Buffett on Bonds and Productive Assets

From this past Monday's interview of Warren Buffett by CNBC's Becky Quick:

"I bought a piece of real estate in New York in 1992, I have not had a quote on it since. I look to the performance of the assets. Maybe...my piece of real estate have had pull backs, but I don't even know about 'em. People pay way too— way too much attention to the short term. If you're getting your money's worth in a stock, buy it and forget it."

He then added this on interest rates and how they affect all other assets:

"...interest rates act like gravity to other asset prices. Everything is based off them."

Buffett then also said:

"...interest rates have a powerful effect on...all assets. Real estate, farms, oil, everything else...they're the cost of carrying other assets. They're the alternative. They're the yardstick."

Interest rates may be the yardstick, but the time to buy certainly isn't when the world is free of trouble.

"...the fact that there are troubles in Europe, and there are plenty of troubles, and they're not going go away fast, does not mean you don't buy stocks. We bought stocks when the United States was in trouble, in 2008 and— and it was in huge trouble and we spent 15 1/2 billion in three weeks in— between September 15th and October 10th. It wasn't because the news was good, it was because the prices were good."

He also said that, while he doesn't have any idea when, some day bond yields will be a lot higher.

"Oh...it's going to happen. And question is...the question is always when. I'm no good on that. The question is to what degree it happens. But you could have interest rates very significantly different than what they are now— in some reasonable period in the future. It's not a game that I can play. I mean, I— I don't have any special insight into that sort of thing..."

As far as Buffett's concerned stocks might have been cheap not long ago, but they're now merely decent values.

"In terms of stocks, you know, stocks are reasonably priced. They were very cheap a few years ago. They're reasonably priced now. But stocks grow in value over time because they retain earnings..."

Bonds, on the other hand...

"There could be conditions under which we...would own bonds. But— they're conditions far different than what exist now."

Becky Quick then pointed out that her co-host on CNBC's Squawk Box, Joe Kernen, went into a retirement specialist recently. The specialist said he should be 40% in bonds. Buffett's response was "you shouldn't be 40% in bonds." He said investors with the "proper attitude" should have "enough cash on hand so they feel comfortable, and then the rest in equities..."

He then added:

"I would have productive assets. I would favor those enormously over fixed dollars investments now, and I think it's silly — to have some ratio like 30 or 40 or 50% in bonds. They're terrible investments now."

Of course, productive assets include not just equities (pieces of businesses) but naturally also entire businesses, as well as things like farms and real estate. As always, they must be attractive assets bought at attractive valuations. Even the best asset can be a dumb and risky investment at the wrong price.

Buffett did explain what he meant specifically by "proper attitude".

He said it's those investors who won't be bothered whether stocks were to drop, for example, 20% in the next month.

Now, 20% over the next month was used to help make his point, but it's not really about a specific percentage.*

It's just that those who tend to react the wrong way to negative price action aren't likely to do very well in equities. In fact, those who react emotionally to price action in either direction will likely end up with poor results in the long run. That more than a few investors tend to buy and sell at the wrong times is, unfortunately, an all too reliable pattern. Buying when the news appears good and selling when the outlook appears less rosy or seems more uncertain isn't a brilliant way to invest. The fact that a favorable outlook makes it feel safer doesn't mean that it is. All else equal, the higher prices that will generally prevail during the good times increases the risk of permanent capital loss (and, of course, the lower prices often available during the not so good times reduce that risk.) Investors often try to time their moves but the evidence is that this is mostly a good idea in theory only. It is likely to increase mistakes and just generally reduce returns.
(Though I'm sure there's some who are able to do this sort of thing...it's just that far more seem to think they can do this effectively than the available evidence suggests.)

The intrinsic value of most quality productive assets simply doesn't move around nearly as much as stock market prices. With so much inherent price movement, eventually sound long-term investments should become available at a discount.

Investment is attempting to capture the long-term compounding of real value, instead of the near-term price movements. That the macro environment will go sour from time to time over a true investment horizon is inevitable. Expect it while realizing that attempts at correctly timing it is folly. The evidence that attempts at properly timing moves consistently well is not smart thing to do isn't insignificant yet, no doubt, many will still ignore this reality.

The good news is that timing things well isn't important over the long haul, paying the right price is.

In any case, buying when the skies are clear then selling during the storm is a great way to pay more than necessary for assets and, ultimately, sell them for too little.

More risk, less reward.

It's clearly not impossible to counteract this adverse tendency, but that starts with being aware of it.

Buffett's not always against the ownership of bonds by the way. In the interview, he points out that he made a lot of money in zero coupon bonds in the early 1980s and added that "...the price of everything determines its attractiveness."

Buffett said that a few years ago "The news was terrible, but the stocks were cheap, you know. News is better now. Stocks are higher. They're still not— they're not ridiculously high at all, and bonds are priced artificially. You've got some guy buying $85 billion a month. (LAUGH) And— that will change at some point. And when it changes, people could lose a lot of money if they're in long-term bonds."

Much later in the interview, Buffett once again talked about the folly of trying to buy and sell stocks based on current news. He said those that do this are "giving away an enormous advantage" then added:

"...I bought a farm in 1985, I haven't had— had a quote on it since. But I know what it's produced every year. And I know it's worth more money now. You know, it— if I'd gotten a quote on it every day and somebody's said, "You know, maybe you oughta sell because there's, you know, there's clouds in the West," or something. (LAUGH) It's — it's crazy."

Investment, in contrast to speculation, has as its focus what a productive asset can produce over a long time frame. Of course, what you pay for that asset -- whether it be an entire business, part of a business, or a farm. or other real estate -- matters. Many think of the stock market primarily in terms of where prices will be over the near or even intermediate term. Learning to think primarily about what something will produce over time instead of price action can make all the difference.

