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Holly LaFon
Holly LaFon
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Transcript of Joel Tillinghast Podcast Interview

Peter Lynch mentee and head of $40 billion low-priced fund shares his wisdom

Holly: Hi, welcome to the GuruFocus podcast. This is Holly. I’m the editor of GuruFocus, and I’m here with Charlie Tian, he joined us for this Skype Interview, and Charlie is the CEO of GuruFocus. And we’re also very fortunate to have Joel Tillinghast today. He is the manager of the Fidelity Low-Priced Stock Fund. That fund has almost 40 billion in assets under management. It is a mid-cap value fund, and it has almost 1,000 stocks in it. And Joel is just one of the top managers in the field today, he’s soundly beaten the S&P, and since inception, and I think he’s rocking it again this year. So Joel, hi. Welcome.

Joel: Hey.

Charlie: Hi.

Holly: Hey, great. Yes. Great. Let me just pull up my questions here. Okay. Well, first of all, we wanted to get to know how you do idea generation. Where do you come up with all of these stock ideas?

Joel: I couldn’t do my job without Fidelity’s huge research department with something like 130 research analysts and our dedicated small-cap team and international small-cap team, in particular. I do lots of research myself, but I really couldn’t do it without the Fidelity analyst core.

Holly: I see, and you have seven other managers with you?

Joel: Yes. Seven other part managers who manage about 6% of the fund, and I manage the other 94% of it, and they also provide research and stock ideas, but the small-cap analyst team, domestic and international, is really the source of the largest number of ideas.

Holly: Wow, must be a lot of brainpower going on there. I also wanted to mention that you have a book that just came out, and we read it. It’s called Big Money Thinks Small, and that’s where the source of a lot of our questions, but we didn’t get a big take on how you got started in investing, so do you want to rewind a little bit and just let us know what happened there? I believe that Peter Lynch was involved.

Joel: Yeah. I joined Peter, joined Fidelity. I was working in a job as a research economist and wasn’t enjoying the job well enough, and felt like I wasn’t working with really outstanding people, and I wanted to work with outstanding people. So I had a very short list of people I wanted to work with, and I called up Peter Lynch, and to my amazement got put through. And didn’t know about his 60 second drill where he’ll listen to any investment proposition for 60 seconds, and he’ll shut you down if he doesn’t like it. But we went on for more than a minute, and eventually, I got the job, and I’m so glad because Peter is a great mentor and teacher.

Holly: So when you were-- I believe you majored in economics. Was managing a fund your goal? Was there something that you loved about investing that you got you into it?

Joel: Yeah. I had been investing since I was about 10 years old. My grandmother and parents had these value line investment surveys around the house because my grandfather had passed away kind of young. And they followed the Peter Lynch idea of know what you own, they were doing research on the odd lots of stock that they had inherited, and I liked to read whatever my parents were reading. And so my first two stocks were Central Maine Power because I noticed that the electric bills kept on coming, and thought that would be a good steady stock, and it was, it just didn’t go up very much. And the other was Beckman Instruments. My father was a biologist, and Beckman made lab instruments that really saved a lot of time and made tests that had otherwise been impossible possible. And so Beckman was a great growth company, and I bought two shares.

Charlie: During the process-- this is Charlie, who do you think influenced you the most? [inaudible]

Joel: I think I implicitly got influenced by The Value Line Investment Survey because that was my first exposure. And what is The Value Line? It’s a multiple of the earnings. They take, say, 15 times earnings and plot the earnings historically times 15 or some other multiple and say that’s what the bear value of the stock is, and that idea sort of stuck with me. Peter Lynch put sort of a different spin on it. Working with Peter Lynch had a great influence on my thought process. I read huge numbers of books, including some that were more background. Anyone Can Make a Million by Dr. Morton Shulman was probably one of the first, but I would say The Value Line where I went to work right after college and Peter Lynch are probably the biggest two [facts?].

Holly: Interesting. And in your book, you talk about the four main things that you look for in a business, and one of them that I thought was interesting is a distinctive character. So you look for a company that offers something that nobody else is really offering, or that’s just in a very special way. And I think you talk about Geico, specifically, and a few other companies. So what kind of character do you look for in companies right now?

Joel: I just look for companies that are willing to do something different. Apple’s Think Different slogan appeals to me because, in retrospect, it was saying they would be willing to do something that other people weren’t offering. A different--

Holly: Are there any right now? Oh, I’m sorry to interrupt, go ahead.

