Donald Yacktman Interview with GuruFocus
During the conversation, he used the word “long-term” many times. One got the feeling that his “long-term” is longer than the “long-term” of most others. Money managers like to use the word “long-term” to justify their recent underperformance, but Yacktman Funds’ shorter-term performance is just as good as its long-term performance.
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Prior to forming The Yacktman Funds in 1992, Mr. Yacktman served in various roles at other management firms and was named Portfolio Manager of the Year by Morningstar in 1991. Mr. Yacktman holds a B.S. Magna Cum Laude in economics from The University of Utah and an MBA with distinction from Harvard University.
Over the last five years, Yacktman has outdone the S&P 500 47.2% to -1.1%, and 174.5% to 34.9% over the last ten years, particularly proving his mettle in preserving capital during market downturns.
Here is what he had to say recently:
GuruFocus: Mr. Yacktman, we interviewed you a few times. I track you closely, read all your letters, and interviews, lots of interviews. I think I know you pretty well, but still I thought I would ask some questions.
Yacktman: Sure. You realize a lot of the work here is done by the younger guys. So, give them credit too, Steve Yacktman and Jason Subotky who aren’t here today, and Russell Wilkins.
I think a lot of times that is the case. But that’s actually my question: What is the decision-making process like?
Yacktman: It’s pretty simple. We do our own research and discuss ideas freely among the investment team. We know our core universe well and look for valuation driven entry points.
We take a generalist approach, so all managers are accountable for companies throughout our investment universe, rather than having sector coverage which we think creates walls in an organization. We like to have the flexibly to invest in what we think the best opportunities for managing risk and achieving results are at a given time and are not short term benchmark oriented investors.
Our process is basically is a function of our goals. The first one is, protect the clients’ capital over time. This is a portfolio level goal, and understand that not all investment ideas will work out. We have a significant amount of our personal net worth in our strategies and we manage them as though we were managing a client’s entire net worth.
The second goal is obtaining what we’d call equity-type returns, approximately double-digit annualized. Our third goal is to beat the (S&P 500) index over a full peak-to-peak cycle. If you go back and study our results from the times when the market has peaked, I think you’ll find that the performance has been very, very good. More importantly, I think that our risk-adjusted returns are really excellent, and that’s what it’s all about.
So the process is then really a function of looking at the cash flows of a company. Most good companies generate cash, and that usually consists of two components; payout and return on retained earnings. Payout is the dividend and net share repurchase. Reinvestment rate is really the wild card in equity investing.
So basically you look at what the company did in the past with the extra cash they have, what they have done with that cash to predict what they might do in the future?
Russell Wilkins: We found what they’ve done in the past is a much better predictor of what they’re going to do in the future than what they say.
Yacktman: The other thing is to really understand the business model. Most of the time the good businesses will make the managers look like stars, rather than the other way around. I remember one of my children said to me once, after dinner when we were talking about investing, “Now let me see if I have this right, Dad. Basically what you’re saying is if you buy above average businesses at below average prices, then on average it’s going to work out?” I said, “Yes, that’s basically it.”
What we’re doing is attempting to shift the odds more in our favor. I can’t overemphasize the importance of patience. So many people in this business think in terms of 10 minutes, or 10 hours, or 10 days, or 10 weeks, or 10 months, not 10 years. Very few people have the inner strength or patience to wait it out.
Actually an interesting point, of course as a manager and long-term investor you want to think long term, but you have pressure from clients. Just look at Bruce Berkowitz: He had an excellent long-term performance, but in just a few months, less than a year, I remember the fund peaked at $21 billion, but now we are talking about $6 or 7 billion. So how do you think about that? Of course as a manager we want to think long term, but what if you have the pressure?
Wilkins: We try to set investor expectations clearly and regularly. It is critical that investors recognize that no manager performs well in all environments. When we talk to potential investors, we emphasize they should not expect us to outperform the market every month, every quarter, every year. We believe investors would be well served not to track us versus a benchmark in shorter time periods.
Very quickly, the money is just gone. To select the companies that you have (P&G, etc), you said high quality, predictable. Do you have a screener that you build, or otherwise where do you generate these ideas?