In this recent post, I mentioned that Buffett last year said "bonds should come with a warning label." Then, as now, he wasn't saying when yields would rise. Getting the timing right is always difficult at best. In fact, it is mostly a waste of energy or worse. The good news is that timing things consistently well is not a requirement when it comes to getting attractive investment results. Look no further than Warren Buffett himself for evidence of this.

As Donald Yacktman and his team like to say" "It's almost all about the price."

That just about sums it up. It's buying productive assets, particularly those that the individual investor understands well, at a price that represents a nice discount to per share intrinsic value.

Adam

* To make his point about the "proper attitude", Buffett used stocks going down 20% in the next month as an example. In this interview back in 2009, Charlie Munger talked about stocks dropping more like 50%:

"I think it's in the nature of long term shareholding of the normal vicissitudes, in worldly outcomes, and in markets that the long-term holder has his quoted value of his stocks go down by say 50%."

The point isn't really the percentage. It's to focus on what an asset is intrinsically worth and buy it cheap enough instead of focusing on what the quoted price happens to be on any given day. If cheap, and you want more of a particular asset, buy more. If expensive, and you want less of the asset, then maybe sell. Otherwise, ignore the quoted prices and use that energy making sure value has been judged well. Better yet, if justifiably confident about an assets prospects, expend that energy elsewhere once enough shares are owned at an attractive valuation. The bottom line is to keep fear and greed in check and just mostly ignore the quoted prices. Emotional reactions cloud investment judgments and destroy returns.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Yacktman Funds 4Q 2012 Update

Here's the top 10 holdings of the Yacktman Fund (YACKX), according to Morningstar.com:

Yacktman Fund Top 10 Positions (as of 12/31/12)
News Corp. (NWSA)
Procter & Gamble (PG)
Pepsi (PEP)
Cisco (CSCO)
Sysco (SYY)
Viacom (VIAB)
Microsoft (MSFT)
Coca-Cola (KO)
C. R. Bard (BCR)
Stryker (SYK)

Yacktman Focused Fund (YAFFX) is very similar to the Yacktman Fund, though their are certainly some minor variations. Considering the name, it's not exactly surprisingly that the fund is somewhat more concentrated.

Yacktman Focused Fund Top 10 Positions (as of 12/31/12)
Procter & Gamble
News Corp.
Pepsi, Inc.
Cisco
Sysco
Microsoft
C.R. Bard
Stryker
Clorox Company (CLX)
Johnson & Johnson (JNJ)

In fact, both portfolios are rather concentrated with the top ten making up 51% in the Yacktman Fund and 59% in the Yacktman Focused Fund.

Both funds have very low turnover by almost any standard. If nothing else that means what is owned now is likely to be in the portfolio for quite a while. Consumer stocks -- both "defensive and "cyclical" -- make up more than half of these two portfolios (with a strong tilt toward so-called "defensive"...35-40%).

The performance of these funds can be found here and at Morningstar.com.

Yacktman Fund Update

The biggest recent addition (and an entirely new position) in the fund is Dell (DELL) but is no where near a top 10 position. The stock still makes up less than 1% of the fund based upon available information. Considering where Dell was selling during the fourth quarter, that likely means -- unless the current attempts to take Dell private fail -- it will end up resulting in a nice gain but not a long-term investment.

Increases to the size of positions that were already held by Yacktman include: Stryker, Coca-Cola, and Avon Products (AVP).

Reduced positions include: H&R Block (HRB) and Research in Motion (RIMM)

Positions that were sold entirely: Liberty Ventures (LVNTA)

With Dell being the biggest change, clearly none of these moves had a huge impact on the portfolio.

Here's a new interview with Donald Yacktman in Barron's.

In the interview, Yacktman says their focus is to first protect client money, then make them money, and ultimately beat the S&P 500 over the long haul.

He also explains why Dell was to the portfolio and why they don't see Apple (AAPL) as an attractive investment (basically...the phone biz is too unpredictable). One key difference in their approach compared to many other funds these days seems to come down to time horizon. In the interview, Yacktman points out that volatility does encourage and lead to more short-term trading but...

"...short-term traders tend not to do very well over time. Most people think in terms of 10 minutes, 10 hours, 10 days, 10 weeks,10 months, but not 10 years. Most people just don't have the patience."

The difference in time horizon shows up in their 2-3% portfolio turnover. It's an approach clearly focused on long run risk-adjusted forward returns instead of chasing near-term price action.
(As the Barron's article points out, Yacktman doesn't mind at all being the "tortoise" among the many active "hares" in the market.)

The merits of their style seems unlikely to be obvious up in a bullish environment, even if extended. That's partly what inevitably tempts too many participants to trade. Yet, if their long run results are any indication, Yacktman and his team is doing something right.

Adam

Long positions in PG, PEP, CSCO, MSFT, KO, DELL, and AAPL established below recent prices and, in some cases, at much lower prices.
--- 
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice.

The Cost of Complexity

I mentioned in my post on Monday that:

In [Donald] Yacktman's view, businesses with both low capital intensity and low cyclicality (Coke: KO, Pepsi: PEP, and P&G: PG are the specifics mentioned) are likely to earn the highest returns.

The benefits owning shares in quality businesses long-term (especially if bought when occasionally selling at a fair or better than fair price) comes down to potential returns relative to risk.

Simple to understand? Certainly. Easy to implement as a core investing approach? A bit less so.  

The evidence to support the merits of owning shares in these kinds of businesses long-term isn't hard to find nor is it particularly complicated. A simple insight can sometimes trump details and complexity. When it occasionally does, use it. What's simple can beat the complex and, in fact, often does.

Yet simple isn't always better. It is just that what is used should be neither more simple nor more complicated than it need be.

It's possible, of course, to make things too simple.

Science views complexity as a cost. That additional complexity must be justified by the benefits. 

