David Rolfe (Trades, Portfolio) is the chief investment officer of the $4 billion investment firm Wedgewood Partners and a past speaker at the GuruFocus Value Conference. Since inception in 1992, Wedgewood Partners has delivered an 11.40% annualized return compared to the 9.67% return in the S&P 500 index. Recently, Rolfe took questions from GuruFocus readers. His answers to those questions are below.
Question: How do you determine intrinsic value? If you use a DCF model, how do you deal with uncertainty? Do you use different discount rates for different businesses?
David Rolfe (Trades, Portfolio): See http://aswathdamodaran.blogspot.com.
Question: I was wondering if you had any tips in particular for picking value/growth stocks in the health sector, especially pointers on: how to cut through the extra media hype in the sector at the moment, how to read the financials of younger companies when they likely have significant losses and a short history, and ways to find out what the specific technologies/drugs, etc., are that they are pursuing?
Rolfe: The health care sector is wide open, so one shoe doesn’t fit many companies. HMOs possess unique stability of revenues, little pricing risk. Big pharma has easier attributes of existing patent protection, but some pricing risk under Trump/Dems. Biotech is much bigger risk/reward, event driven, and medical device stocks are often very volatile around earnings announcements. You can find plenty of wide moats, growth and outsized profitability. Cutting through the hype? There are more informative blogs in this sector than ever before. If you look hard enough you will find four to five that are more than worthy of your analytical time. Most are not free anymore. You get what you pay for. Younger companies? Uncle. I’m not that smart. No Ph.D. No MD. Such companies go into our “Too Hard” file. “Value” in the 10th year of a historic bull market that is hooked on too many years of QE-zero interest rates? Good luck, and Godspeed.
Question: You may have heard the news about David Einhorn (Trades, Portfolio) or Jeremy Grantham (Trades, Portfolio) questioning whether value investing is still a "viable strategy" given the overvaluation present in today's markets and the fact that growth stocks have finally been outperforming value stocks. My question is, do you think the value investing approach has "died," is currently out of favor or has just gotten a heck of a lot harder?
Rolfe: See last two sentences in question No. 2 reply. “Value” never dies. Never. Price is what you pay, value is what you get. Harder? You are spot-on, a heck of a lot harder! Note too the underperformance of value-heavy benchmarks has been lead-weighted with banks during spread-thin quantitative easing (QE) over the past 10 years, while growth-heavy benchmarks, up until this past September, have enjoyed the elixir of no-price-is-too-much to pay for either revenue growth or earnings growth.
Question: What are your thoughts about the retail sector? I was a little surprised you closed your position in TJX Companies Inc. (TJX, Financial). Has anything changed about your views in retail?
Rolfe: We sold our position in TJX to concentrate on Ross Stores (ROST, Financial). Both are extraordinary businesses. The off-price retail channel, in our humble opinion, is the most retail-centric sector that is the most insulated from Amazon (AMZN, Financial)’s apparel buzzsaw. Space does not allow a full discussion of the competitive advantages of the off-price channel, but do study each company’s history of buying inventory for dimes-on-the-dollar, their incredibly efficient inventory management and rapid inventory turns, their unique “treasure hunt” loyal customers, their outsized profitability relative to any other retailer (apparel or not) and the off-price channel’s most-rare ability to generate margin in literally any consumer economic environment boom or recession.
Question: When looking for potential investments, what types of metrics are most important to you during the initial screening phase?
Rolfe: We want to own terrific business for years – hopefully many years. Look for sustainable competitive advantages. Moats. High return of cash flow as a percent of invested capital. Profitability machines. Then assess if such competitive advantages can be sustainable for the foreseeable future. Look of course for skin-in-the-game, competent managements. If you are wrong, better businesses typically don’t crash as bad as bad businesses (assuming you didn’t pay a ransom valuation for the stock).
Question: If you were currently sitting on 50% cash in your portfolio, would you be looking to invest it all in the near term, dollar cost average it into the market over the course of the next couple of years, or sit on it in the near term and hope for equities to get cheaper?
Rolfe: The sharp correction since September has presented a terrific opportunity to start. Beyond that, dollar cost average.
Question: How does your investing approach change in a rising interest rate environment? Or will it not change at all?
Rolfe: Probably not much at all. We focus on great businesses and we only own 20 stocks. We try to think and act like successful business owners that truly take a multi-year approach in our thinking, portfolio management and the all-important temperament. We are not macro investors. If we were right on a macro call of a sustainable rising interest rate environment, it would be pure luck. We ain’t that clever! (Godfather I).
Question: A question regarding Buffett buying back stock at 1.2x book value. In the fourth quarter of 2017, due to the new tax laws, Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial)'s book value was marked up by many billions of dollars. As such, a buyback at 1.2x the "new higher book value" would seem like less of a deal.
Rolfe: Buffett just significantly changed his buyback approach. See his press release. Very good news, in our opinion. Buffett has been elephant safari hunting for years now. He finally found an elephant that he knows and understands better than anyone in the Omaha Zoo – his own company!
Question: What are your thoughts about all the mergers these days? As larger conglomerates are formed out of these vertical re-alignments, what does it mean for those companies that are left behind? How will these unions change the way normal people live and operate? Do you see any trends?
