Coronavirus fears have swept through markets recently, as concerns about its potential global impact have rapidly accelerated from “This will be bad for China for a while” to “How many weeks of food should our family have on hand?” In the face of this anxiety, we want to explain how we’re factoring in the possible significance of this virus on the value of your investments.
At Oakmark, we buy stocks at substantial discounts to our estimates of their intrinsic value, taking the perspective of being the sole owner of a private business. We estimate these intrinsic values by forecasting future cash flows and discounting them to today. The S&P 500 trades at a 2020 GAAP P/E ratio of around 23-24x today, which, converting earnings to cash flow, means the typical company will generate 4%-5% of its current market cap in 2020 cash. Mathematically, most of the total value of a growing company comes from the aggregate cash it will generate in the years 2023-2050 and beyond.
If 2020 cash flows for the entire market dropped all the way to zero, the aggregate value of the market should only fall by 4%-5%. Therefore, we believe the proper question to ask when analyzing the coronavirus (or any emerging macro risk) is “How much will this affect the long-term cash flows of businesses?” I doubt very much that the owner of a thriving family business would accept a dramatically reduced offer for her entire company today versus two months ago simply because of virus fears.
While we can’t answer that long-term cash flow question with certainty, we can look back at prior “epidemic” fears to see the impact they had over time. SARS, bird flu, Ebola, and the West Nile virus are all examples of exogenous medical emergencies that the market faced the past two decades. In all cases, world economies adjusted to the threats without seeing significant impacts to long-term cash flows. In all four of those cases, the S&P 500 index exceeded its pre-outbreak high within two months of the initial concerns.
But it’s not just epidemics…it’s always something. In Bill Nygren’s third-quarter market commentary of 2016, when he discussed the Oakmark Fund’s 25th anniversary, he cited a litany of frightening events that occurred over that preceding quarter century (including the aforementioned epidemics, Desert Storm, 9/11, the global financial crisis, Brexit, etc.). Despite all of these risks, the S&P 500 increased nine-fold over that time frame (and the Oakmark Fund 19-fold).
As with those other nerve-wracking crises (each uniquely different from each other), no one knows how this particular issue will develop. There isn’t enough data today to reach specific conclusions. But you should know that at Oakmark, our framework for dealing with exogenous risks like this is to attempt to determine the impact on business value rather than extrapolate near-term costs in perpetuity.
Average Annual Total Returns (as of 12/31/2019)
|Fund||3 Month||1 Year||3 Year||5 Year||10 Year||Inception|
|S&P 500 Total Return Index||9.07%||31.49%||15.27%||11.70%||13.56%||10.00%|
Gross Expense Ratio (as of 09/30/2019): 0.92%
Net Expense Ratio (as of 09/30/2019): 0.88%
Fund Inception: 08/05/1991
The net expense ratio reflects a contractual advisory fee waiver agreement through January 27, 2021.
Past performance is no guarantee of future results. The performance data quoted represents past performance. Current performance may be lower or higher than the performance data quoted. Total return includes change in share prices and, in each case, includes reinvestment of dividends and capital gain distributions. The investment return and principal value vary so that an investor’s shares, when redeemed, may be worth more or less than the original cost.
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 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 Oakmark Fund’s portfolio tends 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.
The discussion of the Fund’s investments and investment strategy (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) represents the Fund’s investments and the views of the portfolio managers and Harris Associates L.P., the Fund’s investment adviser, at the time of this publication, and are subject to change without notice.