"In science complexity is considered a cost, which must be justified by a sufficiently rich set of new and (preferably) interesting predictions..." - From the book "Thinking, Fast and Slow" by Daniel Kahneman

Well, investors ought to view complexity in a similar way. 

Investing is always about getting the best possible returns, at the lowest possible risk, within one's own limits. Since it is already inherently enough of a challenge, there's no need to make it more so by adding unnecessary complexity. Don't use calculus when arithmetic will do the job. Save the more powerful tools for when they can actually add value (and especially avoid some of the worse-than-useless overly complex theories taught by modern finance).

Now, just because something is relatively simple doesn't mean lots of homework isn't necessary.

There absolutely is lots of hard work involved.

The reason for and advantage of owning shares in some of the quality franchises -- superior returns at less risk if bought well -- is clearly not all that difficult to understand. Having enough discipline, patience, and the right temperament to stick with it is the tougher part. 

Well, that and maybe not becoming distracted by the various forms of investing alchemy cloaked in incomprehensible faux sophistication: 

"...most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising 'Take two aspirins'." - Warren Buffett in the 1987 Berkshire Hathaway Shareholder Letter

Quality stocks. Less drama. Little mystery. Effective. 

Think of them as the "two aspirins" of investing. 

I'm sure that many will still choose to own shares of the highest quality stocks primarily for "defensive" purposes. I doubt that changes anytime soon. Somehow, the thinking goes, they'll jump in and out while not having mistakes and frictional costs to subtract from total return. Sounds good in theory. I'm sure there are even some who can make that sort of thing work for them. There are likely even more who incorrectly think they can.

So, despite the evidence, investing in high quality businesses long-term remains an approach that's still not frequently employed.*
(I mentioned in the previous post that Jeremy Grantham has described these high quality businesses as the "one free lunch" in investing.)

It's a subject I've covered many times on this blog (okay...maybe too many times based upon the number of related posts I have listed below) because it just happens to have been and remains a cornerstone of investing for me.

Unfortunately, investors need more patience now compared to when valuations were quite attractive not too long ago (though at least it's not nearly as bad valuation-wise as it was a decade or so ago). Most of the best quality enterprises are rather fully valued right now.
(Over the shorter run -- less than five years -- anything can happen as far as relative performance goes. It's the longer time horizons -- more like twenty years or so -- that the "offensive" merits of high quality businesses become more obvious. A full business cycle or two. I realize that some, or maybe even many, market participants consider five years to be longer term these days.)

Still, it makes sense to embrace any simple, understandable, yet effective method of delivering above average risk-adjusted returns while generally avoiding the esoteric.**

Finally, the assessment of risk is necessarily imprecise and is certainly not measured by something like beta. Real risks does not lend itself to the all too popular quantitative methods. What can be measured, should be, but much of the important stuff can't be measured all that well. It requires a mixture of both quantitative and qualitative.

"You've got a complex system and it spews out a lot of wonderful numbers that enable you to measure some factors. But there are other factors that are terribly important, [yet] there's no precise numbering you can put to these factors. You know they're important, but you don't have the numbers. Well practically everybody (1) overweighs the stuff that can be numbered, because it yields to the statistical techniques they're taught in academia, and (2) doesn't mix in the hard-to-measure stuff that may be more important. That is a mistake I've tried all my life to avoid, and I have no regrets for having done that." - Charlie Munger in this speech at UC Santa Barbara

When it comes to managing risk (and many other things), it's often a mistake to allow the less important but easy to measure stuff to triumph over what's more meaningful if tougher to measure. 

Adam

Related posts:
The Quality Enterprise: Part II - Aug. 2012
The Quality Enterprise - Aug. 2012
Consumer Staples: Long-term Outperformance, Part II - Dec. 2011
Consumer Staples: Long-term Outperformance - Dec. 2011
Grantham: What to Buy? - Aug. 2011
Defensive Stocks Revisited - Mar. 2011
KO and JNJ: Defensive Stocks? - Jan. 2011
Altria Outperforms...Again - Oct. 2010
Grantham on Quality Stocks Revisited - Jul. 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - Nov. 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - Apr. 2009
Best and Worst Performing DJIA Stock - Apr. 2009
Defensive Stocks? - Apr. 2009

Long positions in KO, PEP, and PG established at much lower than recent market prices. No intention to buy or sell shares near current valuations.

* To me, the shares of many of these businesses are not especially cheap these days even if they have been at times over the past few years. It's worth waiting for a good price then acting decisively when valuation is attractive. Since each is unique, the necessary homework to build some depth of knowledge and understanding can be done while waiting for the right price. These may be lower risk but they're certainly not no risk. Margin of safety still matters. There's no way around the preparation and patience required in investing. After figuring out what's attractive at a certain price lots of waiting is inevitably necessary.
** Some may become bored by the straightforwardness. A few may even choose more complicated, high risk journeys just to enhance the challenge. Long-term Capital Management (LTCM) comes to mind. Charlie Munger said it best in this 1998 speech:

"...the hedge fund known as 'Long-Term Capital Management' recently collapsed, through overconfidence in its highly leveraged methods, despite IQ's of its principals that must have averaged 160. Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger's 1998 speech to the Foundation Financial Officers Group

Uncomplicated, understandable, yet effective ways to produce attractive risk-adjusted returns should be embraced. Sophisticated or esoteric methods, especially those involving leverage, should not. Best to be wary of overconfidence in any profession. It can get even the most talented into trouble.

Munger's Speech to Foundation Financial Officers - 1998

Yacktman: Above Average Businesses, Below Average Prices

Here's a good GuruFocus interview with Donald Yacktman and Russell Wilkins of the Yacktman Funds. Check it out in its entirety. 