Rolfe: Great question. Space constraint does not allow for a cogent answer. I’ll give it a Cliff’s Notes try. We are living in transformational economic times. But you could have made the same prescient statement/forecast in 1908, 1918, 1928, 1938, 1948, 1958, 1968, 1978, 1988, 1998, 2008 and 2018. The transformational speed today is epic – as it was in decades past. Civilizations don’t know the new transformational speed limit because they never posted on the sign posts of our daily lives. One gets a clearer sense of the speed only when it personally affects their livelihood – or 401K. The “pipes” of the internet were laid during the crazy dot-com spending in the late 1999s-early 2000s. The pipes today have become wicked fast and fat. Mobile speeds are astonishing. Everyone today carries a Mensa-smart cell phone that is part and parcel a cinema, a movie library, every TV and cable channel, an instantaneous global news organization, a mall, a bank, a financial planner, a social party, home movies, their business, the ability to transact international business in a nano-second, indeed their life and livelihood in their respective back pocket or purse. Business models that are exempt from internet disruption are few and far between. Even the stasis of local, state and federal governments are not immune. You are spot-on. Mergers that render smaller companies impotent occur every week. How do normal people live? My word, I can’t even endeavor to answer that existential question. Any investor that has recognized the trend started years ago that a handful of now mega-sized tech companies that have been able to scale to enormity without the concomitant necessity of enormous capital are, by far, the richest neighbor in your neighborhood. That trend, in my view, may be hard to break any time soon.
Question: Among all the value investors, you are unique in my view because Wedgewood's heavy exposure in two areas that Buffett has long avoided – technology and health care. Can you share how did you overcome the hurdles that many value investors have when it comes to tech and health care stocks, such as circle of competency and rapid pace of change? Do you have a different holding period for tech and health care stocks than consumer and financial stocks?
Rolfe: First off, throw away some labels of stocks. Throw away preconceived hurdles. The “value” crowd needs to stop labeling stocks, particularly “tech.” Tech is not a monolith. Mr. Buffett has made it too easy for too many value folks to say, in part, “If Buffett refuses to invest in tech stocks because he can’t understand or predict what tech companies might look like a decade from now, then who am I to even try?” That’s a crutch. In fact, if I may be so bold to posit, even Buffett and Munger have “evolved.” (And I say that in all due respect. We have been shareholders in BRK.B for almost 20 years here at Wedgewood Partners.) The “investment industry” places “tech” as a monolith in too many benchmark indices, ETFs, manager descriptions, and on and on. “Tech” evolves into the mainstream. The Ford Motor Company (F, Financial) is a “tech” company. An automobile (a horseless carriage) used advance technology to improve the transportation over a horse and buggy. Henry Ford used advanced assembly line technology to bring horseless carriages to the masses. Apple (AAPL, Financial) was once a tech hardware and tech software company. Beginning with the iPod and then with the ubiquity of the iPhone they have morphed into a “consumer discretionary” company, then into a “consumer non-discretionary” company, then into a “consumer staple” company. Today, as most smartphone users contemplate and budget for their monthly smartphone expenses, as they do their monthly mortgage, rent, car payments, credit card payments, cable payments, food expenses, I would suggest that Apple has become a “utility company.” Buffett owns a ton of Apple. Munger has sung the praises of Alphabet (Google), one of the widest moat “advertising companies” he has ever seen. Is Facebook (FB, Financial) better described as an advertising company, rather than a tech company? Are Visa (V, Financial) and PayPal (PYPL, Financial) better described as payment/transaction facilitators rather than tech companies? You can even find Buffett-esque moats in traditional tech. For example, back in the mid-1990s we owned Linear Technology (now owned by Analog Devices). Linear Technology designs and manufactures analog semiconductors. Back in the day, the company had a remarkable, multi-decade history of both enormous profitability and literally never posting anything but positive cash flow generation every month in their corporate history, belying the fact that they are not only a tech hardware company but a semiconductor company too (you semiconductor investors out there know how notorious boom-bust most semiconductor companies are). You get the drift.
Question: With Celgene (CELG, Financial), have the recent setbacks (especially the ozanimod RTF) and the seemingly overpriced acquisition changed your view of management team and Celgene's long-term prospects? What filters do you use when looking into biotech stocks (can you use Celgene versus Biogen and maybe Regeneron as a comparison)?
Rolfe: No doubt about it, Celgene is a “show-me” stock. Filters? The usual. A multiyear, patent-protected product line-up with pricing power, plus an under-appreciated pipeline.
Question: From a fundamental growth perspective, Berkshire seems to have the lowest growth rate among your top holdings, yet it's a largest holding. What factors do you consider when deciding how much you would allocate to your largest holding?
Rolfe: Berkshire’s growth rate is higher than you might suspect. The growing cash balance has been a 300-400 basis point headwind to growth. That first-class problem will be resolved in the years to come with the new stock buyback policy. Largest holding? Our assessment of the best-ranked, multi-year risk-rewards of our 20 holdings. Investing, both security analysis and portfolio management, is a craft – a combination of art and science.
Question: Why did you close out your position in Express Scripts (ESRX) in light of the Cigna Corp. (CI) takeover bid?
Rolfe: We had sold our ESRX position before the takeover.
Read more here:
David Rolfe Buys 3 Stocks in 3rd Quarter
David Rolfe's Wedgewood Partners 3rd Quarter 2018 Client Letter