Yacktman: We are focused on a fairly narrow universe of companies we know well. These entities are principally higher quality, U.S. domiciled, larger capitalization companies.
We use a variety of techniques to find ideas, including screens, although the best opportunities are often created because of short-term challenges within a business or its sector.
A good example of knowing the investment universe would be News Corporation (NWS). Several years ago we had a big position in Liberty Media which itself was a large shareholder of News Corporation, so we studied the company thoroughly. In 2008 News Corp’s shares fell with the decline in the market and the media sector got hit especially hard. We took the opportunity to establish a position in the shares when the price became attractive. As we like to say at the firm, “It’s almost all about the price.”
You wrote before that, I think a year ago, you want to invest in high quality companies now. You said high quality companies are cheaper at this time—
Yacktman: Yes, but relative to other equities. They have been cheaper historically.
Relatively cheaper. What is your definition of a high quality company?
Yacktman: We think quality is a combination of characteristics. We like to start with high return-on-asset businesses. We also like predictability. We prefer businesses that have fairly stable operating results in both good and challenging economic environments. Below is a simple chart we use to demonstrate characteristics we like.
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We believe that companies that have low capital intensity and low cyclicality like Coke (KO) Pepsi (PEP), or Proctor & Gamble (PG) have the ability to earn some of the highest returns. What you’re looking for is both the low asset requirements and low cyclicality. It is at its best when a company sells a disposable product or a recurring service. We also like to see a large market share.
Proctor & Gamble is an example of a quality company to us. While it has disappointed people and the company has not been able to raise its gross margins like expected, we think the businesses are strong and the outlook solid.
So it seems like the best time to buy those companies is when they have trouble, not when they are doing very well.
Wilkins: That’s usually when you get the best price. Sometimes we get opportunities when defensive stable businesses are unpopular because the businesses appear to be unexciting.
Everyone thinks they have more trouble than they actually have, probably.
Yacktman: It’s a manic depressive market.
Do you talk with management?
Yacktman: We do if we think it is important to better understanding our investment thesis or if we want to convey something, usually about capital allocation or compensation philosophy.
Because you’re huge?
Yacktman: For large cap oriented investors we aren’t that big. Recently with say on pay, we have heard from management teams more often.
Who makes the buy decision?
Yacktman: Typically at least two of the senior portfolio managers will be in agreement to make a decision. Building positions is usually a gradual thing. You don’t wake up one morning and decide to put 10% into a position.
We talked about out of favor, and you mentioned Research In Motion. That stock has lost around 90-something percent from the peak, and today we just reported that Prem Watsa from Fairfax bought another 25 million shares.
Yacktman: And the stock hardly moved.
Yeah, it hasn’t moved. What do you think about the company? You own a position.
Yacktman: Here’s the dilemma with it. It has a wide array of possible outcomes. We felt we had protection with the balance sheet and customer base, but given the history of dramatic leadership change in the cell phone industry, people are nervous. I think you have three pieces. You have the cash and excess working capital, you have the patents and you have the embedded customer base. The real problem has been delays in getting a new phone to market. The length of time without a viable product has caused the customer base to become an ice cube on a hot day.
Wilkins: In our opinion, the price has declined a lot more than the value has dropped.
The company is doing restructuring, laying off lots of people. There are lots of costs with that, when they lay off people, especially in Canada.
Yacktman: While restructuring is expensive, we think the company is taking the right steps by aggressively cutting costs.
So you will not add to the position?
Yacktman: We did, during the second quarter, but not very much.
But you think the situation is…
Wilkins: You know, It’s just all about the price. There are lots of assets we think hold significant value.
I was doing reading in the interview we had last time. Seems like a concept you use is called forward rate of return, and you use free cash yield plus growth rate. Where do you apply this? This apparently cannot be applied everywhere. If you apply this to Apple, the growth rate, like 40-something percent…
Wilkins: It is important to calculate a normal growth rate. You may need to use a multi-stage model for companies that have high short term growth.
Yacktman: And recognize that when you start getting those off-the-charts, high growth numbers, it’s not going to last. Most businesses are difficult to project many years out. Growth is really critical because the rate of return on marginal units is very, very high. But the problem is that the market has a central tendency to overprice things, and put very high multiples on companies that are growing quickly, even if it is for a short period.