Some highlights (all excerpts below are Donald Yacktman quotes):

Above Average Businesses, Below Average Prices
"...one of my children said to me once, after dinner when we were talking about investing, 'Now let me see if I have this right, Dad. Basically what you're saying is if you buy above average businesses at below average prices, then on average it's going to work out?' I said, 'Yes, that's basically it.'"

So much for using complex formulas to boost returns.

On Patience
"So many people in this business think in terms of 10 minutes, or 10 hours, or 10 days, or 10 weeks, or 10 months, not 10 years. Very few people have the inner strength or patience to wait it out."

On Focus
"We are focused on a fairly narrow universe of companies we know well."

On Capital Intensity and Cyclicality
The interview includes a useful chart that Donald Yacktman used to demonstrate the business characteristics he and his team find attractive. On the y-axis is capital intensity and on the x-axis is cyclicality from high to low. It's a simple but useful way to think about businesses. As an example, they have consumer staples shown as low capital intensity and low cyclicality.

I'd add that greater cyclicality and capital intensity means that a strong balance sheet is a must. Too much financial leverage can get any business (anyone) in trouble, but excess financial leverage with highly cyclical and capital intensive businesses is just asking for it.

In Mr. Yacktman's view, businesses with both low capital intensity and low cyclicality (Coca-Cola: KO, Pepsi: PEP, and P&G: PG are the specifics mentioned) are likely to earn the highest returns.*

Jeremy Grantham has previously described the higher quality stocks as the "one free lunch" in investing.
(Coca-Cola, Pepsi, and P&G are all in the top 25 of the GMO Quality portfolio)

I happen to think that sometimes, even if rarely, a simple insight can trump details and complexity. When it occasionally does, use it. A simpler approach can beat the complex and, in fact, often does.**

Back to the Yacktman interview:

On Valuation
The managers at the Yacktman funds have mentioned the following mantra on prior occasions:

"It's almost all about the price." 

Well, the chance to buy a good business cheap is usually when it is experiencing difficulties. During the interview, Russell Wilkins also points out sometimes a stock gets cheap when prospects for a business seem solid but unexciting.

On Growth
Yacktman points out that many businesses, especially the high growth ones, have difficult to project long-term prospects. That high growth doesn't generally last very long, yet valuations of fast-growers often assume growth will continue for an extended time. 

"...the problem is that the market has a central tendency to overprice things, and put very high multiples on companies that are growing quickly, even if it is for a short period."

Well, when high growth selling at a premium price disappoints, watch out below. 

On Hewlett-Packard, Microsoft, and Cisco
Hewlett Packard (HPQ) is cheap but its history of doing dumb things with cash (Yacktman specifically mentions the value destroying event that was the Autonomy purchase) and their relatively high net debt has kept it a smaller position for the Yacktman team.

The Yacktman team is more favorable toward Microsoft (MSFT) and Cisco (CSCO) considering their also cheap valuations but much stronger balance sheets. As a result, both of those stocks are larger technology positions than Hewlett-Packard.

Special situations like Hewlett-Packard have been some of their biggest winners but they recognize that these have a higher probability of not working out. So they tend to keep positions like Hewlett-Packard on the smaller side.

Check out the full interview.

Adam

Long positions in all stocks mentioned

* To me, the shares of many of these businesses are not especially cheap these days even if they have been at times over the past few years. It's worth waiting for a good price then acting decisively when valuation is attractive. Since each is unique, the necessary homework to build some depth of knowledge and understanding can be done while waiting for the right price. These may be lower risk but they're certainly not no risk. Margin of safety still matters. There's no way around the preparation and patience required in investing. After figuring out what's attractive at a certain price lots of waiting is inevitably necessary.
** Some may become bored by the straightforwardness. A few may even choose more complicated, high risk journeys just to enhance the challenge. Long-term Capital Management (LTCM) comes to mind. Charlie Munger said it best in this 1998 speech:

"...the hedge fund known as "Long-Term Capital Management" recently collapsed, through overconfidence in its highly leveraged methods, despite IQ's of its principals that must have averaged 160. Smart, hard-working people aren't exempted from professional disasters from overconfidence. Often, they just go aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger's 1998 speech to the Foundation Financial Officers Group

Uncomplicated, understandable, yet effective ways to produce attractive risk-adjusted returns should be embraced. Sophisticated or esoteric methods, especially those involving leverage, should not.

Munger's Speech to Foundation Financial Officers - 1998

Yacktman 1st Quarter 2012 Update

Below is the 10-year performance through 03/31/12 of the funds that Donald Yacktman and his team manage:

The Yacktman Fund (YACKX) had a cumulative 10-year return of 180.24%.*

The Yacktman Focused Fund (YAFFX) did even better returning a cumulative 197.09% over the past 10 years.

For a comparison, the S&P 500 was up 49.72% over the same time frame.

These funds are very similar but the more concentrated of the two funds, as the name suggests, is the Yacktman Focused Fund.

Top 5 Holdings of The Yacktman Focused Fund

1 Procter & Gamble (PG)

2 News Corp (NWSA)
3 Pepsi (PEP)

4 Microsoft (MSFT)

5 Sysco (SYY)

Approximately 41 percent of the Yacktman Focused Fund portfolio is in the top 5 stocks. 

Top 5 Holdings of The Yacktman Fund

1 Pepsi (PEP)

2 News Corp (NWSA)
3 Procter & Gamble (PG)

4 Microsoft (MSFT)

5 Cisco (CSCO)

Approximately 34 percent of the Yacktman Fund portfolio is in the top 5 stocks.

From their 1st Quarter 2012 Letter:

Consumer Staples
We think the combination of predictability, quality, and valuation of companies like Procter & Gamble, PepsiCo, Clorox, and Coca Cola is especially important in a time when we perceive many significant risks in the world.   

