TO OUR SHAREHOLDERS
The Dodge & Cox Stock Fund had a total return of 1.0% for the six months ended June 30, 2018, compared to a return of 2.6% for the S&P 500 Index.
MARKET COMMENTARY
During the first half of 2018, U.S. growth stocks (the higher valuation portion of the equity market) outperformed value stocks (the lower valuation portion) by nine percentage points,a continuing a long-term trend. Since the end of 2014, growth has bested value by 32 percentage points;b growth-oriented companies in sectors and industries associated with technology—most notably the “FAANG” stocks (Facebook, Amazon, Apple, Netflix, Google)—have led markets.
Dodge & Cox’s approach is value oriented, and the Fund has performed well compared to the U.S. value investment universe—outperforming the Russell 1000 Value Index by 12 percentage points over the past three and a half years. However, the broad-based S&P 500, which was boosted by growth stocks, outperformed the Fund by four percentage points over this same period.c
INVESTMENT STRATEGY
We understand that there are periods when value is trumped by growth. However, we believe the current divergence may narrow. In the United States, the valuation differential between growth and value stocks is wider than usual, with growth stocks trading at historically large premiums. Returns of value-focused strategies have been influenced by valuation spreads, and we believe current conditions are favorable for value stocks to rebound. While investors may not immediately recognize the intrinsic value of companies in relation to sales, cash flows, earnings, or book value, market prices over time tend to be driven by long-term fundamentals.
In the first six months of 2018, we made gradual portfolio adjustments in response to diverging valuations. For example, we sold selected technology and retail holdings that had performed strongly, such as Walmart.d In recent years, Walmart—the largest retailer in the world—has faced additional competition from large online retailers, such as Amazon. In 2015, Walmart announced a transformation plan that focused on increasing investment in labor, technology, and sales growth; the company successfully executed on these initiatives and improved its same store sales. In addition, Walmart restructured and expanded its ecommerce division by entering into a partnership with JD.com (China’s largest retailer), purchasing Jet.com, and naming Jet founder Marc Lore as head of Walmart’s ecommerce. Under Lore’s leadership, U.S. online sales growth year over year increased from 29% at the end of fiscal 2016 to at least 50% in each of the first three quarters of fiscal 2017.
On the heels of these positive developments, Walmart’s share price performed strongly, and we sold the position in early 2018. We continue to find selected opportunities in industries such as Media and Banks.
Media
Within Consumer Discretionary, Media is an important overweight position: 11%e of the Fund compared to 2% of the S&P 500 on June 30 . The media landscape is evolving due to new direct- to-consumer entrants, changes in consumer viewing and listening habits, shifting revenue streams, and industry consolidation. Uncertainty surrounding pending merger and acquisition (M&A) transactions and potential regulatory incursions (e.g., unbundling, forced wholesale access, price regulation on broadband) pose risks to the Fund’s media investments. Nevertheless, we recently added to Comcast, Time Warner (before it was acquired by AT&T), and Charter Communications after weighing each company’s long-term fundamentals against its attractive valuation.
Comcast
Comcast (CMCST, Financial)—the largest U.S. cable provider—has been held in the Fund since 2002; over the years, we have actively added to and trimmed from the position based on relative valuation. In the first half of 2018, Comcast’s share price declined 17% amid concerns about its $31 billion cash offer to acquire UK-based pay-television company Sky PLC and its $65 billion all-cash bid for a majority of Twenty-First Century Fox’s assets.
Given these developments, our equity and fixed income teams worked together to evaluate Comcast’s risk/return profiles for a range of potential M&A outcomes. We spoke with company management about their overall M&A strategy and reconfirmed our longstanding view that they are skilled at allocating capital to create shareholder value. We believe the Sky acquisition is strategically sound because it would expand Comcast’s international presence and provide greater scale to amortize content costs. In July, Comcast dropped its bid for Fox and continued its pursuit of Sky.
In our opinion, the market has overly penalized Comcast’s share price as a result of concerns about bidding wars and subscriber growth. Trading at a multi -decade low valuation versus the S&P 500, Comcast was our largest addition in the Media industry during the first six months of 2018. The company has a de- facto local monopoly on broadband internet services in many parts of the United States and, despite talk of “cord cutting,” has the potential to grow through increased broadband penetration and pricing power in residential and business services. We believe NBC Universal (owned by Comcast) can increase its operating profit through affiliate fee increases at NBC and continued investment in its theme parks. In addition, owner- operator Brian Roberts has created significant shareholder value and leads a strong management team. Comcast, the Fund’s second-largest holding, was a 3.8% position on June 30.
Wells Fargo
During the first half of 2018, we opportunistically added to Wells Fargo (WFC, Financial) (down 7%), which was weak among bank stocks and detracted from performance. In February, Wells Fargo entered into a consent agreement with the Federal Reserve (Fed) that, among other things, placed restrictions on the bank’s asset growth (capped at $1.952 trillion). This regulatory agreement stemmed from Wells Fargo’s previously disclosed improper sales practices.
Since 2016, Wells Fargo has made substantial progress improving its governance, compliance controls, and operational risk management. Notably, the leadership and composition of the company’s board has improved, including the election of six new independent directors in 2017. Management has affirmed its commitment to have third parties conduct an initial risk management review by the end of 2018. The company has settled with regulators regarding its auto insurance and mortgage sales practices and has also resolved class-action lawsuits with shareholders and consumers. Furthermore, Wells Fargo passed the Fed’s annual industry stress test in June and received approval to use $32.9 billion for dividends and share buybacks over the next 12 months, representing a significant return of capital to shareholders.
After a comprehensive review, we believe Wells Fargo’s superior franchise, deep management team, track record of generating higher returns than other banks, and attractive valuation at 1.5 times book value make it a compelling long-term investment opportunity. On June 30, Wells Fargo was the Fund’s largest holding (a 3.9% position).
IN CLOSING
Despite concerns about tariffs and trade wars, we remain optimistic about the long -term outlook for the U.S. economy and the portfolio, which trades at a discount to the overall market (13.9 times forward earnings compared to 17.1 times for the S&P 500).
As a result of individual security selection, the Fund remains tilted toward more economically sensitive companies: as of June 30, Financials comprised 26% of the portfolio, Information Technology accounted for 16%, Consumer Discretionary was 15%, and Energy represented 9%. We believe the Fund is well positioned based on our view that longer-term global economic growth will be better than many investors expect, interest rates will continue to rise, and the outlook for corporate earnings remains attractive.
Patience, persistence, and a long-term investment horizon are essential to our investment approach. We encourage our shareholders to take a similar view. 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, Dana M. Emery,
Chairman President
August 1, 2018
- The Russell 1000 Growth Index had a total return of 7.3% compared to –1.7% for the Russell 1000 Value Index during the first six months of 2018.
- The Russell 1000 Growth Index had a cumulative total return of 58.0% compared to 26.1% for the Russell 1000 Value Index from December 31, 2014 through June 30, 2018.
- The Dodge & Cox Stock Fund had a cumulative total return of 38.4% compared to 26.1% for the Russell 1000 Value Index and 42.0% for the S&P 500 from December 31, 2014 through June 30, 2018.
- The use of specific examples does not imply that they are more or less attractive investments than the portfolio’s other holdings.
- Unless otherwise specified, all weightings and characteristics are as of June 30, 2018.
