Excerpt from Graham & Doddsville newsletter for the month of October 2020, featuring an interview with Oakmark’s Bill Nygren, who shares his approach to value investing.
Read all about it – the fall 2020 issue of Graham & Doddsville, published by the Columbia Student Investment Management Association (CSIMA) in partnership with the Heilbrunn Center for Graham & Dodd Investing at Columbia Business School.
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Q3 2020 hedge fund letters, conferences and more
David Einhorn’s Greenlight Capital funds returned 5.9% in the third quarter of 2020, compared to a gain of 8.9% for the S&P 500 in the same period. This year has been particularly challenging for value investors. Growth stocks have surged as value has struggled. For Greenlight, one of Wall Street’s most established value-focused investment funds, Read More
In this issue’s in-depth interviews, you can read about:
- Bill Nygren, CFA, Portfolio Manager of the Oakmar Funds at Harris Associates – Mr. Nygren discusses Oakmark’s approach to value investing, which looks past traditional GAAP accounting to find businesses whose potential may be understated today. Bill shares with readers a few sectors Oakmark finds attractive, as well as his general views on today’s markets and how they compare to prior periods in his career;
- Ray Kennedy, CFA of Hotchkiss & Wiley – Ray shares his framework for credit investing in today’s uncertain times, and how his thoughts on the macro environment impact his approach;
- Sara Ketterer and Alessandro Valentini ’06 of Causeway Capital – Sarah and Alessandro describe Causeway’s unique lens on value investing, which combines rigorous fundamental business analysis with a quantitative overlay that helps structure their portfolios;
- John Mullins and Dan Kaskawits ’11, CFA of Lyrical Asset Management – Dan and John are co-portfolio managers and they explain their concentrated approach to value investing, which focuses on finding high-quality businesses whose secular growth characteristics are underappreciated by the market, resulting in cheap valuations;
Additionally, you’ll find two stock pitches from current CBS students who are participating in the Women in Investing Conference. We hope you enjoy this issue of Graham & Doddsville and welcome your questions and comments. To read past issues of the newsletter, please visit our archive.
Interview With Oakmark’s Bill Nygren
Bill Nygren has been a manager of the Oakmark Select Fund (OAKLX) since 1996, Oakmark Fund (OAKMX) since 2000 and the Oakmark Global Select Fund (OAKWX) since 2006. He is also the Chief Investment Officer for U.S. Equities at Harris Associates, which he joined in 1983; he served as the firm’s Director of Research from 1990 to 1998.
Mr. Nygren has received many accolades during his investment career, including being named Morningstar’s Domestic Stock Manager of the Year for 2001.
He holds an M.S. in Finance from the University of Wisconsin’s Applied Security Analysis Program (1981) and a B.S. in Accounting from the University of Minnesota (1980).
Editor’s Note: This interview took place on September 30th, 2020.
Graham & Doddsville (G&D): Can you walk us through your background and what brought you into the world of investing?
Bill Nygren: I grew up in a middle-class family in St. Paul, Minnesota. In school, I always did better with numbers than words and baseball was one of my passions outside of school. One of the things that attracted me to baseball was how easily available all the statistics were. I played Strat-O-Matic Baseball as a kid and was always looking in our local newspaper at the full page of baseball box scores that they had. Coincidentally in the St. Paul Pioneer Press, the business section was right next to the baseball box scores and that section had all the stock quotes on it. I was intrigued by this page of numbers that I didn’t know. When I asked my dad and he told me that they were stocks and that the numbers represented dollars, it suddenly became very interesting to me. So that interest in stocks and numbers was there from a young age.
I also grew up in a very traditional household. My dad worked outside the home and my mom raised the kids. My mom was always on a very tight budget for grocery spending. Therefore, she would always shop specials. When I was a little kid getting dragged to the grocery store with my mom, a weekly shopping trip would usually involve three different locations so we’d buy the stuff that was on sale at each store. If grapes were on sale one week and cherries weren’t, we had a lot of grapes in the house. We would alter our purchasing habits based on prices that were charged. That was how I learned to behave as a consumer—always trying to expand what my dollars could buy by being very careful about the price that I paid.
Additionally, there was a family trip out to visit an older cousin of mine who was serving in the Air Force. This would have been, I guess, the tail end of the Vietnam War. The trip took us through Las Vegas and my dad took my older brother and me into, I think what was the Kroger grocery store across the street from the Motel 6 that we were staying in. My dad pulled out five nickels and he said, “I’m going to show you two boys why you should never gamble.” He put the first nickel into a slot machine and seven nickels came out. Then he put the next one in and a few more nickels came out. I could see my dad getting frustrated because his object lesson was going awry.
But I was standing there saying, “Dad, stop. You’re way ahead, stop, stop.” And he just got angrier and angrier and threw these nickels in until they were all gone and then said, “See boys, you should never gamble.” By then my eyes were huge and I thought, “This is fascinating. I just watched my dad make multiples of his money. If only he hadn’t been so foolish to throw it all away.”
That created a fascination with understanding gambling versus investing. My dad worked in the accounting department at 3M Company. He had a business background, so I knew he understood probabilities and dollars and what made sense for investing. And here he was telling me gambling was foolish. So, I started studying all forms of gambling. I learned that lotteries gave you an expected value of about 50 cents on the dollar and horse racing was maybe 83 cents. If you played craps really well, you could get that up to 99. And if you counted cards in blackjack, you had a chance to get better than 100 cents.