Joel: Yeah. The idea is you don’t want pure commodities. If they all look the same, then the margins won’t be very high, and so if you look at them and have forgotten, like, what’s unique about this company? That’s telling you something. That’s telling you it’s probably a commodity and you don’t-- it’s okay if they’re a little quirky or odd or different because that is probably what they’re offering to consumers, something different than what’s out there.

Charlie: I have a question related to this character. You mentioned in the book that you said consumer brand companies enjoy comparative mold and high margin in general. But companies like Procter & Gamble, Nestle, their product, does it sound like a commodity you’re talking about, instead of something different?

Joel: I think that they did have a stronger [moat?] 20 years ago than they have today and that they look more like commodities. Yeah. I think consumer preferences change, so nothing is forever, and part of the character-- what you want is a learning company, a company that’s willing to change with the times. And so although I think Walmart (NYSE:WMT) has become old and sedate, under Sam Walton it was a great learning company. He stole all the great ideas of other retailers and applied them to Walmart. And optimistically, their purchase of Jet is an attempt to learn about e-commerce. Pessimistically, they’re too big and too successful to keep learning and growing. But you want companies that can adapt, and I think that’s kind of the problem with some of the consumer branded companies, how do you make soup exciting to the next generation? It’s hard. How do you make highly processed foods exciting? Well, maybe you have to take the additives out of it. But food preferences change more slowly than electronics, where I have an iPhone 6 and Apple is already trying to make that obsolete.

Holly: Right. I feel like Nestle (NSRGY) has a big problem with that because I’ve been reading with Daniel Loeb (Trades, Portfolio) and his advice on that company and just how their products have been selling. They have so many billion dollar products, but millennials don’t want to eat them anymore because of sugar and just how hard it is for them to re-steer that enormous ship.

Joel: Yeah. Or Coca-Cola (NYSE:KO) is a prime example. As a child in a nutrition-conscious and thrifty household, I probably had Coca-Cola twice a month, and it was always a treat, and all my associations were good, I mean, how could you not like a little bit of sugar, some bubbly water, some caffeine? All happy associations. But now that people have three Coca-Colas a day, the nutritional aspects have-- sugar isn’t so good for you, the caffeine, maybe not so hot either. And so I think the millennials have a different take on it.

Holly: Right. Do you see a lot of good future for those companies? How would you rate them, how they’re doing, changing like that? Or are they companies you would just kind of steer clear of?

Joel: It’s on a case by case basis. Pepsi (NYSE:PEP) was trying to offer healthier beverages, and it didn’t quite work, but--

Holly: Right, but with Coke, it was-- that kind of ties into your other point about looking for longevity in a company.

Joel: Yeah, but it’s going to-- if it does go away, it’ll go away slowly. Cigarette consumption has been going down since surgeon general’s warning more than 50 years ago, and the stocks have outperformed, but unit consumption has gone down. In every wealthy country in the world, people are smoking less, and from a public health standpoint, that’s a good thing, we’d guess.

Holly: So whenever you’re looking at a company that has-- looking for longevity, that’s going to go for the long haul, what factors are you looking for to make those decisions?

Joel: You’re looking for habits that can’t be quickly changed. People are habituated to tobacco and in a gentler sense, habituated to caffeinated beverages, and they don’t change those habits quickly, and that’s what you want. What you don’t want is something where-- if I’m sick of Twitter, I shut it off--

Holly: Good idea sometimes. [laughing]

Joel: --but if I don’t like Facebook (NASDAQ:FB), it’s harder to shut it off because you have a list of people who are sharing their baby pictures and cat videos. So even if you think, Gee, this is not very productive, and I’d like to spend more time with the dozen people who really matter to me than the 200 people who matter a little less, it’s hard to kick that.

Holly: Well, one company that you have, that the longevity has been in question, is Best Buy. So how would you think about it there?

Joel: What matters completely for them is whether they have a learning culture and are adapting well to the changes, and I’d say relatively, they have adapted well. The consumer wants to be served both online and in stores, and so in stores, they’ve put in things that need to be in stores. If I am buying an appliance, I want to see whether the avocado finish or the steel finish really looks as good as I think it does, I want to see whether it will fit into a city apartment that has very specific dimensions. You want to see whether the loading and unloading is uncomfortably high or low, and so there is a reason why you would want to see the appliance in a store. There’s not a reason why you need to see a Tom Petty CD in the store, you can say, I know I want to buy it, you can mail it to me. And so they’ve taken shelf space out of categories like recorded music and moved that more online. So I think they do have a learning culture, but the future will tell. I mean, Amazon is a formidable competitor, and they are relentless. The ones that I would really count out are slow learners or non-learners.

