David Herro was interviewed by Morningstar on September 27, 2007. The value investor looking for values worldwide shares his insights on a number of issues:
On it is exceptional time to be investing in good quality businesses
Herro: I think this is an exceptional time to be investing in good-quality businesses defined as companies that earn good returns with good management with sound capital allocation, good free cash flow streams: that's our definition of quality, and then at price – at a low price.
So it's very, very easy today to find these types of companies. Why? Because there is fear and fright in the markets, people are flocking to safety: Treasury bills, Treasury bonds, money markets, bank deposits. They're flocking to safety and they are completely ignoring what I think is a very compelling valuation in global stocks today.
But you know what, people often do this. They'll wait until there is a big rally, and then they'll get in in the second or third quarter of that rally, but that's fine. We think right now that it pays to get this exposure. Stocks haven't done anything in 10 years, and incidentally, you touched upon it. 10 years ago, in the late '90s in particular, stocks were rich. If you look at what stocks did from '95 to 2000, they went up exponential; they were rich. And now, we have just the opposite. They are selling at very low prices.
On many investors focus on macroeconomic trend instead of individual company’s fundamentals:
David Herro: I think there is a lot of exactly what you're saying is happening. People are afraid to stay focused on the fundamentals, so they are going to the macro. The problem with that for them is the macro changes like the wind, it's like the weather. There is so many variables, there is unstable coefficients, and people get whipsawed.
What we actually try to do is use the impatience of the population of investors, who all of a sudden now are consumed with and obsessed with the macro. We try to use this to benefit our shareholders. As they are all, for instance, in the second quarter of 2010, concerned about European debt and they're all dumping European financials, then we'll buy them if they're good-quality businesses at the right prices.
For our investment style, in a perverse way, it’s a positive, but for a typical investor, they are getting whipsawed by this and my recommendation would be, aim high in steering as they tell you in driver's ed, don’t get caught up in the short-term variability and the white noise and in things that you cannot predict such as short-term macro trends.
On why and how they have been more active in the volatile market:
Herro: Great question, because if in the beginning of ’08 we were way overweight financials, by the end of ’09, we actually trimmed a lot of those financials as they got closer to their targets. So, in one year they went from being stocks that had perhaps a 150% to 200% upside to having just 50% or 60% upside. So we trimmed them, and we trimmed them in late ’09 and early 2010, but then the European crisis, sovereign debt crisis, came in the second quarter of 2010, and these things headed south again.
So, stocks that we had just trimmed in the third and fourth quarter of ’09, and the first quarter of ’10, we started buying back in the second and third quarter of 2010, which again is very counter to our typical behavior, but when you see such dramatic price movement, in our view, not much has changed in terms of the fundamentals, we have to act. We have to continually position the portfolio such that our money is weighted in those stocks that have the highest expected rate of return.
Also check out: On it is exceptional time to be investing in good quality businesses
Herro: I think this is an exceptional time to be investing in good-quality businesses defined as companies that earn good returns with good management with sound capital allocation, good free cash flow streams: that's our definition of quality, and then at price – at a low price.
So it's very, very easy today to find these types of companies. Why? Because there is fear and fright in the markets, people are flocking to safety: Treasury bills, Treasury bonds, money markets, bank deposits. They're flocking to safety and they are completely ignoring what I think is a very compelling valuation in global stocks today.
But you know what, people often do this. They'll wait until there is a big rally, and then they'll get in in the second or third quarter of that rally, but that's fine. We think right now that it pays to get this exposure. Stocks haven't done anything in 10 years, and incidentally, you touched upon it. 10 years ago, in the late '90s in particular, stocks were rich. If you look at what stocks did from '95 to 2000, they went up exponential; they were rich. And now, we have just the opposite. They are selling at very low prices.
On many investors focus on macroeconomic trend instead of individual company’s fundamentals:
David Herro: I think there is a lot of exactly what you're saying is happening. People are afraid to stay focused on the fundamentals, so they are going to the macro. The problem with that for them is the macro changes like the wind, it's like the weather. There is so many variables, there is unstable coefficients, and people get whipsawed.
What we actually try to do is use the impatience of the population of investors, who all of a sudden now are consumed with and obsessed with the macro. We try to use this to benefit our shareholders. As they are all, for instance, in the second quarter of 2010, concerned about European debt and they're all dumping European financials, then we'll buy them if they're good-quality businesses at the right prices.
For our investment style, in a perverse way, it’s a positive, but for a typical investor, they are getting whipsawed by this and my recommendation would be, aim high in steering as they tell you in driver's ed, don’t get caught up in the short-term variability and the white noise and in things that you cannot predict such as short-term macro trends.
On why and how they have been more active in the volatile market:
Herro: Great question, because if in the beginning of ’08 we were way overweight financials, by the end of ’09, we actually trimmed a lot of those financials as they got closer to their targets. So, in one year they went from being stocks that had perhaps a 150% to 200% upside to having just 50% or 60% upside. So we trimmed them, and we trimmed them in late ’09 and early 2010, but then the European crisis, sovereign debt crisis, came in the second quarter of 2010, and these things headed south again.
So, stocks that we had just trimmed in the third and fourth quarter of ’09, and the first quarter of ’10, we started buying back in the second and third quarter of 2010, which again is very counter to our typical behavior, but when you see such dramatic price movement, in our view, not much has changed in terms of the fundamentals, we have to act. We have to continually position the portfolio such that our money is weighted in those stocks that have the highest expected rate of return.
