The following is an analysis of the most current portfolio of Mr. Wally Weitz. The analysis will use a system that I designed that is based on the ratio that Warren Buffet released to the public in 1986, which he coined “Owner Earnings.” For those new to this type of analysis, I would recommend reading an introduction to my system by clicking here. My goal is ultimately to analyze the portfolios of each guru highlighted here on GuruFocus, and then to subsequently re-analyze them every quarter when possible as changes are made. My purpose in writing these articles is to show the power of Buffett’s ratio in analyzing stocks, ETFs, mutual funds and individual portfolios. If one can fill their portfolios with companies that score high using my system and avoid those which fail, one should be able to increase the probability of becoming a successful investor in my opinion.
Profile of Mr. Weitz:
Wally Weitz is the founder and president of Wallace R. Weitz & Company. Weitz, a CFA charterholder, manages Partners III Opportunity Fund and co-manages the Value Fund, Partners Value Fund and Hickory Fund.
Weitz's investment career began at age 12, when he invested his profits from various entrepreneurial ventures. After going through a charting phase in high school, he discovered Benjamin Graham's "Security Analysis" and was converted to value investing. After earning a BA in economics at Carleton College in 1970, Weitz spent three years in New York doing security analysis, primarily on the small companies in which G.A. Saxton made over-the-counter markets. In 1973 he joined Chiles, Heider & Co. Inc., a regional brokerage firm in Omaha, where he spent 10 years as an analyst and portfolio manager. In 1983 he started Wallace R. Weitz & Company, and now heads a group of eight investment professionals that manages approximately $4 billion.
Weitz's approach to value investing has evolved over the years. It combines Graham's price sensitivity and insistence on a margin of safety with a conviction that qualitative factors that allow companies to have some control over their own destinies can be more important than statistical measurements, such as historical book value or reported earnings.
On Jan. 10, 2012, GuruFocus published the Weitz Funds Q4 Letter to Shareholders and in it you will find a paragraph that clearly shows that Weitz is a big fan of “owner earnings.”
The heart of our investment approach is to recognize, and take advantage of, the difference between a company's business value (or intrinsic value) and its stock price. Business value is a function of the amount of cash a company will generate for its owners over the next 10-20 years. A stock's price is a function of investor attitudes, emotions, expectations and competing alternatives for investor capital. Stock prices are generally much more volatile than the underlying business values. This gap between price and value gives the patient investor the opportunity to buy at bargain prices and sell at high prices.
There are serious financial issues facing investors. The European debt crisis, a slowdown in the Chinese economy, and a feeble U.S. economy leave investors anxious and gloomy. However, our take is that while these and other factors may keep a lid on economic growth for another year or two (or longer), our companies' stock prices are cheap enough relative to their business values that we feel good about being 75-85% invested. Given the muted near-term outlook, we are happy to hold 15-25% cash reserves to take advantage of the inevitable temporary market dips, but we have very little faith in our (or anyone else's) ability to time the market.
Mr. Weitz has clearly stated that his is a big fan of owner earnings and also believes that his holdings are cheap relative to their business values. So let’s see if we can have our system analyze the portfolio of Mr. Buffett’s neighbor and see what we can come up with:
The portfolio of Weitz is clearly tailor made for the value investor, but also has the qualitative aspects that you would find in studying Fisher’s work. So like Buffett, he seems to be “85% Graham and 15% Fisher.” From looking at the “price to owner earnings” column in the table above you will find that 40 out of the 67 stocks analyzed (59.7%) are scoring a 1 on our system. Therefore, using that ratio, 59.7% of the stocks are cheap relative to their business value, confirming Mr. Weitz’s statement. What about the qualitative aspect of the portfolio measured in CapFlow? We found that 47 of the 67 stocks analyzed (70.1%) of his holdings score a 1 on our system. So far so good! When we then do our FROIC analysis, Weitz unfortunately comes up short with only 15 out of the 67 (22.38%) of his holdings scoring a 1 on our system, by achieving a 15% or greater FROIC.
Clearly he is buying the stocks cheaply relative to their owner earnings and most of the companies in his portfolio have good management at the helm. The problem is that the majority of his holdings have way too much in total capital relative to their owner earnings generation. This is a common problem for value investors as they tend to buy companies with strong P/B value ratios where shareholders equity is a major part of total capital. The secret to our system is to not only buy cheap, well-managed stocks, but also to buy companies that are returning at least 15% in owner earnings relative to the total capital employed. In the end I don’t care if a company makes pencils, trucks or printers, FROIC holds them all equal. The FROIC ratio is like a greedy task master and wants to see strong return on every $1 of total capital employed.
Therefore when we do our final score on Mr. Weitz’s portfolio we get 1.55, so he is still below the master Warren Buffett, but ahead of the Gates/Larson team. The final score is a non-weighted average of each portfolio’s total score divided by its total non-financial holdings.
Disclaimer: Always remember that these are the results of our research based on the methodology that I have outlined above and in other articles previously published. This research is provided as an educational tool and should not be considered investment advice, but just the results of our research. There are many ways to analyze a stock and you should never blindly follow anyone’s work without doing your own due diligence or by seeking the help of an investment advisor, if you so need one. As Registered Investment Advisors, we see it as our responsibility to advise the following: We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong. Please note, investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter “Mycroft” Psaras, and should not be construed as personalized investment advice. Information expressed does not take into account your specific situation or objectives, and is not intended as recommendations appropriate for you. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.
About the author:
From his work on free cash flow in the investment process, Mycroft has now decided to bring his theories to the field of money management as well as work as an independent consultant for Hedge Funds, Pension Funds and ...More Institutions in general. His dream is to someday soon open a mutual fund where he can help as many people as he can benefit from what he has learned over the years.