the equity via the net present value of future flows, discounted with a rate that conservatively parallels the level of risk in the business’s operations. Private Capital’s philosophy states that earnings per share are subject to accounting manipulation, can be used as a smokescreen to hide potential problems, and, as such, is not emphasized in their analysis.
3. Qualitative Analysis
In conjunction with financial statement analysis, a through qualitative analysis is conducted simultaneously. As expected with value investing, due diligence is conducted to yield an in-depth look at business strategy, company culture, market position, and all competitive advantages. Unlike most firms however, PCM places an emphasis on management analysis. Key officers are examined in terms of intellect, ability, motivation and focus. The historical relationships of key officers with investors, their compensation with respect to the shareholder value created / destroyed, and input from competitors, suppliers and customers are other factors examined for consistency.
4. Long-term considerations
Like Warren Buffett, PCM approaches investments as if one was buying the entire firm. All of the aforementioned research yields numerous strengths and opportunities for all equities. PCM seeks to account for these factors in all of their investment decisions. Generally speaking, PCM seeks equities that are undervalued or out of favored, in order to capitalize upon an expected price appreciation. Thus, the aforementioned studies serve to allow PCM to obtain a reason margin of safety in all of their investments. As a rule of thumb, PCM tends to hold equities for a period of 3 to 5 years. However, PCM may shed positions earlier when company fundamentals change for the worse, shift in industry outlook occurs, or large macroeconomic events occur.
In terms of performance for the year, the fund has trended a return of 7.9% versus the S&P’s return of 5.9%. In 2009 and 2010, the fund returned 44.6% and 15.9%, while the benchmark returned 26.5% and 15.1% for the same period. The yields an excess return of 18.1% in 2009, and .8% in 2010 in favor of the fund. However, the fund underperformed in both 2007 and 2008, with a 10.5% margin in 2008. The long term performance of the value fund is largely positive, with a 10 year average of 7.2%, and a 15 year average return of 15.5%. Since inception, the firm has returned on average, 15.8% annually, while the benchmark has returned 9.8% for the same period.
Looking forward, PCM acknowledges that the future is uncertain, with civil unrest throughout the world, disaster after disaster occurring in Japan, and an unresolved debt crisis in Greece as several examples of stressors. Furthermore, PCM feels that the US dollar has a credibility issue, due to the perceived inability of politicians to deal with both the deficit and the declining strength of the dollar. In addition, PCM acknowledges that the large inflow of cash into the equity markets is largely in part due to the negative return on sitting on cash when inflation is factored in. PCM acknowledges that the very same incoming flow of capital also serves in part to eliminate attractive investment opportunities as prices are pushed up. Finally, the threat of an oil shock in the Middle East is as they stated, “the single most significant exogenous threat to our economy and the stock market”. As such, their overall outlook is pessimistic for the near future.
As seen in the following charts and tables, the firm’s investments are heavily situated in technology, consumer services, and health care. From quarter to quarter, the greatest addition occurred in the consumer goods sectors, with a gain of 3.50%. The greatest reduction was seen in the technology sector at 5.90%. PCM, in its totality, manages approximately $1.6 billion, with 71 equities held. The top five holdings comprise 22.37% of all equities held, with 4 of the top holdings in the technology sector.
Ca Inc. (CA)
CA Inc is an IT software company specializing in the management of people, information, processes, systems and databases. CA trades at $21.98 with a market capitalization of $11.15 billion. The estimated cost of each share of CA in the portfolio is $24.32, yielding a potential capital loss of 9.6%. From Q4 of 2010 to Q1 of 2011, the position of CA increased by 2.57% in the firm’s aggregate portfolio. CA is currently the largest holding of the firm, comprising 6.57% of all equities held.
CA has a P/E ratio of 13.75, a P/B ratio of 1.98, and a P/S ratio of 2.53. Earnings for the year were reported at $1.60 per share, with a minor dividend yield of .91%. Revenues topped $4.4 billion, with a net income at $823 million, yielding an 18.58% margin. Historically, CA has grown its revenues and earnings annually by 5% and 52.6% over the last 5 years.
Fitch Ratings declared CA’s outlook to be stable with all senior notes remaining at BBB+. In other news, CA acquired Interactive TKO, an applications developer, for $330 million. This acquisition is expected to help CA and their clients utilize cloud-based applications more efficiently.