Holly: I see. Those that aren’t adapting well to the new situation with Amazon and whatnot. Great, I’m trying to pull up a different question here. Okay. Sorry. I wanted to get back into how you’re sourcing your ideas. And for the average investor, it’s hard because you have such a, I mean in your book, you have a prodigious amount of knowledge on, it seems like, every one of your stocks. And I know you have a research team that you’re looking at reports, earning calls, everything. So for fundamental analysts, and they’re looking at all of the same information that you have on these companies, what can they look at to give them an edge? Is there some way that they can get around the consensus view everyone is going to compile by having the same information?

Joel: Okay. The second section of the book is about knowing what you own and, say, it’s about staying away from places where you probably don’t have an edge, and so one area where you probably don’t have an edge unless you specialize it is very complicated derivative securities. You probably don’t know how to use a triple-levered VIX. Unless you are in the industry, you have no idea what a triple-levered VIX is all about. So don’t do it.

Holly: Good advice.

Joel: There are industries that are easier to understand. And one of the attractions of consumer products is that, as a consumer, you probably know what the basis of comparison is and can say, You know, the experience at Best Buy (NYSE:BBY) is nothing special, or it’s good, depending on your own experience. You’re capable of making that. But in biotech products, unless you’re a doctor, you have no way of judging, will phase one data turn into phase two, will that get past to phase three, will this turn into a large product? That takes so much specialized knowledge, I’m not very good at that, and so that’s something to stay away from. Or economics, people get too big picture and step in to take the bets that they really have no edge in.

Charlie: If we ever want to invest in consumer branded companies, how can we get an edge? Because the product seems to be easy to understand and the company business model seems to be simple. How can an investor get the edge there?

Joel: They can spot products that are different and better than competitors are offering. I sort of lucked into the Monster Energy Drink, this was something that was different and wasn’t being offered at the time, but it’s also a spectrum. So a lot of industrial companies are closer to being understandable, and parts of technology you may be able to understand because of your own experience, but if you’re investing in an artificial intelligence startup, unless you’ve got a Caltech Ph.D., you have no way of evaluating this. And so there’s a spectrum of understandability, and stay close to your sweet spots, or don’t go into places you don’t understand. If you don’t understand it, you won’t know whether it’s a good company, and I have no way of telling you whether an artificial intelligence or cloud computing company is a good company. Or a biotech company. That’s the limits of my knowledge. Insurance, there are parts of it that are extremely difficult to understand, and maybe you should stay away from them. But there are a lot of industries that, yeah, with a little bit of study, you can do it. It’s a spectrum. It’s not like put it all into consumer non-durables because they’re relatively the most understandable. It’s not stay away completely from biotech because there are understandable multi-product biotech companies that have a number of successful products on the market already, and there the dynamics are somewhat more understandable.

Holly: Okay. Charlie, sorry. Did you have anything to add to that?

Charlie: Yeah. We want to talk about the insurance companies you discussed a lot in your book, UnitedHealth Group (NYSE:UNH), also your largest holding, and Aetna (NYSE:AET). Can you say something about it, discuss those companies because evaluations, of course, now are quite different from the time when you wrote the book.

Holly: And I think UnitedHealth Group, wasn’t that also your best performing position this quarter?

Joel: Yeah. It was a pretty good performer this quarter. Yeah. I have to look at the attribution because I don’t quite focus on it except when I have to, but yeah. It’s been good. So market multiples have expanded a lot and the period that Obama would go directly to a straight, single-payer system have receded. And some of their bets on the newer services have played out, you have to value growth more explicitly when you-- at today’s price, to justify holding the stock, but there are a lot of stocks where you have to build in a certain level of growth to justify today’s stock prices. I’d say that’s true for the S&P Index generally. If we have no growth for periods, it’s hard to get to the stock price. But the history of America is that there has been growth.

Holly: So right now in the stock market, obviously it’s very high, more than 30 times earnings, and you said-- I think it’s close to that. But I think you said that the last time a highly visible group of stocks is traded at more than 30 times earnings, it has ended in tears. Do you think we’re in one of those times now? And if so, what should investors do?

