Nygren manages the $6 billion Oakmark Select fund, which invests in about 20 mid-cap and large-cap U.S. stocks — or as he puts it, his 20 favorite ideas. The fund has returned 21 percent a year on average over the past three years, beating the Standard & Poor’s 500-stock index by near three percentage points, and beating other large-blend stock funds by about 4 percentage points.
Nygren recently spoke with The Post about where he is putting his money today, the kinds of companies that are poised to benefit when the Federal Reserve finally increases rates and the missed opportunity in stocks he didn’t buy soon enough.
This interview has been edited for length and clarity.
How do you characterize the market we’re in now? And how are you navigating it?
When you think about where we are now in the market, go backward. The market has tripled from where it was six years ago. So if you thought it was at an appropriate level six years ago, then it’s easy to conclude that we must be abnormally high now and in dangerous territory. Our view six years ago was that we had a buying opportunity. We went from a period where we had very low price to earnings ratios on very low earnings to numbers that are more like normal. P/E now is in the mid to upper teens, that’s about what it’s averaged historically.
Some people interpret the market as fairly valued and think it must be time to sell. We would think that a fairly valued market means you should expect returns going forward that are about average. And average has been a [few percentage points] a year more than you can get in intermediate term bonds. So it’s not a super exciting number, compared to it tripling over the last six years. But I think an equity investor today who is invested for the long-term can expect a mid- to upper-single digit minimum return in the market. I think there are certain areas where investors are still skeptical because performance was so poor six years ago, like financials, where if you tilt your portfolio in that direction you’re likely to do better than the market.
Let’s talk more about that. Citigroup, Bank of America and JPMorgan Chase are in your top 10 holdings in the Oakmark Select fund. Tell me why you’re investing so heavily in financials.
To start with, the average large bank today is selling around book value or below it. Most of them believe they can earn a double-digit return after all of the legacy mortgage costs have worked their way through the income statement and after we get to somewhat more typical short-term interest rates — it’s unlikely that they’re going to be zero forever.
So if you believe that, and banks are selling at single digit multiples at a time when the S&P 500 is almost twice that much, then selling at half the market multiple doesn’t seem like the right end point for the banks. Now some of the argument has been that it’s too risky. I think investors are penalizing banks for what they were six years ago. On average they were over-leveraged, they had made loans to people without worrying about whether they’d get paid back. But within the last seven years or so, banks have not done a lot of lending, the lending they have done is the good old-fashioned lending and they expect to get paid back. The other thing is balance sheets have improved dramatically.
I think investors have been quick to penalize the banks for the additional demands on capital by the regulators, but they haven’t given them credit for that by saying these are becoming much less risky businesses. You hear a lot of investors say you’re never going to earn a great rate of return.
If we get the slow economic growth and slow loan growth environment that a lot of people who are negative on banks think is likely to happen, I think the flip side of that is banks have enough capital and ought to be able to return to shareholders almost all of their earnings. Look at something like Bank of America, which is one of our largest holdings. Two years from now they should have a book value per share of about $24 from about $17 today. If they don’t have much loan growth, they don’t need to reinvest any of their earnings. Even with no growth they could have yields of more than 8 percent.
How would your view be affected if the Federal Reserve raise rates?
First, we’re not macro people. We don’t think we’re any better at forecasting what’s going to happen to interest rates or the economy than anybody else is. So our analysis is all bottom up. But with that said, if you look at the banks’ balance sheets today, we believe they are likely to benefit from higher rates, which is unlike the way banks were structured 15 or 20 years ago. Effectively what banks are doing is creating a very low cost funding source. They collect deposits, and then they lend that out. That low cost source of funding doesn’t create much value because banks can borrow for almost nothing anyway.
In the environment where rates pick up a little, banks would benefit from having the higher deposit rates. The rates on deposits aren’t as sensitive as the short term Treasury bill. There would be a lag. Returns to savers have never been timed with T-bill rates because banks are providing a service to you as well. You’ve got an account, they’re cashing your checks for free, they’re producing statements every month, so they couldn’t pass through the equal value. A lot of banks run money-market funds and they can’t charge the fees on them right now because that would push the return to a negative number. So as rates rise gradually, I think we’ll see a positive effect on bank earnings. The returns to savers would go up, but the returns for banks would go up more.
Walk me through your criteria for choosing investments.