GuruFocus rated CA with the business predictability rank of 1 star.
Symantec Corporation (SYMC)
SYMC provides system management and security solutions through three geographic segments: Americas, The Middle East / Africa, and Asia Pacific Japan. Their shares currently trade at $18.97, with a market capitalization of $14.33 billion. PCM acquired each share at an estimated cost of $16.48, yielding a potential capital gain of 15%. SYMC is the 2nd largest holding of the firm, comprising 4.64% of all equities held. From quarter to quarter, SYMC’s position decreased by 1.51%.
SYMC has a P/E ratio of 24.96, a P/B ratio of 3.18, and a P/S ratio of 2.32. Earnings totaled $.76, with a net profit margin of 10.08% on revenues of $6.1 billion. Over the last 10 years, SYMC has grown its revenues and free cash flow annually by 18.3% and 17.4% respectively.
Symantec recently acquired Clearwell Systems, an electronic legal discovery firm, for $390 million. This acquisition is expected to provide SYMC with future opportunities in the electronic discovery market. In other developments, Symantec is expanding their operations in Dublin to focus on their identity and authentication products.
GuruFocus rated SYMC with the business predictability rank of 4 stars.
Valeant Pharmaceuticals (VRX)
Valeant Pharmaceuticals is a multinational pharmaceutical company that develops and markets pharmaceutical products in the US, Canada, Australia, and New Zealand. VRX currently trades at $55 per share, with a market capitalization of $16.39 billion. The estimated cost per share of VRX in the portfolio is $56.49, yielding a capital loss of 2.6%. VRX’s position decreased by 2.22% from quarter to quarter, and is the 3rd largest holding of the firm, comprising 4.24% of all equities held.
VRX has a P/B ratio of 3.24 and a P/S ratio of 13.21. Revenues totaled $1.18 billion for the year, with a loss reported at $208.19 million. Earnings for the same period were reported at $3.09 per share. On an annualized basis, over the last 5 years, VRX has grown its free cash flow and book value by 4.5% and 11.9% respectively.
Deutsche Bank placed a price target of $62 on VRX, while Piper Jaffray reaffirmed their “overweight” rating on VRX. On July 15th, VRX announced the acquisition of the dermatologic division of Janssen Pharmaceuticals for $345 million.
GuruFocus rated VRX with the business predictability rank of 1 star.
Hewlett-Packard Corporation (HPQ)
Hewlett-Packard provides a variety of services and products ranging from software to IT consultancy to their clients. HPQ currently trades at $35.09, with a market capitalization of $72.78 billion. HPQ has an average cost basis of $44.63, yielding a capital loss of 21%. PCM increased their holdings of HPQ by 8.53% from quarter to quarter.
HPQ currently has a P/E ratio of 8.61, a P/B ratio of 1.91 and a P/S ratio of .58. Revenues topped $126 billion, with a net income at $8.7 billion, yielding a margin of 6.95%. Earnings were $4.08 for the year, with a dividend yield at 1.37%. In the last 5 years, Hewlett-Packard has grown its revenues and earnings annually by an average rate of 13.1% and 28.8%.
HPQ was recently awarded a 4 year contract by the Australian Minerals and Metals Group to provide cloud services. In addition, they also extended their working relationship with the BMW group to provide further support for BMW’S networking infrastructure.
GuruFocus rated HPQ with the business predictability rank of 1 star.
Mentor Graphics Corporation (MENT)
Mentor Graphics Corporation provides software and hardware solutions that help their clients produce products such as integrated circuits and video game consoles. MENT currently trades at $12.08, with a market capitalization of $1.34 billion. MENT was acquired at an estimated cost of $13.84, yielding a capital loss of 12.7%. From quarter to quarter, PCM reduced their holdings of MENT by 11.09%.
MENT has a P/E ratio of 28.09, a P/S ratio of 1.48, and a P/B ratio of 1.74. Revenues exceeded $900 million, with a net margin of approximately 3.12%, and earnings totaled $.43 per share. Over the last 5 years, MENT has grown its free cash flow by 4.5% and book value by approximately 2.9%.
Mentor Graphics recently upgraded their verification academy website to help educate and train clients to the usage of the Universal Verification Methodology.
GuruFocus rated MENT with the business predictability rank of 1 star.
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