Third quarter returns were solid for the Fund as low rates and central banking stimulus helped markets push higher despite economic challenges. The Fund performed in line with the Russell 1000® Value benchmark and lagged the S&P® 500 Index (which has been dominated by a small group of technology companies that continued to race higher during the quarter).
The significant performance gap between growth and value has caused many to ask whether value is due for a comeback or if it is an outdated strategy. This question was frequently asked in the late 1990s, just before value came back with a vengeance. Interestingly, even with the atypically long run of growth stock dominance, at quarter end the 20-year returns for the Russell 1000® Growth, Russell 1000® Value, and S&P 500 Index were virtually in line with each other.
The Fund was able to significantly outperform all these benchmarks over the last 20 years because we focus on the long-term attributes of individual investment opportunities and the risks encompassed by those securities. Unlike many value managers, we prefer to own a solid business rather than buying something that is merely inexpensive and may be risky due to cyclicality, leverage, or impending business obsolescence. With our strong focus on quality while not overpaying (even for great businesses), we have successfully generated solid returns over long time periods while protecting well in the difficult markets.
How to get growth without overpaying
Many of our favorite current investments are in businesses, including Samsung, Bolloré, and News Corp, that trade at bargain prices due to some combination of complexity, conglomerate discount, or unwarranted fears about some of their business lines. These businesses would likely be viewed as growth stocks and trade at much higher valuations if they were simplified or broken up. Take Samsung (XKRX:005935, Financial), which has technology leadership in semiconductors, foundry, display, mobile phones, and appliances and strong growth potential from new markets like 5G, AI, and automotive businesses. Samsung's preliminary operating earnings for the quarter were more than $10 billion and the preferred shares, net of cash and excess investments, trade at about 7 times our expectation of next year's earnings. During the quarter, Samsung announced a huge $6.6 billion contract with Verizon to provide 5G equipment and build out. We wonder what valuation that business alone would get if publicly floated given the crazy enthusiasm for IPOs these days, but in the larger structure of the company, that unit is lost to many.
Much of Bolloré's (XPAR:BOL, Financial) value comes from its 27% ownership of Vivendi, and Vivendi's value is largely accounted for by its 90% ownership of Universal Music Group (UMG), the leading owner of music rights. Not that long ago, music looked like a dying business due to piracy concerns, but largely because of the popularity of streaming services, it has developed into one of the best positioned businesses we see today. Vivendi (XPAR:VIV, Financial) recently sold 10% of UMG for EUR3 billion and has committed to an IPO of the unit by 2023. Recently management said that the timeframe for an IPO could be accelerated, and given the market's robust response to new issues, we think this would be a good idea and could help close the steep discount that exists on both Vivendi's and Bolloré's shares.
Another company that we think offers strong growth and trades at a substantial discount is News Corp. (NWSA, Financial). In the last few years, the company has been simplifying its business, selling off non-core assets and increasing the transparency in its financial reporting. Today News Corp has two excellent businesses which should provide long-term growth. Dow Jones owns The Wall Street Journal, Barron's, and a rapidly growing risk and compliance business. News Corp also owns significant online real estate, including a 62% ownership of REA Group, a publicly traded security in Australia, and realtor.com. Few have paid attention to the shares, probably due to the biases against newspaper businesses and the complexity of the financial reporting.
We believe we can generate solid returns over time in the three highlighted investments just from the cash flow and growth they can produce, and whether or not others reward them with a higher multiple. If we get both the business results we project and a higher multiple, that can enable a spectacular outcome, much like Microsoft delivered in the last few years. Many have already forgotten that Microsoft's shares languished for almost a decade in the Fund before improved business results helped deliver extremely strong share price returns.
Samsung's shares rose with a solid rebound in profits and general strength in global technology shares. We think there could be a significant improvement in earnings across many of Samsung's businesses next year and the shares represent an unusually compelling bargain.
Bolloré delivered good results due in part to a share price increase in its Vivendi stake. Bolloré's stock trades at a 40% discount to just the value of the Vivendi holding. In addition, it has an extremely valuable port and logistics business and a solid-state battery business which should improve significantly due to a supply agreement for Mercedes buses.
Macy's (M, Financial) continued to struggle as its retail business remains under pressure. The value of its real estate has also been challenged, especially because some of the best properties are in cities like New York and San Francisco that are seeing the biggest impact on commercial rates as people work from home or move to more rural locations.
Weatherford International (WFTLF) debt declined due to continued challenges in the energy sector.
Hengan (HKSE:01044) shares were weaker during the quarter after producing strong outperformance in the first half of the year.
Cisco's (CSCO) stock was lower during the quarter after delivering strong results but giving weaker earnings guidance. The stock sells at a modest multiple of earnings and cash flow and the company continues to successfully transition its business to more predictable software, services, and security.