Old Tech
Microsoft [was] the top contributor to fund results in the first quarter, appreciating more than 20%, though we believe the stock remains inexpensive at less than 10 times our expectation of 2012 earnings when adjusting for net of the cash on the balance sheet. While HP struggled, we think the shares are remarkably inexpensive and the management team has improved significantly since Meg Whitman became CEO.

In this Barron's interview from a little over a year ago, Donald Yacktman had this to say about the investing business:

This business boils down to what you buy and what you pay for it. The market level is incidental to us.

In the interview, he also talks about how inexpensive high-quality companies are compared to what he's seen over the years.

Unfortunately some (though certainly not all) of the high-quality companies he is referring to are much more expensive now.

I've mentioned this before, but it's worth noting again that the annual turnover of the portfolios managed by Yacktman and his team is typically under 10 percent.

In fact, they are often well under that 10 percent number.

According to Morningstar, lately it has been more like 2 to 3 percent.

Impressively low.

It's always good to see someone producing above average returns by paying the right price for sound businesses that compound over time in value.

I'll take that approach over some special aptitude for trading any day.

Adam

* From the letter: The performance data quoted for The Yacktman Fund and The Yacktman Focused Fund represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that the investor's shares, when redeemed, may be worth more or less than their original cost. The current performance may be higher or lower than the performance data quoted.

Established long positions in PG, PEP, KO, and MSFT at much lower prices. Have no intention to buy any of these near current prices. Also, have established a position in HPQ near its recent price.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice.

Yacktman on PepsiCo

Donald Yacktman and his team recently responded to GuruFocus readers' questions. Here's a short excerpt of what he had to say about PepsiCo (PEP):

We believe the company will need to show improved results from several of the key areas of strategic focus or there may be a new management team in place in the near future. The potential for the stock is less about the growth, which we think is mid-to high single-digit per year, and more about the combination of valuation and quality of business. - Donald Yacktman

Donald Yacktman has liked PepsiCo for some time but that seems a slightly less favorable assessment compared to previous ones by him and his team.

PepsiCo has some high quality businesses, but the execution on some fronts lately has been somewhat disappointing.

Earnings is expected to be down this year compared to last year. Using this year's number, PepsiCo is selling for nearly 16x earnings.

So, while not expensive (especially if an investor believes those earnings will begin to bounce back next year), it hardly seems like a bargain near the current valuation considering some of their recent difficulties.

A larger discount until they prove some things to shareholders seems warranted.

Check out the full article. In it, the co-managers at Yacktman Funds respond to a bunch of  readers' questions.

Adam

Established a long position in PepsiCo at less than recent market prices

Donald Yacktman On Stocks

Below is the 10-year performance through 12/31/11 of the funds that Donald Yacktman and his team manage:

The Yacktman Fund (YACKX) had a cumulative 10-year return of 174.52%.*

The Yacktman Focused Fund (YAFFX) did even better returning a cumulative 194.07% over the past 10 years.

For a comparison, the S&P 500 was up 33.35% over the same time frame.

From the latest letter:

Old Tech
Last year, the shares of many more established technology companies were out of favor, allowing us to increase our weighting to a group which we call "old tech". At the end of 2011, Microsoft and Cisco were our largest "old tech" positions...

Consumer Staples
These businesses tend to be fairly stable and predictable, with a strong ability to handle uncertain economic periods. We reduced our weightings in Coca‐Cola and Clorox during the year due to their strong price performance.   

Consuelo Mack recently interviewed Donald Yacktman. Some excerpts from that interview:

High Quality, Profitable Businesses
I've been doing this for over 40 years, and I can't remember another period of time where I've seen so many high-quality, profitable businesses selling at prices relative to the market this cheaply.

Behaving Like a Bond Buyer
...what we're seeing now is, in effect, the so-called AAAs of equity, things like Coke and Pepsi and things like that, have these very high returns, relative to other things. And so, why would one go to lower grades when they can stay with these so-called AAA-type bonds? Only they're really equities.

Beach Balls Pushed Underwater
Conceptually, what we're doing is buying beach balls being pushed underwater, and the water level is rising. And so, if one has the patience to stay with that, then eventually the pressure will come off, and the longer it takes, because the water level's rising, the more the bounce will be. 

The full interview with Donald Yacktman is certainly worth checking out.

The top holdings in the funds managed by Yacktman at year-end include Pepsi (PEP), News Corp (NWSA), Procter & Gamble (PG), Microsoft (MSFT), and Cisco (CSCO).

Adam

* From the letter: The performance data quoted for The Yacktman Fund and The Yacktman Focused Fund represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that the investor's shares, when redeemed, may be worth more or less than their original cost. The current performance may be higher or lower than the performance data quoted.

Interview with Donald Yacktman
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice.

Tweedy, Browne: Positions In Globally Diversified, Underleveraged Businesses

Morningstar's 2011 International-Stock Fund Manager of the Year was awarded to the team that manages the Tweedy, Browne Global Value Fund (TBGVX). It's their flagship international fund.

The team of managers at Tweedy, Browne tend to be positioned in "larger, more globally diversified, underleveraged businesses" selling "products that are of growing interest to emerging middle classes around the globe."*

The fund has relatively low turnover which is always good to see.

According to Morningstar, the annual turnover of the fund is just 12% so there's a pretty good chance the shares owned at the end of a quarter will be held longer term. Funds with very low turnover like Tweedy, Brown Global Value are more about investing, less about trading.

In contrast, what's owned by a fund with very high turnover at the end of a quarter doesn't mean much. What was owned at the end of the quarter has a decent chance of having been sold or being sold sooner than later. Unfortunately, there are too many funds with very short time horizons when it comes to stocks. These funds are more about trading, less about investing.

Here's the top five holding of the Tweedy, Browne Global Value Fund as of the end of the 4th Quarter 2011:

Top 5 Holdings
1 Philip Morris International (PM)
2 Nestle (NSRGY)
3 Diageo (DEO)
4 Roche (RHHBY)
5 Total (TOT)

The team did trim their position in Diageo somewhat during the quarter. Otherwise, there were no changes among the top five holdings.

