The Dodge & Cox Stock Fund had a total return of 15.8% for the first quarter of 2021, compared to 6.2% for the S&P 500 Index and 11.3% for the Russell 1000 Value Index (R1000V).
Investment Commentary
The U.S. equity market has experienced a major reversal in the performance of value and growth stocks.2 From the beginning of 2017 through September 2020, U.S. growth stocks outperformed value stocks by 101 percentage points.3 This long-term trend was fueled by growth-oriented companies in sectors and industries associated with technology—most notably the "FAANG" stocks (Facebook, Amazon, Apple, Netflix, Google). By the summer of 2020, more and more investors questioned whether value investing was still a viable strategy. At Dodge & Cox, however, we continued to believe value investing would be rewarding in the long term, despite prolonged underperformance.
In September 2020, the U.S. equity market began to shift in value's favor. The successful development of COVID-19 vaccines and the vaccine rollout have created optimism about economic growth and helped propel market returns. Segments of the market that had previously lagged (e.g., Energy, Financials, Industrials) have outperformed significantly, and the U.S. stock market surged to an all-time high in March. Stock prices now reflect investors' expectations for a strong economic recovery. Interest rates and oil prices have risen sharply, boosting the Financials and Energy sectors. Over the past two quarters, the Fund has outperformed the S&P 500 by 21 percentage points and the R1000V by 11 percentage points.4
Going forward, we believe there is a strong case for recent trends to continue. First, while the valuation gap between value and growth stocks has recently narrowed, value stocks continue to trade at a significant discount to growth stocks. Importantly, the Fund trades at a meaningful discount to both the broad-based market and value universe: 14.1 times forward earnings compared to 22.7 times for the S&P 500 and 19.2 times for the R1000V.5 Lower starting valuations have historically been followed by attractive long-term returns.
Second, the current backdrop of high consumer savings rates, pent-up demand, rising interest rates, and higher energy prices is encouraging. As more of the population becomes vaccinated, economic activity should accelerate. We continue to have deep conviction in our portfolio, which is comprised mostly of companies with strong franchises that would benefit from long-term economic growth. While we recently trimmed the Fund's Financials and Energy holdings as share prices increased, the Fund remains significantly overweight these economically sensitive sectors: 26.6% in Financials (compared to 11.3% in the S&P 500 and 20.6% in the R1000V) and 8.4% in Energy (compared to 2.8% in the S&P 500 and 5.1% in the R1000V).
Third, we believe that many of the high-valuation technology companies that have influenced overall U.S. equity market returns have extreme valuations reflecting high expectations. These companies face significant challenges, not only in justifying their valuations but also because of mounting competitive, technological, and regulatory threats. In addition, they have benefited from lower interest rates and COVID-19 tailwinds, both of which look likely to change from here.
Our decades of experience have taught us that labels can be dangerous when investing. We are an active "value" investment manager because we believe starting point matters to long-term returns; that's why we continually weigh valuations against fundamentals. We keep an open mind when looking for investments—strict value and growth categories do not define our investable universe. Instead, we optimize the portfolio based on relative valuation opportunities.
We believe patience, persistence, and a long-term investment horizon are essential to investment success. We encourage our shareholders to take a similar view. Thank you for your continued confidence in Dodge & Cox.
First Quarter Performance Review
The Fund outperformed the S&P 500 by 9.7 percentage points during the quarter.
Key Contributors to Relative Results versus the S&P 500
- The Fund's overweight position and holdings in Financials (up 25% compared to up 16% for the S&P 500 sector) added significantly to results. Capital One Financial (COF, Financial), Wells Fargo (WFC, Financial), MetLife (MET, Financial), and Charles Schwab (SCHW, Financial) performed well.
- The Fund's Information Technology holdings (up 16%) outpaced the S&P 500 sector (up 2%) by a wide margin. Notable contributors included HP Inc. (HPQ, Financial) and Hewlett Packard Enterprise (HPE, Financial).
- The Fund's average overweight position in Energy, the strongest sector of the Fund and the Index, generated attractive results. Occidental Petroleum (OXY, Financial) was a standout performer.
- Johnson Controls International (JCI, Financial) was also a key contributor.
Key Detractors from Relative Results versus the S&P 500
- The Fund's overweight position and holdings in Pharmaceuticals had a negative impact on relative results. Novartis (NVS, Financial) and GlaxoSmithKline (GSK, Financial) lagged.
- Charter Communications (CHTR, Financial) and Cognizant Technology Solutions (CTSH, Financial) also detracted.
The Fund outperformed the Russell 1000 Value by 4.6 percentage points during the quarter.
Key Contributors to Relative Results versus the R1000V
- The Fund's overweight position and holdings in Financials (up 25% compared to up 18% for the R1000V sector) benefited results. Capital One Financial, Wells Fargo, MetLife, and Charles Schwab were top contributors.
- Returns from holdings in Information Technology (up 16% compared to up 11% for the R1000V sector), combined with a higher average weighting in the sector, contributed. HP Inc. and Hewlett Packard Enterprise performed well.
- A higher average weighting in Energy had a positive impact. Occidental Petroleum was a standout performer.
- The Fund's underweight positions in the Consumer Staples and Utilities sectors, the weakest segments of the Index, aided relative performance.
- Johnson Controls International was also a key contributor.
Key Detractors from Relative Results versus the R1000V
- In the Health Care sector, the Fund's higher average weighting and weaker returns from holdings detracted. Pharmaceuticals holdings lagged, especially Novartis, GlaxoSmithKline, Sanofi (SNY), and Roche (XSWX:ROG).
- Charter Communications and Cognizant Technology Solutions also detracted.
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. The Russell 1000® Value Index is composed of those Russell 1000® companies with lower price-to-book ratios and lower forecasted growth values.
2 Generally, stocks that have lower valuations are considered "value" stocks, while those with higher valuations are considered "growth" stocks.
3 The Russell 1000 Growth Index had a total return of 117.46% from December 31, 2016 to September 30, 2020 compared to 16.61% for the Russell 1000 Value Index.
4 The Dodge & Cox Stock Fund had a total return of 40.03% from September 30, 2020 to March 31, 2021 compared to 19.07% for the S&P 500 Index and 29.31% for the Russell 1000 Value Index.
5 Unless otherwise specified, all weightings and characteristics are as of March 31, 2021.
S&P 500® is a trademark of S&P Global Inc. Russell 1000® is a trademark of the London Stock Exchange Group plc. For more information about these indices, visit dodgeandcox.com.
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.
