To Our Shareholders
The Dodge & Cox Global Stock Fund had a total return of 21.0% for the six months ended June 30, 2021, compared to a return of 13.1% for the MSCI World Index.
Market Commentary
Global equity markets have rebounded significantly since their March 2020 lows when the World Health Organization first declared COVID-19 a pandemic, and continued to appreciate through the first half of 2021. In the United States, the S&P 500 Index reached an all-time high in June, as the successful rollout of COVID-19 vaccines, unprecedented fiscal and monetary stimulus, healthy consumer balance sheets, and tightening labor markets created optimism about economic growth. Segments of the market that had previously lagged—such as Energy and Financials—surged, underscoring the importance of patience and persistence for value-oriented investors. Internationally, share prices have also risen, in anticipation of a continued robust earnings recovery from the lows caused by the pandemic.
Within this backdrop, value stocksa have outperformed growth stocks by a substantial 8 percentage points since September 30, 2020.b However, despite this outperformance, the valuation gap between value and growth stocks globally remains remarkably wide: the MSCI World Growth trades at 30.1 times forward earnings compared to 14.7 times for the MSCI World Value.c
Investment Strategy
While the rollout of COVID-19 vaccines is proceeding at different rates around the world, we remain optimistic about further earnings growth as economies continue to recover. The Fund remains geared to an economic recovery, with a continued emphasis on lower valuation opportunities. The Fund trades at a meaningful discount to both the broad-based market, as well as the value universe: 13.2 times forward earnings compared to 19.9 times for the MSCI World and 14.7 times for the MSCI World Value.
Many traditional value sectors continue to trade at significant relative discounts to the market versus historic averages, with Financials, Energy, and Materials looking demonstrably cheaper than the rest of the market. The Fund is overweight these sectors. Unlike the situation in the 2008-09 global financial crisis, governments around the world have provided extraordinary support throughout the pandemic, the U.S. banking system is profitable and well capitalized, and consumers are ready to spend. We believe this bodes well for sectors exposed to economic recovery. Notably, the U.S. government has provided more fiscal stimulus since March 2020 than it provided in the New Deal, Marshall Plan, and global financial crisis combined, as a percentage of gross domestic product (GDP).
In contrast, many of today’s growth stocks are technology companies with extreme valuations that reflect high expectations. We believe a number of these companies face significant challenges, including mounting competitive, technological, and regulatory threats. In addition, their valuations have benefited from lower interest rates and their perceived durability amid COVID-19, both of which could change going forward.
Periods of significant volatility can create some of the best opportunities from a valuation perspective. Our disciplined, value-oriented approach—grounded in our extensive research, long-term investment horizon, and organizational independence—has enabled us to invest in out-of-favor companies with strong fundamentals during periods of uncertainty. Having said this, it is important to weigh company fundamentals against valuations and not simply focus on either value or growth labels when selecting individual investments. Not all value stocks are great investments—there may be good reasons certain companies are inexpensive. Additionally, investors can easily miss attractive opportunities by rigidly defining their universe.
During the COVID-19 downturn, the Fund added to depressed cyclical portions of the market (e.g., Energy, Financials, Materials), largely funded with trims from more defensive segments. However, since Pfizer and BioNTech announced they had successfully developed a COVID-19 vaccine, we have taken largely reciprocal actions in the portfolio amid changing valuations. We have trimmed more cyclical stocks as value has recovered, and we have added to more defensive sectors based on company-specific opportunities. As the Fund’s holdings in the Energy and Financials sectors outperformed, we sold Bank of America, ConocoPhillips, Hess, Mitsubishi UFJ, and Societe Generale to fund other relatively more attractive investment opportunities within the global universe.d We also trimmed APA, Capital One Financial, Schlumberger, and Wells Fargo, among other holdings, based on their increased valuations. Despite these trims, the Fund remains overweight Financials (25.0% compared to 13.6% of the MSCI World). Many of the financial services companies we own have low relative valuations and stand to benefit from continued economic growth and higher interest rates. Meanwhile, the Fund’s Energy holdings (6.7% compared to 3.2% of the MSCI World) trade at attractive valuations, generate high free cash flow relative to the market, have committed to returning capital to shareholders, and should benefit from recovering demand for oil as economies reopen.
We recently added significantly to the Fund’s holdings in Health Care based on low relative valuations, attractive business models, and several company-specific opportunities. In the first half of 2021, we added meaningfully to Sanofi and GlaxoSmithKline within the Pharmaceuticals industry and also started a new position in Incyte.
Sanofi
Based in France, Sanofi (SNY, Financial) is a global pharmaceuticals company with leading positions in rare diseases, vaccines, over-the-counter consumer health products, and emerging markets. Over the past decade, the company was beset by a variety of operational issues and low research and development (R&D) productivity, which led Sanofi’s Board of Directors to change its CEO in 2015 and again in 2019.