Some more excerpts of note from the most recent Tweedy, Browne Quarterly Commentary:

Our fourth quarter results were led by continued strength in consumer staples stocks such as Philip Morris, Diageo, Walmart and Unilever, and a significant uptick in some of our more cyclical holdings including Axel Springer, Total, Royal Dutch, and Union Pacific.

Later in the letter they added...

We continue to maintain significant positions in consumer staples and healthcare stocks, but also have substantial positions in more cyclical areas such as insurance, industrials, energy and media. While the spread in valuation between the more defensive and the more cyclical parts of the equity market has widened of late, the overall valuation for our portfolios remain quite reasonable to attractive with a forward 2012 weighted average price earnings ratio for our Funds' equities, which range between 11.4X and 12.3X estimated earnings.

It's notable that positions in consumer staples make up over 30% of the portfolio. That high percentage allocation is not unlike the low turnover equity portfolios of Berkshire Hathaway (BRKa) and The Yacktman Funds. Many funds have a smaller allocation because they're considered "defensive" investments even though there's plenty of evidence that suggests otherwise.

Both Berkshire and Yacktman have more than 30% of their equity portfolio in consumer staples stocks.

Readers of my many prior posts on consumer staples stocks will know that I generally favor shares of the better ones as core long-term holdings.

Of course, like anything else, the shares need to be purchased at reasonable valuations. Many of them were very reasonable valued not too long ago.

The discounts on most are much smaller now.

Still, when bought well and held longer term the best consumer staples businesses are capable of producing very attractive risk-adjusted returns.

Adam

* From the Tweedy, Browne 4th Quarter 2011 Commentary

Established long positions in PM, DEO, TOT, WMT, and UNP at much lower than recent prices

Yacktman Funds 4Q 2011 Update

Here's an update from Donald Yacktman and his team on the funds they manage:*

The Yacktman Fund (YACKX) returned 10.63% per year over the past ten years.

The Yacktman Focused Fund (YAFFX) returned 11.39% per year over the past ten years.

For a comparison, the S&P 500 is up 2.92% per year over the same time frame.

At the end of the most recent quarter, both funds continued to hold substantial positions in large capitalization stocks with many being household names.

These funds are very similar but the more concentrated of the two funds, as the name suggests, is the Yacktman Focused Fund.

Top 5 Holdings of The Yacktman Focused Fund

1 Pepsi (PEP)

2 News Corp (NWSA)
3 Procter & Gamble (PG)

4 Microsoft (MSFT)

5 C.R. Bard (BCR)

Approximately 40% of the Yacktman Focused Fund portfolio is in the top 5 stocks. 

Top 5 Holdings of The Yacktman Fund

1 Pepsi (PEP)

2 News Corp (NWSA)
3 Procter & Gamble (PG)

4 Microsoft (MSFT)

5 Cisco (CSCO)

Approximately 35% of the Yacktman Fund portfolio is in the top 5 stocks. 

The annual turnover of these portfolios is typically less than 10%. That low turnover rate is impressive and, as far as I'm concerned, something not seen often enough.

Yacktman continues to have minimal exposure to financials (~5%) though some small new positions in banks were added last quarter (Goldman Sachs GS, State Street: STT, Northern Trust: NTRS and Bank Of America: BAC).

None of the recent bank purchases are large enough positions to be in the top 25.

Donald Yacktman was asked, in this recent interview with Consuelo Mack, about having added positions in financials after mostly avoiding them in recent years:

...in all cases, you'll notice they're very small positions, and we spread the risk. Sometimes, when things are less predictable, the way to deal with that is to have a smaller position and allow for a greater spread over what your normal hurdle rate would be, to allow for that uncertainty. - Donald Yacktman

The only bank that is a top 10 position is U.S. Bancorp (USB).

The following stocks purchased in the 4th quarter had a greater than 1% portfolio impact.

Stocks purchased
C.R. Bard
Avon Products (AVP)
Pepsi
Microsoft

There were no top 25 positions sold last quarter.

The two funds that Yacktman and his team manage have performed very well but what's even more notable, at least to me, is how they go about producing those returns.

One of the common phrases we use at our firm is, "It's almost all about the price". Often, the most important variable in having a successful investment and managing risk is the price paid for a security. - Donald Yacktman in the 3Q 2011 letter:

They've been able to outperform by generally buying shares of quality businesses with the best risk-adjusted returns and having the discipline to buy when selling at a nice discount.

Adam

* From the letter: The performance data quoted for The Yacktman Fund and The Yacktman Focused Fund represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that the investor's shares, when redeemed, may be worth more or less than their original cost. The current performance may be higher or lower than the performance data quoted.

Established long positions in PEP, PG, MSFT, CSCO, USB at lower than recent prices
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice.

Quotes of 2011

A collection of quotes from 2011. All were said or written at some point during this calendar year.