Joel: The highly visible group of stocks are amazing growth companies like Amazon (AMZN) and Facebook and Tesla (NASDAQ:TSLA). I don’t hold them because I don’t know how to imagine their future, not because they’re necessarily overvalued. Amazon has come so far from being the best source for low-priced books with the most comprehensive catalog. Now it’s more like Sears Roebuck, it used to be the everything store. Now Amazon is the everything store. And Amazon web services, it’s an engine of growth, but it’s hard to say what the future is. Generally, I think it’s broad, but you have to believe that there will be half a trillion dollars worth of cash flows that will be distributed to Amazon shareholders from here to eternity, and that’s a bet that I don’t know how to begin to estimate.

Charlie: That’s why you don’t own those companies.

Joel: Yeah. So it’s why I don’t own it. It’s more because it’s out of my circle of confidence and not because they’re necessarily overvalued. It’s frustrating for value investors that some of the most exciting stories are in companies that are not in my circle of confidence.

Charlie: Is that the reason that lots of value investors are under-performing these days in your opinion?

Joel: Yeah. If you’re not participating in the relentless rally in Facebook, Amazon, Tesla, Google, Apple, then it’s kind of hard. To the extent that they’re big parts of the Index, people who don’t participate are going to underperform.

Holly: Are you having trouble finding those low priced stocks right now? You seem to find quite a few. What would make you different from somebody-- because we talk to a lot of value investors who have the big complaint that it is very difficult to find those low price stocks, so how are you doing it?

Joel: The biggest source of current buy ideas is in small-cap Japan, and their [inaudible] depends on some fantastic fidelity analysts in our Tokyo office. But if you’re sticking strictly to American small-caps, it’s really tough because-- I hosted the meeting for America Online, which was a big deal in the ‘90s, and I met Michael Dell (Trades, Portfolio) of Dell Computing when it was a small-cap company. And today, the small-cap companies, the venture start ups are not coming public until they’re very big. And as a public market participant, I think it’s a bad thing that unicorns are waiting until they’re very big companies to come to the public market.

Holly: I see. Sorry, Charlie, go ahead.

Charlie: Yeah. You mentioned about the cash flow streams, Amazon, [inaudible] trading, is that discount to cash flow-- is that the [inaudible] you use for company evaluation?

Joel: Yeah. It’s saying if the market cap of Amazon is half a trillion dollars, then sometime between here and eternity, you will have to get half a trillion dollars worth of cash flows that would get returned to shareholders somehow. And that’s a pretty demanding forecast. [crosstalk] Strictly speaking you should present value those cash flows so it would be more than half a trillion dollars worth of cash flow that has to come back to shareholders.

Charlie: Yeah. That’s actually related to one of our user’s questions. How do you develop the discount factor when you talk about the cash flow, future cash flows?

Joel: Yes. In practice, I use a heuristic. I sort of say, 8% is a premium above the bond rate, and it offers enough of an equity risk premium, but I don’t do well with discounting Blue Sky possible but not probable cash flows. I think paying attention to whether the cash flows will materialize is more important than getting the discount rate right, although obviously using a 7% discount rate rather than an 8% discount rate will increase the value of your present value by 14% or whatever.

Charlie: Yeah. That makes lots of sense. That’s actually is related to another-- related to the longevity you’re talking about before, actually.

Joel: Yeah. Will you really get those cash flows? I think some people were disappointed that I wasn’t more mathematical, although other people were disappointed that I was too technical, but focusing on whether you really will get those cash flows is so much more important, the longevity and believability of those cash flows.

Charlie: That makes lots of sense. Can you talk about why you hold so many stocks in your portfolio? You have about 1,000 stocks in your Low-Priced Fund these days. Why do you hold so many? Even from a diversification point of view, it sounds like a lot.

Joel: Yeah. A lot of them are foreign. A lot of them are for information purposes, in that if I don’t own a stock, a Fidelity analyst will say, “Well, I don’t really have to call this company because we don’t own it.” So it’s a way of encouraging more research in trying to open up the information. Companies are more willing to talk with me if I--

Charlie: I see. That’s interesting.

