Bill Nygren Market Commentary | 3Q21

September 30, 2021

“Having a noble purpose and looking after all stakeholders tends to result in great outcomes for shareholders.”

-Hubert Joly, The Heart of Business1

At Oakmark, we are long-term investors. We attempt to identify growing businesses that are managed to benefit their shareholders. We will purchase stock in those businesses only when priced substantially below our estimate of intrinsic value. After purchase, we patiently wait for the gap between stock price and intrinsic value to close.

Shareholders vs. Stakeholders
I want to follow up on last quarter’s commentary about governance with a related topic that we get asked about: shareholders vs. stakeholders. Is it really one against the other?

From 1997 through 2019, the Business Roundtable sided with Nobel-Prize-winning economist Milton Friedman. Friedman had a lot to say about the role of business in society, but is mostly remembered for stating in his book, Capitalism and Freedom2, “There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits.”

Then, in August 2019, the 181 CEOs who comprise the Business Roundtable, responding to changing societal and investor expectations, issued an update on its view of the purpose of a corporation: “Each of our stakeholders is essential. We commit to deliver value to all of them.” This was widely viewed as a rebuke to Friedman and the end of businesses being managed solely for their owners. I want to share Oakmark’s view on this topic because we don’t see shareholders and stakeholders as having opposing interests.

In his book The Heart of Business, Hubert Joly, the CEO who turned around Best Buy, says that to thrive, a company needs to have a noble purpose, defined as “the positive impact it is seeking to make on people’s lives.” Once that is agreed on, all possible actions should be evaluated on how they further that purpose. At one of my first partner meetings, we discussed whether we should pass along a cost increase to our clients. One of our founders ended the debate by saying, “If we do what’s right for our clients, the business will take care of itself.” Oakmark’s noble purpose is, and always has been, to help our shareholders meet their financial goals. Our founders knew that if we delivered on that, we’d simultaneously maximize the value of our company.

This philosophy of sacrificing near-term earnings to maximize value was not in vogue in the 1990s. “Turnaround artists,” like “Chainsaw” Al Dunlap, gained fame by drastically slashing costs. They believed that business value was maximized by maximizing each quarter’s earnings. Though excessive costs needed to be trimmed, the turnaround artists’ cuts went much deeper.

Today, some CEOs are again following this playbook. Slicing R&D expenditures at drug companies or drastically cutting ad spending at consumer companies, for example, produce a quick pop in earnings—and often the stock price. But several years down the road, they usually result in reduced sales and decreased business value.

At Oakmark, we believe that if stakeholders are mistreated, neither profits nor value can be maximized. CEOs can increase the next quarter’s or the next year’s profits by taking advantage of stakeholders—their employees, customers, suppliers and communities. But, eventually, employees find new jobs, customers switch brands, suppliers find other buyers, communities withdraw zoning approvals and business value declines. The negative results of pursuing maximum short-term profits have given “profit maximizing” a bad reputation.

Sustainable profitability can only be achieved by treating stakeholders fairly. That’s why Oakmark’s research process includes examining customer satisfaction, employee turnover, supplier financial health and community relations. We have to consider these factors so that our estimate of business value is based on recurring earnings. Further, we believe that the short-term costs of stakeholder-friendly actions are often overstated. They are usually expensed immediately because their lasting benefits can’t be precisely quantified. That brings me to an example from my childhood.

In the 1970s, blackout rules prevented televising NFL home games that weren’t sold out. It was always uncertain whether or not the Minnesota Vikings’ games would be televised. I remember how excited I’d be each week hearing that General Mills had purchased the remaining tickets, allowing the game to be on TV. Some said General Mills did this for its stakeholders—its employees and community—as opposed to maximizing profits for its shareholders. I believe stakeholders and shareholders both benefitted.

Consider the long-term benefits of General Mills being the hero that let us watch those games. It made employees proud of their employer and maybe helped with talent acquisition. The thousands of disadvantaged kids who got to attend NFL games were perhaps more likely to become General Mills customers or employees. And across the state, maybe we were all more likely to buy Betty Crocker cake mix instead of Duncan Hines. While the tickets were purchased in the name of being a good corporate citizen, I believe it was the most effective marketing ever done by General Mills and clearly benefitted the company’s shareholders.

Would Friedman argue against this spending because it reduced profits? Absolutely not. His writing from more than 40 years ago sounds eerily timely: “In the present climate of opinion, with its widespread aversion to ‘capitalism,’ ‘profits,’ the ‘soulless corporation’ and so on, this is one way for a corporation to generate goodwill as a by-product of expenditures that are entirely justified in its own self-interest.

General Mills accepted lower short-term profits in its pursuit of higher long-term value. And the stakeholders also benefitted. In The Heart of Capitalism, Joly states that “shareholder or stakeholder” tradeoffs are artificial because an “and” solution often exists. “We maximize performance not by choosing between stakeholders, but by embracing all of them. We choose employees and customers and shareholders and the community.” Joly cites examples from his time at Best Buy, including reducing its carbon footprint by installing LED lights throughout the stores. “This helps the environment and helped us save money on our energy consumption. Again, not a zero-sum game.”

Earlier this year, one of our holdings, Bank of America, announced that it was raising its minimum hourly wage from $15 to $20 and would increase it to $25 by 2025. The company received great press for placing the well-being of its employees above profits. But was it really either/or? Bank of America’s chief human resources officer spoke to the bigger picture: “A core tenet of responsible growth is our commitment to being a great place to work…that includes providing strong pay and competitive benefits to help them and their families, so that we continue to attract and retain the best talent.” Bank of America understood that engaged, high-caliber employees are more productive, less prone to turnover and, therefore, less expensive in the long run. Increasing the pay for employees wasn’t elevating employees above shareholders; it was the right thing to do for employees and for shareholders.