Amazon's Jeff Bezos on Inventing & Disrupting
"Just by lengthening the time horizon, you can engage in endeavors that you could never otherwise pursue. At Amazon we like things to work in five to seven years. We're willing to plant seeds, let them grow—and we're very stubborn. We say we're stubborn on vision and flexible on details." - Jeff Bezos

The Bond Market Rules
"Unrecognized as saviors, the bond vigilantes are demanding the keys to the Eternal City. If the Italian people are very lucky and very wise, they will allow themselves to be ruled by the bond market." - Thomas Donlan

PIMCO's Bill Gross
"Wall Street sort of lost its way, in that investment banking became a function not of allocating capital properly, but levering capital and levering the returns on capital as opposed to transferring capital to productive industries." - Bill Gross

Bogle Back to the Basics - Speculation Dwarfing Investment
"...our financial system has directed around $200 billion a year into initial public offerings and additional new public offerings and then additional offerings of company stock--$200 billion. We trade $40 trillion worth of stocks a year. So, that's 200 times as much speculation as there is investment. One only has to understand that all this trading back and forth, by definition, doesn't enrich the investor, because if I buy, you sell and vice versa, but what it does is enrich the croupier in the middle, which we call Wall Street..." - John Bogle

Final Wesco Meeting: More From Charlie Munger
"I like people admitting they were complete stupid horses' asses. I know I'll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn." - Charlie Munger

Warren Buffett on the 'New Normal' & 'Black Swans'
"I think the luckiest person around is the baby that's born in the United States today. I don't think there's any question about it. I mean...that person is going, on average, to enjoy a far better life, you know, than John D. Rockefeller had many years ago or that I have now....and so I think if there's a new normal, it will be a higher normal in terms of the average person of how they lived 20 years from now and 50 years from now." - Warren Buffett

"...we will have black swans, but we'll overcome black swans." - Warren Buffett

Final Wesco Meeting: A Morning With Charlie Munger
"Clever derivatives broke dozens of companies. It killed them. Bankrupt. We don't need these kinds of innovation in finance. It's OK to be boring in finance. What we want is innovation in widgets." - Charlie Munger

"When we bought See's Candies, we didn't know the power of a good brand. Over time we just discovered that we could raise prices 10% a year and no one cared. Learning that changed Berkshire. It was really important." - Charlie Munger

Munger on the Financial Sector
"Why should an investment banker go to Greece to teach them how to pretend their finances are different from what they really are? Why isn't that a perfectly disgusting bit of human behavior?" - Charlie Munger

Klarman: Trophy Properties vs Fixer-Uppers
"Price is perhaps the single most important criterion in sound investment decision making. Every security or asset is a 'buy' at one price, a 'hold' at a higher price, and a 'sell' at some still higher price. Yet most investors in all asset classes love simplicity, rosy outlooks and the prospect of smooth sailing. They prefer what is performing well to what has recently lagged, often regardless of price. They prefer full buildings and trophy properties to fixer-uppers that need to be filled, even though empty or unloved buildings may be the far more compelling, and even safer, investments." - Seth Klarman

Barron's Interview: Donald Yacktman
"I have to go back a minimum of 18 years to find blue-chip or high-quality companies selling at these kinds of prices relative to other things out there. It is a very unique period." - Donald Yacktman

2010 Berkshire Shareholder Letter: $ 66 Billion in Cost-Free Deposits
"At Berkshire, we have now operated at an underwriting profit for eight consecutive years, our total underwriting gain for the period having been $17 billion. I believe it likely that we will continue to underwrite profitably in most – though certainly not all – future years. If we accomplish that, our float will be better than cost-free. We will benefit just as we would if some party deposited $66 billion with us, paid us a fee for holding its money and then let us invest its funds for our own benefit." - Warren Buffett

Buffett: Six-fold Increase in Living Standards
"Money will always flow toward opportunity, and there is an abundance of that in America. Commentators today often talk of "great uncertainty." But think back, for example, to December 6, 1941, October 18, 1987 and September 10, 2001. No matter how serene today may be, tomorrow is always uncertain.

Don't let that reality spook you. Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born. The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential – a system that has worked wonders for over two centuries despite frequent interruptions for recessions and even a Civil War – remains alive and effective. 

We are not natively smarter than we were when our country was founded nor do we work harder. But look around you and see a world beyond the dreams of any colonial citizen. Now, as in 1776, 1861, 1932 and 1941, America's best days lie ahead." - Warren Buffett

Happy New Year,

Adam

Quotes of 2010

Consumer Staples: Long-term Outperformance, Part II

Jeremy Grantham has called quality stocks the "one free lunch" over the long run. 

While the definition of quality is necessarily subjective, the Consumer Staples SPDR (XLP) ETF is made up of a whole bunch of high quality businesses. It's a convenient low frictional cost way to gain exposure to them if they're generally priced right.

Top 5 Holding of XLP
Procter & Gamble (PG)
Philip Morris International (PM)
Wal-Mart (WMT)
Coca-Cola (KO)
Kraft (KFT)

Yet, since not all consumer staples businesses are created equal, I'd rather own what I consider the best individual stocks within the sector.*

This recent prior post and CNBC article provide some more background on the excellent long-term track record of many consumer staples stocks.

Jim O'Shaughnessy did a sector analysis of the stock market over a four decade period. Here's a couple of his findings:

- Not only did consumer staples do the best among 10 sectors, the highest performing stocks in the consumer staples sector had the highest buybacks plus dividend yield (shareholder yield).
- Those with the highest shareholder yield had an average annual return of 17.8%. So they have worked very well as an "offense" over the long run, despite their reputation, and produced above market returns.
(As I've said: Over the shorter run -- less than five years or so -- anything can happen as far as relative performance goes, of course.)

Consistent with their reputation, they can provide better downside protection than most other stocks. Yet, the evidence is there that, over the long haul, many consumer staples businesses are, in fact, not just "defensive" in nature even if they're frequently described and thought of that way.

Characterizing them as "defensive" underestimates their long-term "offensive" potential.

Now, consumer staples stocks often do underperform during bull markets so their reputation is understandable. Naturally, some investors and especially traders, attempt to time when they want to own these kind of stocks based upon the perceived risks that exists in the market environment.
(i.e. In a bull market, own fewer consumer staples. In a bear or, at least, uncertain market, own more.)

An approach that, at a minimum, certainly adds frictional costs and the chance to make costly mistakes. To me, it is one of those great sounding ideas until you have to put it into practice. Like choosing the fate of Sisyphus when a perfectly attractive alternative exists: To buy shares of quality businesses at a discount and allow compounding to work for them over time.