For starters, at Oakmark we are very long-term investors. We think as more and more investors become short-term and momentum focused, the opportunities become greater for the investor who is going to take a fundamental approach and invest for the very long term. We’re looking to identify companies that today are selling at a large discount from what we believe they can be worth five to seven years from now.
We’re looking for companies where we expect that per share value to grow over time. And we’re looking for companies where management is on the same side as shareholders. Where their economic incentives create an environment where the stock price gets bigger, as opposed to just create an environment where the company gets bigger.
What areas are you favoring right now?
Let’s start with what we aren’t investing in. Investors have become very frustrated with how low yields are in the fixed-income market, and they have migrated to companies with relatively safe business models. Companies that tend to pay out most of their earnings. Like utilities, consumer nondurables that are viewed as only a little bit riskier than bonds but have much higher yields. Those stocks have gotten bid up by the frustrated fixed-income buyers, so we have very little invested there.
We think there is an unusual opportunity today to buy very high-quality, high-growth companies without paying much of a premium. In our portfolio you’ll find companies like MasterCard and Google or Amazon. But companies that sell at a small premium today that have sold or we believe have the fundamentals they deserve to sell at a very large premium.
I think that’s one of reasons so many other investors get frustrated by this market and kind of draw their line in the sand saying things are too expensive. They say they got burned by financials in ‘07, don’t ever want to own those again. And then as a value manager they don’t like to pay more than the market multiple.
So you’ve gone from companies that were at a deep discount to companies that are fairly valued but could be trading at a premium?
What we always do is look for companies that we believe are selling at significant discount to their intrinsic value. Six years ago, like all the other value investors, we were finding that good industrial companies with high market shares were selling at big discounts to market multiples. All you had to do was believe the economy would recover and they were cheap. Every value manager liked them.
There are people who think value managers are condemned to only be able to purchase lousy companies and they get them when they’re super cheap. We don’t think that way at all. We’re always trying to explain how can you own Google? How can you own Monsanto? The reason is when we go through the math on any company to see what it’s worth, we don’t just assume everything deserves to sell at the same multiple.
There are a lot of inferior companies that we don’t think deserve that multiple, and there are other companies that we think had extended periods of tailwinds that deserve a pretty significant premium. Something like Google, the biggest beneficiary of the transition of advertising from print to electronic. How long will that trend likely continue? I think for a very long time. As value managers, we usually identify those trends, but we say the market is paying so much for them.
What was your biggest investment mistake?
One of the mistakes I made earlier in my career, even before I was a mutual fund manager, was thinking that as a value investor the only people I could learn from were other value investors. I think you find a lot of value investors who think that way. They read 10 books on Warren Buffett. If you’re only going to read a book on one manager, that’s the right one to read. But by the time you get to book eight, nine or 10 about the same person, I think there’s a lot to be learned from investors who use different styles.
As I’ve read more about some of the great hedge fund managers like Michael Steinhardt or George Soros, I find I learn more about how to treat my own investments when I read about them than I do when I read about what Buffett eats for breakfast. If you read about how someone thinks or approaches something completely different from the way you approach it, you can learn more. It can increase your confidence in how you’re doing things or you can say that’s a neat way of thinking and if I apply that to what I do it would be a slight change. The person who always watches MSNBC might learn something if they listen to Fox News once in a while and vice versa.
Any regrets from earlier in your investing career?
Almost anyone who has been in the business as long as I have, the biggest mistake was something they thought was attractive they didn’t have the capital — missed opportunities.
I look back at a couple years out of the crisis when Apple was trading at about $80 a share. One of our analysts recommended it. I was convinced enough to buy it in the Oakmark fund, but I couldn’t quite get over the hurdle of saying it was one of my 20 favorite ideas. It was very close. That stock went from $80 to, split adjusted, it’s almost $1,000. Missing that opportunity trumps every other mistake I’ve made in Oakmark Select. Not investing heavily enough in your biggest idea.
Why did you hold back?
I didn’t like the way management was hoarding their excess capital, and I was concerned that was a philosophy that wasn’t likely to change. Tim Cook deserves a lot of credit for the way he has handled excess capital. Now most of it comes back to shareholders, either preferably through repurchasing shares or through dividends. Before they kept growing the mountain of cash in their balance sheet to the point it was inconceivable they would ever need it.
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