If an increase to $20 was good, why stop there? Why not $50 per hour? Because the benefits the business receives at $50 don’t justify the expense. The bank would no longer be able to price its products competitively and would lose business. The employees would “win” in the short term, but eventually the lost business would lead to job cuts, meaning both employees and shareholders would lose. The negative effects of stakeholder overreach are no different than when CEOs overreach to inflate short-term profits. Both hurt shareholders and stakeholders.

One way to think about the value a company adds to society is how much more customers are willing to pay for its products than they cost to produce. A benefit of defining societal value by this metric is that the only arbiters of how valuable a product is are the consumers who freely spend their own money. I love wine, but don’t understand why people buy Screaming Eagle for $3000 a bottle. But it doesn’t matter that I won’t pay up for brands like Lamborghini, Chanel or Screaming Eagle; their customers will. In open markets, the good a company can do is constrained by what maximizes long-term profits, and long-term profits are constrained by how much good a company does.

It’s no surprise, then, that the largest market cap companies—Apple, Microsoft, Alphabet and Amazon—are arguably the companies that are expected to create the most value for society. If the goal is to maximize the social good a business can do, a byproduct is maximizing the value of the business and vice versa. Thought of this way, the value for shareholders and stakeholders is maximized by the same actions. The decision-making process may start at different points, but the outcome is the same.

When Oakmark Select owned shares in Thermo Electron in the 1990s, I had the privilege of meeting with its brilliant founder and CEO George Hatsopoulos. At the age of 14, after the Nazis invaded Greece, George made and sold clandestine radios that received Allied troop broadcasts. After coming to the United States, he founded Thermo in 1956 to commercialize new electronics technology. In the 1980s, Thermo used IPOs of partial stakes in its venture-stage businesses to provide funds for increasing its R&D spending. It was a typical opportunity for Oakmark—a corporate structure that most investors didn’t bother to understand and a large amount of income statement spending that wouldn’t produce returns until well past most investors’ time horizons.

Our question was whether George was pursuing pet projects because he and his employees loved the science or if the spending was truly economic. So I wanted to determine if the business was being run to maximize value. I still remember George’s answer to my question about whether the business was being run for stakeholders or shareholders: “If you think very long term, it is a tautology.” Like us, he saw it as two sides of the same coin.

Though we made good money on Thermo, our shareholders would have been better off had I never sold it. After 50 years on its own, in 2006 Thermo completed a merger of equals with Fisher Scientific, creating Thermo Fisher Scientific. Today, it has a market cap over $200 billion. Not bad for the work of one immigrant! And fully three decades ago, George had figured out that today’s “shareholder vs. stakeholder” debate was really no debate at all.

1Joly, Hubert. 2021 The Heart of Business. Harvard Business Review Press

2Friedman, Milton, and P. N. Snowden. 2002. Capitalism and Freedom. Chicago, IL: University of Chicago Press.

The securities mentioned above comprise the following preliminary percentages of the Oakmark Fund’s total net assets as of 09/30/21: Alphabet Cl A 3.7%, Amazon 0.0%, Apple 0.0%, Bank of America 2.7%, Best Buy 0.0%, General Mills 0.0%, Microsoft 0.0% and Thermo Fisher Scientific 0%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

The securities mentioned above comprise the following preliminary percentages of the Oakmark Select Fund’s total net assets as of 09/30/21: Alphabet Cl A 9.6%, Amazon 0.0%, Apple 0.0%, Bank of America 4.6%, Best Buy 0.0%, General Mills 0.0%, Microsoft 0.0% and Thermo Fisher Scientific 0.0%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

The security mentioned above comprises the following preliminary percentage of the Oakmark Global Select Fund’s total net assets as of 09/30/21: Alphabet Cl A 12.3%, Amazon 0.0%, Apple 0.0%, Bank of America 4.7%, Best Buy 0.0%, General Mills 0.0%, Microsoft 0.0% and Thermo Fisher Scientific 0.0%. Portfolio holdings are subject to change without notice and are not intended as recommendations of individual stocks.

Access the full list of holdings for the Oakmark Fund as of the most recent quarter-end.
Access the full list of holdings for the Oakmark Select Fund as of the most recent quarter-end.
Access the full list of holdings for the Oakmark Global Select Fund as of the most recent quarter-end.

The Oakmark Funds’ portfolios tend to be invested in a relatively small number of stocks. As a result, the appreciation or depreciation of any one security held by the Fund will have a greater impact on the Fund’s net asset value than it would if the Fund invested in a larger number of securities. Although that strategy has the potential to generate attractive returns over time, it also increases the Fund’s volatility.

Because the Oakmark Select Fund and Oakmark Global Select Fund are non-diversified, the performance of each holding will have a greater impact on the fund’s total return, and may make the fund’s returns more volatile than a more diversified fund.

The stocks of medium-sized companies tend to be more volatile than those of large companies and have underperformed the stocks of small and large companies during some periods.

The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change and may change based on market and other conditions and without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.

Certain comments herein are based on current expectations and are considered “forward-looking statements”. These forward looking statements reflect assumptions and analyses made by the portfolio managers and Harris Associates L.P. based on their experience and perception of historical trends, current conditions, expected future developments, and other factors they believe are relevant. Actual future results are subject to a number of investment and other risks and may prove to be different from expectations. Readers are cautioned not to place undue reliance on the forward-looking statements.

All information provided is as of 09/30/2021 unless otherwise specified.