The commentary I wrote at the end of last quarter about the evolution of value investing generated a lot of comments and encouragement to write more on the topic. Quoting from that article sums up our view, “Buying great businesses at average prices is just as much value investing as buying average businesses at great prices.” That is somewhat at odds with the popular view that value investors buy only dull, slow growth, structurally disadvantaged companies that trade cheap relative to their book value and earnings, while growth investors buy exciting, rapidly expanding, competitively advantaged companies that trade expensive relative to their book value and earnings.
Instead, we see two continuums. The first is cheap vs. expensive and the second is low growth vs. high growth. Certainly, there is usually a positive correlation between the two. Slow-growth companies often sell at low valuations and high-growth companies often sell at expensive valuations. In an attempt to simplify, the two continuums are often merged into one, with value at one end and growth at the other. And when cheap stocks happen to also have good growth, this can get confusing.
Morningstar Value-Growth Scores
We have a lot of respect for the work Morningstar does educating individual investors. They created the style box approach for classifying mutual funds, which makes it easier to see how a fund performed compared to others with the same investing philosophy. They developed a proprietary metric to classify individual stocks as value, core or growth, then use that metric to classify funds as value, blend or growth. Morningstar combines valuation statistics, such as price-to-book, price-to-earnings and dividend yield, with growth statistics showing how rapidly sales, earnings and book value have increased and are expected to increase. They call individual stocks that have a raw score less than 100 “value stocks” and over 200 “growth stocks.” The Oakmark Fund’s highest scoring company, Hilton Worldwide, is clearly a high-growth business. We bought it when it traded at about the S&P 500 P/E multiple and continue to own it because we believe it deserves a somewhat higher premium than it currently has. At the opposite end of the spectrum, in negative territory, is Citigroup, which is clearly a company that has been struggling and investors have given up on. Nobody would argue that it is a growth stock!
While the scores are logical for most of our companies, it gets messy when a cheap stock also has rapid growth. One of our favorite holdings today is First Citizens, the bank that bought Silicon Valley Bank from the FDIC. First Citizens scores well on value metrics as it trades at roughly tangible book value and 8 times earnings. But partly due to the acquisitions it made, both book value and earnings per share have more than tripled in the past three years. And that’s faster growth than most popular growth stocks! Morningstar scores First Citizens almost as high as Hilton, solidly a growth stock. In comparison, Wells Fargo, which sells at similar P/E and P/B ratios, scores at the very low end of the value category. Should First Citizens be called a growth stock or a value stock? The answer is yes!
Same thing for another of our holdings related to Charter Communications. We think Charter is an inexpensive stock that investors are treating as a dying cable TV company instead of a leading, growing infrastructure company, providing hi-speed internet access. Morningstar agrees with us that Charter is solidly in the value camp. But another of our holdings, Liberty Broadband, whose primary asset is Charter stock, is even cheaper than Charter—on our numbers about 30%. That’s the kind of double-dip discount we love! In fact, if Liberty was larger and more liquid, we would own more of it instead of owning Charter. But due to GAAP accounting rules not giving Liberty credit for the current market value of its Charter shares, Liberty looks expensive relative to its book value. This “cheaper version of Charter” is scored by Morningstar as closer to a growth stock than a value stock.
This would all be just a fun way to credit us for buying cheap stocks that are also growing but may be confusing to investors. Morningstar categorizes mutual funds as growth, blend or value based on each portfolio’s weighted average value-growth score over several years. In a diversified portfolio, oddities like First Citizens and Liberty Broadband cause only minor distortions in the portfolio score and may even be offset by other stocks in the portfolio. But in a concentrated fund, like Oakmark Select, large position sizes magnify the effect of those scores. Oakmark Select’s ownership of First Citizens and Liberty Broadband instead of more Wells Fargo and Charter puts Select on the bubble between value and blend. A small increase in its score over the next few quarters could result in Select’s category placement becoming a candidate for review by Morningstar.
Why does this matter? Say that an investor was taking a tax loss on one of their mutual funds and wanted to reinvest in a high-performing value fund that has announced it will not be making a capital gain distribution this year and has a value-growth score under 100. They would miss Oakmark Select. Even worse, current shareholders might redeem their investments after incorrectly concluding that we’ve changed how we invest. Many fund companies would resolve this by simply buying a less attractive bank and avoiding the cheaper Charter. At Oakmark, we will always invest your assets in the opportunities we believe are most attractive and will attempt to prevent any confusion by increasing shareholder communication.
In the same commentary I referenced at the start of this, I wrote that the spread in P/E ratios is higher today than it normally is. And that means we believe low P/E and P/B stocks are even more attractive today than they normally are. You can see that in our Morningstar value-growth scores, which change as the opportunity set changes. Remember the quote from that commentary, “Buying great businesses at average prices is just as much value investing as buying average businesses at great prices.” In 2022 we did just that, buying growth stocks whose prices had fallen sharply. We thought that made the Oakmark Fund’s portfolio as undervalued as ever, but it also became growthier. That was reflected by its value-growth score rising to a level that is associated with a blend category. But this year, after strong performance by those cheap growth stocks, we sold them and bought low P/E stocks. The Oakmark Fund’s value-growth score fell to its deepest value level since the dot-com bubble in 2000.
Despite our more inclusive definition of value, the Oakmark Fund today looks like a very typical value portfolio. At the end of October, the portfolio’s weighted average P/E on 2024 projections was 10 compared to 18 for the S&P 500. Despite paying less than 60% of the market multiple, the expected growth plus yield of our portfolio is higher than the consensus for the S&P 500. That’s why we’re so excited about the outlook for the Oakmark Fund.
The holdings mentioned comprise the following percentages of total net assets as of 10/31/2023:
|Security||Oakmark Fund||Oakmark Select Fund|
|Charter Communications Cl A||2.2%||4.6%|
|First Citizens Bcshs Cl A||1.6%||6.6%|
|First Citizens Bcshs Cl B||0%||0.4%|
|Liberty Broadband Cl C||1.0%||2.3%|
|Silicon Valley Bank||0%||0%|
Portfolio holdings are not intended as recommendations of individual stocks and are subject to change. The Funds disclaim any obligation to advise shareholders of such changes. Information about portfolio holdings does not represent a recommendation or an endorsement to Fund shareholders or other members of the public to buy or sell any security contained in the Funds’ portfolios. Portfolio holdings are current to the date listed but are subject to change any time. There are no assurances that the securities will remain in the Funds’ portfolios after the date listed or that the securities that were previously sold may not be repurchased.
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.
The price to earnings ratio (“P/E”) compares a company’s current share price to its per-share earnings. It may also be known as the “price multiple” or “earnings multiple”, and gives a general indication of how expensive or cheap a stock is. Investors should not base investment decisions on any single attribute or characteristic data point.
The price to book ratio (“P/B”) is a stock’s capitalization divided by its book value.
The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.
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 is 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.
Oakmark Select 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.
Investing in value stocks presents the risk that value stocks may fall out of favor with investors and underperform growth stocks during given periods.
All information provided is as of 09/30/2023 unless otherwise specified.