Today there is an unbelievable disparity between many new companies that are "the hot new thing" and many established businesses. For example, Zoom, whose business has grown rapidly due to the work/school at home environment, has an enterprise value of approximately $140 billion while Samsung, using the preferred price as our valuation point, is approximately $175 billion. For the trailing twelve months, Zoom produced $1.3 billion in revenues and $230 million in operating income. Preliminary results for Samsung's 3rd Quarter are $57 billion in revenues and $10.6 billion in operating income. (Yes, that's just the quarter.)
We think Samsung can grow earnings substantially from here as its semiconductor business, which has been operating near a cyclical low point, could see a major recovery in the next few years. Interestingly, NVIDIA Corp. had an enterprise value of $330 billion at the end of the quarter, nearly twice Samsung's, even though its trailing twelve month revenues barely eclipsed Samsung's quarterly trailing operating profit.
Bob Gibson, one of the greatest baseball pitchers of all time and famous for being one of the toughest competitors in the game, died recently. The last batter he faced before he retired hit a grand slam to end his career. About a decade later, at an Old Timer's Day in Chicago, Gibson intentionally hit the same batter, Pete LaCock, with a pitch as payback for the grand slam he produced in 1975. As he told Bob Costas, "The scales must be balanced no matter how long it takes."
Over time, attractive valuation matters. We have no doubt that scales will be balanced and strongly believe the risk -adjusted returns in companies like Samsung, News Corp, and Bolloré will beat today's speculative high-flyers, and do so with a vastly lower risk profile. Perhaps Ben Graham said it best when he wrote, "Buy not on optimism, but arithmetic." As always, we will be disciplined, patient, and objective with a keen focus on the math when managing the AMG Yacktman Focused Fund (Trades, Portfolio).
1 Returns for periods less than one year are not annualized.
2 The performance information shown for periods prior to June 29, 2012, is that of the predecessorto the Fund, The Yacktman Focused Fund (Trades, Portfolio), which was reorganized into the AMG Yacktman Focused Fund (Trades, Portfolio) on June 29, 2012, and was managed by Yacktman Asset Management (Trades, Portfolio) LP with the same investment policies as those of the predecessor Fund.
3 Since the inception of the Fund's Class N shares on May 1, 1997.
4 Since the inception of the Fund's Class I shares on July 24, 2012.
5 Effective June 30, 2020, the Fund's primary and secondary benchmarks were changed. The Russell 1000® Value Index became the primary benchmark and S&P 500® Index the secondary benchmark; previously the S&P 500 Index was the primary benchmark and the Russell 1000® Value Index was the secondary benchmark.
6 The Fund's Investment Manager has contractually agreed, through May 1, 2021, to limit fund operating expenses. The net expense ratio reflects this limitation, while the gross expense ratio does not. Please refer to the Fund's Prospectus for additional information on the Fund's expenses.
7 Mention of a specific security should not be considered a recommendation to buy or a solicitation to sell that security. Holdings are subject to change.
The views expressed represent the opinions of Yacktman Asset Management (Trades, Portfolio) LP as of September 30, 2020, are not intended as a forecast or guarantee of future results, and are subject to change without notice.
Investors should carefully consider the fund's investment objectives, risks, charges, and expenses before investing. For this and other information, please call 800.835.3879 or download a free prospectus. Read it carefully before investing or sending money.
Past performance is no guarantee of future results.
The Fund is subject to the risks associated with investments in debt securities, such as default risk and fluctuations in the perception of the debtor's ability to pay its creditors. Changing interest rates may adversely affect the value of an investment. An increase in interest rates typically causes the value of bonds and other fixed income securities to fall.
High-yield bonds (also known as "junk bonds") may be subject to greater levels of interest rate, credit, and liquidity risk than investments in higher rated securities. These securities are considered predominantly speculative with respect to the issuer's continuing ability to make principal and interest payments. The issuers of the Fund's holdings may be involved in bankruptcy proceedings, reorganizations, or financial restructurings, and are not as strong financially as higher-rated issuers.
The Fund may invest in derivatives such as options and futures; the complexity and rapidly changing structure of derivatives markets may increase the possibility of market losses.
Investments in international securities are subject to certain risks of overseas investing, including currency fluctuations and changes in political and economic conditions, which could result in significant market fluctuations. These risks are magnified in emerging markets.
The Fund is subject to risks associated with investments in mid-capitalization companies such as greater price volatility, lower trading volume, and less liquidity than the stocks of larger, more established companies.
The Fund is subject to risks associated with investments in small-capitalization companies, such as erratic earnings patterns, competitive conditions, limited earnings history, and a reliance on one or a limited number of products.
The Fund may suffer significant losses on assets that it sells short. Unlike the possible loss on a security that is purchased, there is no limit on the amount of loss on an appreciating security that is sold short.
A greater percentage of the Fund's holdings may be focused in a smaller number of securities, which may place the Fund at greater risk than a more diversified fund.
Companies that are in similar businesses may be similarly affected by particular economic or market events; to the extent the Fund has substantial holdings within a particular sector, the risks associated with that sector increase.