So that’s how you apply it.
Yacktman: It is also important to be flexible, and I think our behavior in the 2008-2009 period demonstrates that. With AmeriCredit (ACF), News Corp (NWS), and Viacom (VIA), all of the stocks had some risk to them, but they offered potentially breathtaking returns. So we sold of Proctor & Gamble and Johnson & Johnson , We kept some defensive positions like Coke that we thought would be durable even if the market continued to go down because we felt on balance the portfolio had enough securities that could rise dramatically if the market stabilized or recovered.
So it’s more like a risk-adjusted potential returns. That’s how you made the decision of switching to AmeriCredit. I was very impressed by that, actually. You bought lots of AmeriCredit during the crisis.
Yacktman: A lot of people didn’t understand their business and stayed far away because it was a subprime finance company. The business model is really relatively simple. They make primarily used car auto loans, largely, to sub-prime borrowers.
The key risk was a dramatic and rapid rise in unemployment rates. That’s where we were vulnerable, and we knew it. But barring unemployment suddenly going to 15% or something like that you had a little breathing room.
That’s different from a home mortgage, right?
Wilkins: AmeriCredit’s customers would probably stop paying on their home before they would stop paying on their car because they need the car to get to work. AmeriCredit also has the ability to repossess and sell the cars when the customer defaults.
Yacktman: You had collateral that was 40-45% of the loan. The problem was the asset backed markets froze so they had to cut back lending and staffing.
So there was some risk, definitely.
Yacktman: There is always some risk, the question is how much is it and is the price you are paying allowing you to effectively manage the risk. AmeriCredit at its low was about 20% of book value. We felt in a wind-down scenario you might get back 60-75% of book. The company eventually got purchased by GM for about 150% of book.
It sold for $3 or something?
Yacktman: It got down there.
And how much money did you make on that?
Yacktman: AmeriCredit hurt our performance in 2007 and 2008 before adding to results in 2009. I think our ability to have it hit results in 2007-2008 and still hold up well during those years speaks to our ability to manage the overall risks in the portfolio.
Controlling risk, that’s the key. So if we think of 2008, 2009, that was a great opportunity for you of course. Do you feel that you learned some things, some lessons from that?
Yacktman: I think that you learn something in every investment cycle, but I think each is different. In the case of 2008-2009, we were reminded that prices can fall dramatically below your long-term appraisal in the short term. We also learned that at very unusual times you may be able to get some outstanding deals in fixed income securities. In some mandates, for example, we raised our ability to invest in high yield from 10% to 20%. We think the new level gives us appropriate flexibility if we have an unusual environment again, but provides investors with a logical limitation.
How about now?
Yacktman: I don’t see a tremendous amount of volatility or nervousness and in that environment the range of outcomes, the range of rate of returns tends to narrow. You don’t have the tail like you did in ’08, ’09, so I think you aren’t being paid to downgrade. That’s why we have such a high percentage in very high quality stocks. We see that as the best risk-adjusted place.
But on a relative basis I’m excited because the yields on some of these stocks compare so favorably to what you can get in cash or 30-year Treasuries. When I say that people think we are interested in getting high dividends, but it’s more about the cash flow. Dividends are a derivative of cash flow. I think what it really says to me is that the 30-year Treasury is more overvalued than these stocks are undervalued.
Yacktman: That’s why the relative spread is so enormous.
Even stocks, the yield historically now is very low, compared with what the stock yield was in earlier times.
Yacktman: It’s just that Treasuries seem very overpriced.
Lots of people are saying the market is cheap, but they are actually talking about relative to Treasuries probably.
Yacktman: What I don’t understand is why anybody in their right mind would want to own a 30-year Treasury today. That amazes me.
How do you think about Hewlett-Packard (HPQ)?
I think Meg Whitman is very capable of doing the necessary management 101. The decision to hang on to the PC business was ultimately the rational one.
Wilkins: We think the stock is inexpensive, however the company has a history of doing some less than desirable things with the cash, which has kept us from taking a bigger position. Also, the company has net debt.
We prefer our larger positions in Microsoft and Cisco, in part because of their balance sheets. Cisco has more than $5 per share in net cash and generates approximately $1.50 per share in free cash flow. The stock is at 17, so less the $5 per share in cash, you are paying about $12 per share for the business. With a 12.5% free cash flow yield (net of the cash) Cisco does not even need to grow for us to have a solid investment.
