Three of the industry’s most accomplished value investors – Bruce Berkowitz of the Fairholme Fund, Tom Marsico of Marsico Capital Management and Wally Weitz of Weitz Funds – spoke at a panel discussion at the Morningstar Investor Conference on May 28. Pat Dorsey, Morningstar’s Director of Equity Research, moderated the discussion.
Below are some excerpts of their thoughts on key questions raised during the panel.
Are valuations low?
Marsico: Valuations are not as compelling as in 1981-2, when interest rates were high and P/E ratios contracted. The opportunities are great, especially with the financial stocks. Valuations in certain areas are better than in 1981.
Berkowitz: In September and October every day was a knife fight. This was the definition of a difficult bear market. It was the cheapest period I have seen in general, although some sectors may have been cheaper at other times. Most stunning was the cheapness of companies’ senior credit, which were giving excess equity returns. This was the first time I have seen this in my career. We could be creditors and end up with 20% annual returns.
What is your outlook for the health care industry?
Berkowitz: We went into health care, which we view as an essential, recession-proof industry with huge free cash flow, although the companies are horrible capital allocators. The cash is there and it flows in even when they make mistakes. Health insurers are our healthcare system – that is not going to change quickly, no matter what the rhetoric may be.
Weitz: We agree that health care companies are the health care system. The government can try to squeeze their margins but they are the players.
Marsico: Regulation in health care will require different decisions. As a society, we can’t afford health care at the level it is provided now. A lot of countries are doing a better job. The US will have a much more regimented, evidenced-based mentality for medicine – an intellectual way to approach the problem. There will be fewer services and fewer drugs. Innovation needs to happen at the drug companies through a change in their culture. The existing large drug companies have lost their culture.
Berkowitz: If you eliminate fraud and excess commissions, we are halfway to solving the problem. Malpractice is still a big problem. The demographics in the US make health care expensive, and someone has to pay for it. Until we all start exercising and stop demanding hip or knee replacements because we are overweight, problems will remain. Health care companies are not making that much but they are bargains because their stock prices have fallen off a cliff relative to their intrinsic values.
How do you value the capital allocators like Berkshire Hathaway?
Berkowitz: For companies like Berkshire, Leucadia, and Sears we use look-through analysis – valuing the assets, income statement and capital structure. Is it cheap? Can you get the future for free with a manager who has a good track record?
Weitz: The “sum of the parts” analysis is seductive, but we have had a poor experience with it. The extra ingredient is management that you really trust to use assets well, to be opportunistic, appropriately cautious and not over-leveraged. Very few managers are that way. Buffett is the only who I would buy a black box from. John Malone is very different – complex and conservative – and good things have happened with his media assets. There are only a few managers over the last 35 years who I would trust.
Marsico: One company that understands cheap assets is Goldman Sachs. They have insights into how to make money without high leverage from seeing capital flows.
Weitz: As for Sears, we don’t know Eddie Lampert. When you delegate decision-making to people you have known for a long time, you want to know how they are likely to decide at a fork in the road.
Berkowitz: We want owner/managers who put themselves in the shoes of outside shareholders. We believe you die only with your reputation.
What problems and questions occupy your time?
Marsico: We have been focusing on the global nature of the markets, to understand how they affect our market and how to invest internationally. Which will be the fastest growing markets? We have sent people to Asia, including China and India, to understand their stimulus programs. We are looking at the balance sheets of countries to see how the dollar is valued. Interest rates are rising but only to a certain level, because then we will attract capital (relative to other countries). We spend a lot of time on policy to understand where regulation is going.
Weitz: We are as micro as possible. We make sure we are focused in right place in case inflation shows up. We want pricing power, and we expect a choppy, mixed bag of news over the next year or two. We are looking forward to a lot of volatility. We don’t want to follow old patterns.
Berkowitz: We are at our 10th anniversary and have averaged returns of 11.5% per year after a very poor year. We are now looking at the senior bonds of companies with yields of 18% – with some approaching 30%. What can be bad about that? These returns are better than our performance record, with less risk, and we are higher in the credit structure. Stocks are the most junior of bonds. Bonds are the most senior of stocks. We have a chance to make a lot of money. I hope this doesn’t change.
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About the author:
Mr. Huebscher is the founder and CEO of Advisor Perspectives, a web site and newsletter that provides investment strategy analysis for financial advisors and wealth managers. In 1982, he founded the investment software division of Thomson Financial, where he created the PORTIA product, a portfolio management system for institutional investors. In 1990, he founded Hub Data, a market data redistribution service, which he sold to Advent Software in 1998. He has also worked in the account aggregation field, as a consultant to both vendors and wealth managers. He is a graduate of the Harvard Business School (1982) and Connecticut College (1976).