Joel: But it’s also a way of cross-checking, where you discover that-- China has shut down a bunch of steel mills that are polluting and small, and this has tilted steel production or has reduced exports of steel at low prices and has encouraged a revival in the mini-mill industry. But this has knocked onto graphite electrodes, where there’s a company, Graphite India, that has had an immense stock rally because of the tightness in the graphite electrode industry. Some of it is for finding out about supply chain, so our small-cap Japan office has been keeping me up on a company that makes products that are used in automotive batteries for electric cars, and so I can’t buy Tesla, but I can buy this company that feeds into the supply chain. And so that’s a helpful thing, to be able to go up and down the supply chain and find growth opportunities that have not been pushed as much as others. It’s for information.

Holly: We had a great reader question. He wanted to know if you managed just one million dollars, not billions, would you still own so many stocks? And also, if you’re so good at picking winners, would you ever consider doing a concentrated portfolio? Or are you just against that in general?

Joel: If I had a million dollars, I would very much have a much more concentrated portfolio.

Holly: I think he’s probably wondering what to do with his own money, probably, or with his own smaller portfolio.

Charlie: How concentrated would that be? 100 stocks? Or 10 stocks? Compared to 1,000 stocks?

Charles: We can’t make a recommendation for an individual’s portfolio, but Joel can probably talk about, broadly speaking, that the cost of trading and things like that that you have to take into consideration.

Joel: Yeah. You should have as many stocks as you have, for that amount of money, a high conviction in, and you should probably set the bar high. For diversification purposes, you probably don’t need more than five stocks in a million dollar portfolio, but it should match your conviction. If you have low conviction, you shouldn’t own it in that kind of a fund. But then if I have low conviction-- usually I see some element that I think could be really good in all 1,000 stocks, and if it turns low conviction, it gets kicked out.

Charles: Hey, Holly and Charlie, I don’t know if you knew this about Joel, but I would say that he has a near eidetic memory, which means that he can recall just about any one of the holdings in the stock and knows it pretty well, at least at a memorable level. He does rely on the analysts for the minutiae, but it’s not like he doesn’t know any of these companies and what they do.

Holly: Oh. Of course.

Charles: So out of the 963, he has recall on all of them, which is pretty amazing because I could never do that.

Charlie: That’s just amazing. I can’t even do it for 20 stocks.

Holly: Right. No, I did read that.

Joel: Yeah, but I think concentration is a great idea if you’re managing a small amount of money, and don’t have unpredictable fund flows, and do have high conviction. You should go with that.

Holly: Right. Okay, and we did-- we had one last question. Another reader was wondering what to do, if we are about to have a bear market, what would be the strategy you would suggest? Do you think you should keep holding in a downturn? Sell everything? Or just wait for the bull market to come back? And I know that you can’t give specific directions, but what are you thinking about there?

Joel: I’m thinking that this is a really tough call to say. You know that valuations are high today, you know that future returns are going to be low. Find the stocks where you have the highest visibility and which you understand the best, combined with the best returns that are available. If you look at those prospective returns and think, God, this is really not so good, then I guess cash is the answer. But I would mostly start by concentrating portfolio in stocks you understand, stocks with good management, companies that are doing something special, resilient companies that have good balance sheets, proprietary products that are priced to give a good return. I wouldn’t start with the big picture, prepare for doom, I don’t think that’s within any investor’s power to figure that out. That was the whole point of thinking small is you don’t know that-- you do know that future returns will not be as good as past returns. But you don’t know a bear market will hit on October 28th and will cause the Dow to drop 18,000 points in a day, you don’t know that.

Charlie: Okay. I have one last question. Can you speak at our GuruFocus conference next year? We would love to have you speak there, we had Donald Yacktman (Trades, Portfolio), Jean-Marie Eveillard spoke for us, and would you please consider speaking at our conference next year in Omaha?

Joel: Yeah. I would consider that.

Charlie: Thank you very much.

Holly: Great. Yeah. We’d love to have you. This has been fascinating. Okay, great. Well, we’re done here, so I just wanted to tell you that we really appreciate you, again, coming on to speak. Again, for anyone listening, this was Joel Tillinghast. He is the head of the Fidelity Low-Priced Stock Fund, a fund that has more than 900 stocks in it, and almost 40 billion in assets under management, that has been beating the S&P 500, and its Russell benchmark, as well. So we’ve been thrilled to talk to you. Thank you very much, Joel. [crosstalk] Thank you. Okay. Have a great day. Okay. Bye-bye.

Listen to the podcast HERE.

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