We talk a lot about value traps these days on our website. Do you think things like HP or RIM are potential value traps? They have lost investors lots of money already.
Wilkins: HP is very diverse and profitable. Ultimately, we think the best way to avoid a value trap is to have a company that produces durable free cash flow.
Yacktman: Time will tell. We consider them special situations. Over our firm’s 20 year history, we have taken some positions in stocks where there may be temporary or even prolonged challenges. We have done so because we felt the valuation was compelling. Some of our biggest winners, like AmeriCredit, started as a special situation. We recognize these positions don’t all work, so typically we keep the position size on the smaller side.
It’s all about the price, but value also, when you do a valuation of the company, it depends on how the company does, what the company does. The value can increase and can also decrease.
Yacktman: We try to consistently adjust our appraisal to new information. When HP purchased Autonomy, we had to adjust our valuation to reflect for the value destruction that occurred.
I don’t see that you have lots of international companies.
Yacktman: We have a preference for American companies because we think we understand the nuances of accounting and management behavior domestically. Many of our top positions have a strong overseas presence, though. We bought Henkel (HENKY) a few years back because we thought it was far cheaper than comparable domestic companies. It also owned nearly 30% of Clorox and 30% of Ecolab. We’ve owned Unilever (UL), we’ve owned Cadbury.
Wilkins: We’ve got companies like Coca Cola where the bulk of their earnings come from international markets even though it is based in Atlanta. If some day Coke moved to Switzerland, it would not change our ability to appraise the business
Okay, my last question. How do you think about the situation in Europe? How it will play out?
Yacktman: Well, there are several aspects of it. First of all –
Wilkins: Politicians will try to use it for their own advantage.
Yacktman: Another one is that our attitude has been… we should focus on things we can control. We believe you can find investments that could do well even if the economy is challenging or the market suffers. Even though the U.S. stock market has done poorly since 2000, we have achieved strong results because we focused on and invested in individual securities. We can set the sails, we can’t control the wind. It’s fun to talk about the economy, don’t get me wrong… I’ll be happy to answer your question directly. But when push comes to shove, it’s what you buy and what you pay for it.
I would say this. The 800-pound gorilla problem is that most of the developed world has a model that’s unworkable when it comes to dealing with older people. We have an aging population, and we have a declining birth rate, and we decided, whether it’s England or Greece or the United States, to use a model that is not workable. The end result is politicians have overpromised on what they can deliver to people.
Growth will override any sort of issues if it can be achieved. And what people don’t realize – again part of it’s the time horizon – a 1% additional growth rate, if you can achieve that, over a period of 72 years, means you will double the standard of living over what you would have had if you had not done that. Now that’s what the whole last 200-plus years, in most of the developed world are all about, industrialization. Yeah, you can argue about pollution, or you can argue about carbon footprint, or whatever, but the reality is I don’t think most people want to go back to what life was like in the early 1800s, if they had a choice.
Wilkins: Think of what the air quality would be like if we’re all still using wood-burning stoves.
Yacktman: Regardless of the issues in the macro world, we believe what is most important is what you own and the price you pay for it. Today we have significant exposure to some of the highest quality businesses in the world at what we think are attractive valuations. In an environment where there is so much global uncertainty it certainly feels good to be able to own such high quality securities.
The views expressed represent the opinions of Yacktman Asset Management LP as of August 17, 2012 and are not intended as a forecast or guarantee of future results, and are subject to change without notice.
Any sectors, industries, or securities discussed should not be perceived as investment recommendations. There is no assurance that any securities discussed herein will remain in a portfolio at the time you receive this information or that securities sold have not been repurchased. The securities discussed do not represent the entire portfolio and in aggregate may represent only a small percentage of a portfolio's holdings. Any securities discussed may no longer be held in an account’s portfolio. It should not be assumed that any of the securities transactions discussed were or will prove to be profitable, or that the investment recommendations we make in the future will be profitable or will equal the investment performance of any security discussed herein. Yacktman Asset Management LP will provide a list of security purchases and sales for the past 12 months upon request.