The current management team—including CEO Paul Hudson who joined from European competitor Novartis and CFO Jean-Baptiste Chasseloup de Chatillon from the auto industry—has made significant changes. The company has shifted R&D funding away from the highly competitive primary care drug market and towards the more lucrative specialty pharma market. Sanofi also launched an aggressive cost-cutting program to raise profit margins closer to peer levels. Recent results are encouraging, with the company achieving 7% earnings per share (EPS) growth in both 2019 and 2020.
Going forward, this pace of earnings growth could continue or even accelerate due to a potent combination of rising revenue and cost cutting. Over the next few years, we believe Dupixent—a blockbuster anti-inflammatory drug with multiple use cases—can also drive substantial growth. Longer term, we are encouraged by an expanding late-stage drug development pipeline with a number of compounds showing signs of initial clinical success. These positive changes do not yet seem to be appreciated by many investors, as evidenced by the company’s below average valuation of 13.4 times forward earnings. On June 30, Sanofi was a 3.5% position in the Fund.
GlaxoSmithKline (Glaxo)
Based in the United Kingdom, Glaxo (GSK, Financial) operates in three fields: pharmaceuticals, where it has a leading HIV franchise; vaccines; and, over-the-counter consumer health. Glaxo’s pharma division is in the midst of a turnaround after having struggled with generic competition for its asthma drug Advair and an unproductive R&D pipeline. Meanwhile, the vaccines and consumer health segments have performed well and have generated healthy profit growth. What makes Glaxo so attractive to us is its compelling valuation. Based on our analysis, we think the current valuation ascribes little to no value to the core pharmaceuticals business.
Like Sanofi, management at Glaxo is actively repositioning the company to enhance its value. A new CEO, Emma Walmsley, was internally promoted in 2017 with the mandate to turn around the company. Hal Barron was brought in as the Chief Scientific Officer and President of R&D. His industry reputation and track record give us confidence he can lead a successful transformation into a specialty-focused pharma company by investing heavily in oncology and immunology. For the pharmaceuticals division, management targets annualized sales growth of at least 5% and annualized operating profit growth of at least 10% from 2021 to 2026. Management plans to spin off the consumer business in 2022 to highlight the value of the individual parts of the company. In addition, recent involvement from activist shareholders may increase the urgency to unlock value in other ways.
We believe Glaxo represents an asymmetric risk-reward opportunity. If the turnaround in the pharmaceuticals division is successful, the investment upside could be meaningful. But even if this does not pan out, the risk of a substantial loss of capital should be mitigated by the modest current valuation, which can be justified by the vaccines, consumer health, and HIV franchises. These types of opportunities are unique in today’s market, which is why we recently added to Glaxo (a 3.5% position on June 30).
Incyte
Incyte (INCY, Financial) is a U.S.-based biopharmaceutical company that discovers, develops, and commercializes proprietary therapeutics, largely focused on oncology. Over the past two years, Incyte has improved its R&D pipeline and launched three new products, which could collectively generate $1 billion in sales annually. We believe Incyte offers an attractive investment opportunity. The company’s reasonable valuation is supported by its main drug, Jakafi, which represents 83% of total revenues. And management continues to reinvest profits from the legacy product portfolio into the R&D pipeline. The team seeks to extend the Jakafi franchise beyond its patent expiry in 2027, and discover the next big drug to transform the company. Finally, Incyte could be an attractive acquisition candidate, given its growth prospects over the next decade, strong Jakafi franchise, and productive R&D organization. In addition, the company’s strong corporate governance and representation of long-term investors on the board align its interests with those of other long-term shareholders like the Fund. Incyte was a 0.6% position in the Fund at quarter end.
In Closing
We are encouraged by the Fund’s performance for the first half of the year. The Fund entered 2021 with overweight positions in some of the most inexpensive and most unloved sectors, namely Financials, Energy, and Materials. That positioning was based on the market’s extreme valuation dispersion and guided by our long-term and bottom-up approach to portfolio construction. Although we had confidence in our research and the Fund’s holdings, we could not be sure whether or when this positioning would be rewarded.
Recent results affirm the importance of our active yet patient approach. While the words "active" and "patient" usually do not go hand-in-hand, they are essential to our investment philosophy. Our active portfolio management strategy has enabled us to capitalize on the wide valuation spreads in the market and position the Fund to look very different from the benchmark. The Fund is poised to benefit from a narrowing of these spreads. Patience and the discipline to stick to our convictions helped drive our recent outperformance, and will characterize our efforts going forward.
With valuations still highly dispersed, we believe that remaining disciplined—by not overpaying for companies and by avoiding value traps—is especially critical today. We will continue to employ our active and patient approach, and we thank you for your continued confidence in our firm. As always, we welcome your comments and questions.
For the Board of Trustees,
Charles F. Pohl, Chairman
Dana M. Emery, President
July 30, 2021