Sisyphus had to eternally roll an immense boulder up hill but it wasn't choice, it was punishment. Some seem willing to take the more Sisyphean investing approach by choice.

If, over the long haul, shares of a business or sector (via an ETF) bought at reasonable valuation** can produce higher returns than the market, why add the chance to make costly mistakes trying to time it?

Doing this creates unnecessary execution risks. Understandably, most will heavily weigh the chance of temporary (or worse, permanent) loss more so than the possibility of missing a gain. Loss aversion is a powerful psychological force. Yet, by definition, additional buying and selling brings a chance to make another error into the equation.

Errors of omission comes to mind.

Missing the chance to own something one doesn't understand well, something outside their circle of competence, is not a problem. That's not a mistake. It's best to only invest in attractively priced things one understands well.

On the other hand, missing the chance to own what one understands that also stacks up favorably against investing alternatives is costly. Sell shares because of concerns about short-term price action, with the intent to buy it back at a lower price, opens up the possibility of making an error of omission. What if it rallies? How do you get back in to the position?

Since consumer staples stocks also generally perform better on the downside during rough markets (their "defensive" characteristics) this jumping in and out of positions based upon perceive market risk makes even less sense.

Of course, this only works if we are talking about a good business that is soundly financed. If business quality was misjudged sell it as soon as possible.

An error of commission.

The fact that many consumer staples businesses have done very well in the past is, of course, no guarantee when it comes to the future (not a disclaimer, a fact). Yet, the evidence more than just suggests businesses with well-known, trusted, small-ticket consumer brands (or FMCG) that also have broad-based distribution capabilities tend to do very well over the long run (branded shampoo, beverages, beer, tobacco, chocolate, and gum among other things).

Great brands and strong distribution, in combination, often produces a sustainable advantage, pricing power, and attractive core business economics.

Are the best days behind these kinds of businesses? Is it too late? Well, maybe, but consider this:

Some think if an investment idea is well-known and seems obvious it can't be really good. In 1938, Fortune Magazine concluded "Several times every year, a weighty and serious investor looks long and with profound respect at Coca-Cola's record, but comes regretfully to the conclusion that he is looking too late." Since that time, Coca-Cola has grown significantly both domestically and around the world. It was not too late in 1938, and we believe it is far from that today. - From the 1Q 2010 Yacktman Quarterly Letter

To me, the probability that a business like Coca-Cola will perform just fine, even if not quite as well, over a longer future time horizon is not low. Of course, in the short and medium term, just about anything can happen to share prices. Expect it. Yet, over the longer haul as the "voting machines" gives way to the "weighing machine", share prices will at least roughly track increases to per share intrinsic business value. Well, that value is ultimately driven by business performance. Much as it was not too late in 1938, it seems unlikely that it is too late now. Many, if not all the forces, that created these long-term results remain in place.

These are mostly durable high quality businesses that produce high return on capital, at relatively lower risk, especially if bought at the right price.***

As always, what's sensible to buy at a plain discount doesn't make sense at some materially higher valuation no matter how good the business may be.

They have a good probability of continuing to possess competitive advantages but, as always, keep an eye on how the economic moat may be changing over time along with capital allocation decision-making by management.

One question I like to ask is the following: If a business stopped innovating for five years what would happen to its financial performance? Most consumer staples businesses would miss some opportunities and lose some market share yet still continue making a nice living.

Not so for most tech stocks. Imagine Apple (AAPL), as good as the company is, not innovating for five years.

Now I suspect one of the reasons why more professional investors do not make full use of, what Jeremy Grantham calls "the one free lunch", is this:

"Smart people aren't exempt from professional disasters from overconfidence. Often, they just run aground in the more difficult voyages they choose, relying on their self-appraisals that they have superior talents and methods." - Charlie Munger in a Speech to Foundation Financial Officers

Some seem to think that when a wise but more straightforward approach comes along there must be more to it:

"...our model is too simple. Most people believe you can't be an expert if it's too simple." - Charlie Munger at the 2007 Wesco Meeting

Sidekick has sage advice of his own

In any case, all too many investors have a difficult time keeping up with the S&P 500.

Yet, many consumer staples stocks have a great long-term record of doing just that over the long haul. That may not be true going forward, but their risk-adjusted merits are not insignificant.

Little to no trading required.

Adam

Some previous related posts:
Consumer Staples: Long-term Outperformance - December 2011
Grantham: What to Buy? - August 2011
Defensive Stocks Revisited - March 2011
KO and JNJ: Defensive Stocks? - January 2011
Altria Outperforms...Again - October 2010
Grantham on Quality Stocks Revisited - July 2010
Friends & Romans - May 2010
Grantham on Quality Stocks - November 2009
Best Performing Mutual Funds - 20 Years - May 2009
Staples vs Cyclicals - April 2009
Best and Worst Performing DJIA Stock - April 2009
Defensive Stocks? - April 2009

* Three of the six stocks in the Six Stock Portfolio are consumer staples and I also have many in my Stocks to Watch. They are not in these portfolios for "defensive" reasons. They're just quality durable businesses that over the long-haul produce high return on capital, at relatively low risk, especially if bought at the right price. Margin of safety still always matters no matter how good a business might seem to be.
** Though certainly not expensive, the one problem at this time, unlike not too long ago, is that far fewer shares of consumer staples businesses are selling at a discount these days. So some patience in building a long-term position seems warranted.
*** With any investment, no matter how seemingly attractive, margin of safety is all-important. It protects against the unforeseen real, even if fixable, business problems. Still, it's worth considering this: "If the business earns 6% o­n capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return even if you originally buy it at a huge discount. Conversely, if a business earns 18% o­n capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result." - Charlie Munger at USC Business School in 1994
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational and educational use and the opinions found here should not be treated as specific individualized investment advice. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions.