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Sydnee Gatewood
Sydnee Gatewood
Articles (2958) 

Dodge & Cox Stock Fund's 3rd-Quarter Commentary

Discussion of markets and holdings

The Dodge & Cox Stock Fund had a total return of 4.3% for the third quarter of 2020, compared to 8.9% for the S&P 500 Index. For the nine months ended September 30, 2020, the Fund had a total return of –11.3%, compared to 5.6% for the S&P 500.

Investment Commentary

The U.S. equity market was extremely volatile during the first nine months of 2020. In the first quarter, the coronavirus (COVID-19) evolved into a global pandemic, disrupting major economies around the world and abruptly ending the longest stock market bull run in U.S. history. U.S. equities fell sharply, but then quickly rebounded off their March lows and performed strongly in both the second and third quarters. The S&P 500 registered its best two-quarter performance since 2009 and reached an all-time high in September. Optimism regarding a COVID-19 vaccine and signs of corporate earnings strength have bolstered investor confidence.

In this challenging economic environment, companies have fallen into two groups: businesses that are largely immune to the economic impact of the pandemic (we think of them as "COVID defensive") and those that have been hit hard by the economic consequences of the pandemic ("COVID cyclical"). Approximately 70%2 of the S&P 500 is in COVID-defensive businesses, particularly those in the Information Technology, Health Care, Consumer Staples, and Utilities sectors. Large technology-related companies have surged, especially the FAANGM stocks— Facebook, Amazon, Apple, Netflix, Google (Alphabet), and Microsoft. However, the other 30% of the S&P 500 is comprised of COVID-cyclical companies—largely in the Financials, Energy, Industrials, and Real Estate sectors—and has not fared well. Energy was the worst-performing sector of the S&P 500 (down 48% year to date), reflecting dramatically reduced demand because of the global economic slowdown.

Over the past decade, U.S. growth stocks have outperformed value stocks3 by an astounding cumulative 233 percentage points.4 The Fund is value-oriented, and while it outperformed the U.S. value investment universe by 27 percentage points,5 it has underperformed the broad-based S&P 500. In September 2020, the market started to shift in value's favor, but it is too soon to know whether this could be the beginning of a major reversal in market leadership.

We continue to have strong conviction in our active investment approach. The Fund remains tilted toward the COVID cyclical and value sectors of the market, with notable overweights in Financials (26.3% of the portfolio versus 9.7% of the S&P 500) and Energy (7.0% versus 2.1%). The portfolio is composed mostly of companies with strong franchises that would benefit from long-term economic growth. We remain confident in our portfolio positioning because of three primary reasons.

First, the valuation differential between value- and growth-oriented stocks has become very large, and this has created ample opportunities for value- oriented investors like Dodge & Cox. We have shifted the portfolio based on COVID-impacted fundamentals and valuations. For example, we recently trimmed holdings that had performed well—such as FedEx and Microsoft—and added to holdings with low valuations, including Raytheon Technologies and Wells Fargo.6 The Fund trades at a significant discount to the overall market: 12.8 times forward earnings compared to 23.0 times for the S&P 500. Historically, lower starting valuations have produced more attractive long-term returns.

Second, while there is substantial uncertainty regarding how the pandemic will evolve, we are encouraged by the trajectory of the economic rebound and the prospects for developing a vaccine. We believe depressed areas of the market that are widely represented in the Fund (e.g., Financials, Energy, Industrials) should recover with enhanced confidence when a vaccine or antibody treatment becomes readily available. In addition, as supply and demand move toward a better balance in the oil markets, Energy could outperform. There is also a chance that U.S. interest rates increase when the economy fully recovers, which would further benefit the Fund's financial services holdings.

Third, history has indicated it is hard to stay a market leader. There are some very large, high-valuation technology companies that have had a large influence on market returns. We believe many of them are overvalued and face significant challenges, not only in justifying their valuations but also because of mounting competitive and regulatory threats.

We believe patience, persistence, and a long-term investment horizon are essential to investment success. Changes in valuations and share prices can happen swiftly and without warning, so we encourage our shareholders to take a long-term view. Thank you for your continued confidence in Dodge & Cox.

Third Quarter Performance Review

The Fund underperformed the S&P 500 by 4.6 percentage points during the quarter.

Key Detractors from Relative Results

  • The Fund's overweight position (averaging 9% versus 2%) and lower returns in Energy (down 22% versus down 20% for the Index sector) hindered performance. Energy was the worst-performing sector during the quarter and the only S&P 500 sector that had a negative absolute return. Occidental Petroleum (NYSE:OXY) and Baker Hughes (NYSE:BKR) were particularly weak.
  • Stock selection in the Health Care sector was negative. Cigna (NYSE:CI), GlaxoSmithKline (NYSE:GSK), and Sanofi (NASDAQ:SNY) performed poorly.
  • Strong performance by large internet- and technology-related stocks not held by the Fund hurt relative results.
  • An underweight position and returns from holdings in Information Technology detracted.
  • A higher average weighting (26% versus 10%) and weaker returns from holdings in Financials (up 2% versus up 4% for the Index sector) had a negative impact. Wells Fargo (NYSE:WFC) and Bank of New York Mellon (NYSE:BK) were key detractors.

Key Contributors to Relative Results

  • Strong returns from holdings in Industrials (up 37% versus up 12% for the Index sector) contributed. FedEx (FDX) (up 80%) was a standout performer.
  • Charter Communications (NASDAQ:CHTR), Dell Technologies (NYSE:DELL), and Comcast (NASDAQ:CMCSA) also contributed.

Year-to-Date Performance Review

The Fund underperformed the S&P 500 by 16.9 percentage points year to date.

Key Detractors from Relative Results

  • In Financials, the Fund's overweight position (averaging 26% versus 11%) and weaker returns from holdings (down 29% versus down 20% for the Index sector) detracted. Wells Fargo, Capital One Financial (NYSE:COF), Charles Schwab (SCHW), and Bank of America (NYSE:BAC) performed poorly.
  • Outstanding performance by large internet- and technology-related stocks not held by the Fund hurt relative results.
  • Meanwhile, the Fund's holdings in Information Technology lagged significantly (up 3% versus up 29% for the Index sector).
  • Energy was the weakest sector of the Fund and the Index. The Fund's overweight position combined with weaker returns from holdings in the sector had a negative impact. Occidental Petroleum, Apache (APA), and Baker Hughes were key detractors.

Key Contributors to Relative Results

  • The Fund's holdings in Industrials significantly outpaced the Index sector (up 17% versus down 4%) due to the exceptional performance of FedEx (up 69%).
  • The Fund's lack of holdings in Real Estate (down 7%) and Utilities (down 6%) helped relative results, as these segments lagged the Index.
  • Returns from holdings in Communication Services (up 12% versus up 9% for the Index sector), combined with a higher weighting (averaging 13% versus 11%), contributed. Charter Communications and Sprint (prior to its merger with T-Mobile US) performed well.
  • Dell Technologies also contributed.
  1. The Fund's total returns include the reinvestment of dividend and capital gain distributions, but have not been adjusted for any income taxes payable by shareholders on these distributions or on Fund share redemptions. Index returns include dividends but, unlike Fund returns, do not reflect fees or expenses. The S&P 500 Index is a market capitalization-weighted index of 500 large-capitalization stocks commonly used to represent the U.S. equity market.
  2. Unless otherwise specified, all weightings and characteristics are as of September 30, 2020.
  3. Value stocks are the lower valuation portion of the equity market, and growth stocks are the higher valuation portion.
  4. The Russell 1000 Growth Index had a total return of 391.2% from September 30, 2010 through September 30, 2020 compared to 158.0% for the Russell 1000 Value Index.
  5. The Dodge & Cox Stock Fund had a total return of 184.6% from September 30, 2010 through September 30, 2020 compared to 158.0% for the Russell 1000 Value Index.
  6. The use of specific examples does not imply that they are more or less attractive investments than the portfolio's other holdings.

Returns represent past performance and do not guarantee future results. Investment return and share price will fluctuate with market conditions, and investors may have a gain or loss when shares are sold. Fund performance changes over time and currently may be significantly lower than stated above. Performance is updated and published monthly. Visit the Fund's website at dodgeandcox.com or call 800-621-3979 for current month-end performance figures.

About the author:

Sydnee Gatewood
I am the editorial director at GuruFocus. I have a BA in journalism and a MA in mass communications from Texas Tech University. I have lived in Texas most of my life, but also have roots in New Mexico and Colorado. Follow me on Twitter! @gurusydneerg

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