Bill Nygren Oakmark Fund First Quarter 2012 Letter to Shareholders
Our best performing stock for the quarter was Bank of America, up 72%. Last year was difficult for bank stocks, especially Bank of America (BAC), but much of that reversed in the past quarter as banks now appear adequately capitalized and many are able to return more capital to shareholders. Our other strong-performing banks included JPMorgan Chase (JPM), up 39%; Capital One (COF), up 32%; and Wells Fargo (WFC), up 25%. Despite the price increases, they all remain undervalued in our view. Apple (AAPL), which increased by 48%, contributed the most to the Fund because it started the year with a higher weighting. We are pleased that Apple, like our bank stocks, will begin returning capital through both a dividend and share repurchases, and we believe the stock remains attractively priced. Largely due to the strong market, no stocks in the portfolio declined by more than 5%. During the quarter, we eliminated three positions: Corning (GLW), Fortune Home and Security (FBHS), and Western Union (WU). Fortune Home came to the Fund as a spinoff. We kept our shares, even though the business is smaller than we would normally purchase, because we believed it was undervalued. The stock subsequently performed well and was sold. Western Union and Corning both underperformed our fundamental expectations, and because we could no longer see a clear path for these businesses to reach our long-term targets, we opted for other opportunities. We added three new positions during the quarter: Parker Hannifin (PH), Franklin Resources (BEN) and Goldman Sachs (GS).
Parker Hannifin (PH-$85) Parker Hannifin is the world’s leading producer of motion and control technologies. Its business is diversified across industries (machinery, trucks and aircraft) and geographies (earnings outside the U.S. account for over half of its total earnings). Priced at just over 11x expected 2012 earnings (plus goodwill amortization), Parker is valued like other highly cyclical businesses. However, the overwhelming majority of Parker’s profits come from its replacement parts business. This business is more profitable and more stable than the company’s original equipment business, and its branded Parker stores give it a large footprint and durable competitive advantage. Therefore, we think it should be valued at a much higher multiple than more cyclical companies. We are impressed with management’s track record as excellent operators and we like the way the company spends shareholder capital. On a recent conference call, the CEO explained a $700 million share repurchase as follows: “The reason that I made the biggest acquisition in the history of the company this last month was because the company is so cheap.” We wish more managements thought about share repurchases this way.
Franklin Resources (BEN-$124) Franklin Resources is one of the world’s largest mutual fund companies, with leading products in both equities and fixed income. Franklin is also well-situated internationally, managing over $3 billion in local assets in 18 countries. The company has deliberately built this international presence over decades, and we believe this provides, and will continue to provide, a distinct competitive advantage. With consensus earnings for 2012 expected to be nearly $9 per share, Franklin is selling for just less than 14x earnings. We adjust that number for the cash and investments on Franklin’s balance sheet, which at year-end totaled about $24 per share and were not producing much income. Adjusting for those investments, the business is priced at just over 11x earnings. Given Franklin’s strong fund performance across various asset classes and geographies, we believe this valuation is attractive. Management has historically returned capital to shareholders through stock buybacks and dividends, and with insiders owning 35% of outstanding shares, we expect Franklin to continue to be good stewards of shareholders’ capital.
Goldman Sachs (GS-$124) Goldman Sachs is a leading global investment banking firm. In 2007, Goldman had a book value of $100 per share. It earned a very high return on that book, with EPS nearing $25. Investors priced the stock as if that earnings level was sustainable, and the stock reached a high of $251. We have always admired Goldman’s profitability, but because of the competitiveness of the financial services sector, we were reluctant to pay a large premium to book value because that implied that its high returns were sustainable. Goldman’s book value per share continued to grow during the financial crisis, and ended the year at $139. Goldman’s stock, however, declined to just $90. At that price, we no longer had to believe that a 25% return on equity was sustainable; we simply had to believe that its balance sheet did not overstate its assets. Not only do we believe that, but we also believe that Goldman’s franchise makes the business worth more than its book value. The stock now sells at only 11x consensus 2012 earnings forecasts, and management is using capital in ways that enhance per-share value, including repurchasing 5% of its shares last year.
William C. Nygren, CFA
Kevin G. Grant, CFA
Average Annual Total Returns (3/31/12)
Expense Ratio as of 9/30/11 was 1.04%
Past performance is no guarantee of future results. The performance data quoted represents past performance. Current performance may be lower or higher than the performance data quoted. The investment return and principal value vary so that an investor’s shares when redeemed may be worth more or less than the original cost. To obtain the most recent month-end performance data, view it here.