The AMG Yacktman Fund (Trades, Portfolio) (Class I) returned 1.77% during the third quarter, trailing the S&P 500® Index, which returned 4.48%. For the 12 months ending September 30, 2017, the Fund returned 13.11% while the benchmark returned 18.61%.
It’s Almost All About the Price
Since the end of 2011, the S&P 500 Index doubled in price while reported earnings only increased by approximately 20% through June 30, 2017. Multiple expansion accounted for approximately 80% of the market’s return, resulting in the S&P 500 Index trading at one of its highest multiples of earnings in history.
A high market multiple has typically resulted in increased risk and lower future returns and makes it more difficult to find true bargains. In some periods, like the late 1990s, even though the market was highly priced we found many bargains because value stocks were out of favor, and we remained fairly fully invested even though we thought it would be difficult for the S&P 500 Index to deliver attractive returns due to high valuations. This proved to be correct, and we were able to deliver strong double-digit annual returns over the decade from December 31, 1999, to December 31, 2009, while the S&P 500 Index declined. At other times, like in 2007-08 and again today, we have carried excess cash because it was more difficult to be fully invested and find enough investments that we felt could achieve attractive returns while managing risk.
Our goal remains to provide strong risk-adjusted returns over a full market cycle, and at this point in an expensive market we have focused on managing risk, maintaining our discipline, and would not find it prudent to lower our standards to stretch for returns. We believe there is far too little focus on risk today and many will eventually be disappointed by the results that markets will achieve over the next decade. Regardless of market levels, when we find true bargains, we are willing to build positions big and small. We have strong confidence in the Fund’s portfolio and think that even with excess cash it can deliver attractive risk-adjusted returns over the long term, and are very optimistic that standout bargains like 21st Century Fox (Fox) and Samsung Electronics Preferred (Samsung) can help us generate outperformance versus the market over time.
Contributors included Samsung, Procter & Gamble (P&G) and Cisco Systems (Cisco)
Samsung (XKRX:005930, Financial)’s stock rose solidly in the third quarter as the company produced strong earnings growth in its semiconductor businesses and successfully relaunched the Note phone. It is remarkable that, just one year ago the company was in the middle of a full-blown public relations crisis due to exploding batteries in the Note 7 and many were wondering if Samsung’s brand would be permanently damaged by the bad press.
In the last year, Samsung has transformed due to significant success in its semiconductor businesses. While the stock has appreciated significantly, its earnings have also increased substantially. We expect this year’s earnings will be more than double the profits that Samsung produced just two years ago in 2015. The stock remains inexpensive, selling for about 5X earnings after adjusting for the excess cash that Samsung maintains.
Procter & Gamble’s (PG, Financial) (P&G) stock appreciated solidly during the quarter as a large shareholder sought a position on the board of directors in a proxy battle against the company. We publicly supported the addition of this highly qualified individual, especially because we felt he would bring an owner’s mentality to the Board. It appears at this time that the director candidate we supported will narrowly miss being added to the Board, but we believe the proxy fight has placed P&G under significant pressure to perform or transform.
Cisco Systems (CSCO, Financial) shares appreciated in the quarter along with strength in the information technology sector. The company continues to migrate its business from larger one-time sales toward subscription services, which makes the company significantly more stable and predictable. Over time, we think the shares will be awarded a significantly higher valuation as others recognize the company’s transformation to increased recurring fees, something we have already seen in Microsoft and Oracle.
Detractors included Fox, PepsiCo (Pepsi) and Avon Products (Avon)
Fox (FOX, Financial)’s shares declined in the third quarter due to general weakness in media shares. Traditional media companies continue to battle against the headwinds of change as customers abandon the traditional cable or satellite television bundle in favor of watching television content over the internet via Netflix, Amazon, Hulu and others. We think these concerns are causing many to neglect some incredibly valuable international assets at Fox that are not part of the high-cost U.S. television bundle and do not get impacted by U.S. consumers canceling cable subscriptions. We think investors will quickly revalue Fox’s shares meaningfully higher if the business results show solid momentum, similar to what we saw with Samsung.
PepsiCo (PEP, Financial)’s (Pepsi) stock sold off modestly during the quarter as packaged food company shares were generally under pressure. We think Pepsi, with its strong Frito Lay business, probably has the best positioning of any large packaged food company in the world, and are confident in the stock’s prospects going forward.
Our small position in Avon (AVP, Financial) detracted from results during the third quarter. Avon continues to struggle with declines in its business as well as concerns about its level of debt. Over the next few quarters, there will be a new CEO, which we think might help stabilize the business. Due to Avon’s challenges, its shares trade at a significant discount to its peers.
Conclusion
We are pleased with the strong absolute returns we have delivered for the first three quarters of 2017. We continue to work hard to find new investment opportunities for the Fund, and in the last several months have added two new small positions. As always, we will continue to be diligent, disciplined and patient while managing the Fund with a focus on risk-adjusted returns over a full market cycle.
The views expressed represent the opinions of the Yacktman Asset Management L.P., as of September 30, 2017, are not intended as a forecast or guarantee of future results, and are subject to change without notice.