All these things we called gambling had expected values less than 100 cents on the dollar, but the things we called investing gave you more; if you bought bonds, you would usually come out just barely ahead of inflation while stocks gave you a much more significant expected return. I became fascinated with stocks throughout high school. During college, almost all of my free time was spent reading investment books from our local library and over the course of a few years, I read most of the books they had about investing. That’s not as heroic as it sounds today because I’m sure the local library would have hundreds of books on investing. Back then they had maybe 10 to 20 books because it hadn’t really become the national pastime to figure out how to day trade and invest.
In my reading, I was always attracted to the people who approached investing the way my mom approached shopping. When Benjamin Graham said, “You buy stocks when they’re on sale,” that completely squared with the way I behaved as a consumer. I started to believe that my style of investing would be value investing. That’s not to say that I believe that’s the only thing that can work. But for me, it was important to have an investment approach that was consistent with the way I thought about money and all other aspects—trying to get the most value for my dollar and applying that same process to investing. I wasn’t fighting any cognitive battles inside my own head.
Once I had the feeling that an investing career is what I wanted to pursue, I thought it made sense to spend a lot of time learning the language of investing, which is accounting. I majored in accounting at the University of Minnesota and I had an internship at Peat Marwick and Mitchell, which was one of the Big 8 eight accounting firms back then. But one of the things that bothered me about an accounting career was that it looked like if you were 10 or 20% better than the person you were sitting next to, you could maybe get paid 10 or 20% more than that person could. There wasn’t leverage. In the investment business, the average investor doesn’t add any value to an index fund, but someone who can outperform the market can deliver tremendous leverage on the value of their time and that had great appeal to me.
And then one last story. My dad was a credit manager at 3M. I enjoyed the outward focus of his job. It was an interesting contrast between my dad and one of my uncles who also worked at 3M. My uncle managed the forms department and knew more about the company than almost any other human did because he helped write the forms that drove the operations for every department. My dad, on the other hand, knew a little bit about a lot of companies because he had to be responsible for credit decisions to 3M customers. Anything that was in the business news usually overlapped with what my dad was doing. When Chrysler was going through its bankruptcy, my dad was involved in decisions about whether or not 3M should continue to sell them product. I loved the external focus of having very broad, but more shallow knowledge as opposed to knowing all the details about one company. That cemented that I wanted to study investments when I went to business school.
Graham & Doddsville: How did you decide where to attend business school and where to launch your investing career?
Bill Nygren: I was at an internship at General Mills the summer before I started business school. The last couple of weeks there, they had executives from different departments taking us to lunch to try and convince us to work for them. I found myself saying, “What I’d really like to do is work in the pension department and work on investing the pension money.” And one of the guys said to me, “If you’re really interested in investing, General Mills probably isn’t the place for you. A very close friend of mine, Steve Hawk, is running this interesting program at the University of Wisconsin called the Applied Securities Analysis Program. I’d suggest you go down there and interview with Steve because I think that program would be really interesting for you.”
So I went and interviewed with Steve. Madison, Wisconsin wasn’t really on my radar, but when I found out I could get my master’s degree there in 12 months, I could start right after undergrad as opposed to waiting multiple years and I could spend most of my time in a program where the students got to invest real money, it was a no-brainer for me to go to the University of Wisconsin. Looking back, this was one of the best decisions in my career.
After Wisconsin, I took a job at Northwestern Mutual Life in Wisconsin and learned two key things during the two short years I spent there. First, it was important to me to work at a company where investment results drove the success or failure of the firm. Northwestern Mutual was driven primarily by its ability to sell insurance and the brand that it had with customers. It was important that they didn’t screw up on the investment side but getting unusually good returns was not as important to them as the ability to sell insurance was. Secondly, I worked in a small department there with portfolio managers whose investment process was kind of a mix of momentum investing and trying to use Wall Street buy recommendations to drive what was in the investment portfolio. As an analyst there, my managers and I were like two ships passing in the night. I would look at something that was on the new low list.
I remember looking at a company called Allied Stores, which owned Brooks Brothers among other things, and getting excited because I thought the real estate value of its properties was worth more than the stock price. Nobody on Wall Street was recommending it. I presented my report a doesn’t seem to be enough interest in this stock for us right now, so let’s keep an eye on it.” The stock did well and Wall Street started recommending it. They came back to me saying, “Hey, you like this Allied Stores, let’s look at buying it.” I responded, “Yeah, but I liked it when the stock was at $15 and I thought it was worth $30 and it’s selling at $27 now. I think there are better things we could do.”
I learned that being good at executing one’s personal investment philosophy didn’t really matter if the people that you worked with were using a different philosophy. Not that theirs was right or wrong; the important thing was that it was different, so we had a mismatch. I decided that I needed to change firms and was looking for a company committed to value investing, where investment results drove its success or failure. I called Steve Hawk and told him that I was going to be looking for another position and asked that he please let me know if he were to come across anything.
A couple of weeks later, my phone rang and it was Steve. He said, “Bill, an alumnus you don’t know named Clyde McGregor from a firm you’ve never heard of, Harris Associates, is going to be calling you in a minute about a junior analyst job. You should take the job. I told him to call you so I have to hang up now.”
A minute later Clyde called and invited me to come down to Chicago to go out to dinner with several Harris partners. They were asking about stocks I was interested in and were genuinely interested in all of the companies where I was hitting a brick wall at my current firm. There was an intellectual meeting of the minds that I’d never experienced before. I ended up joining Harris in 1983. My thought at the time was, “I can learn a lot here and I know the next three to five years will be good. I don’t know beyond that.” At that point, I wasn’t worried about beyond three to five years. And here we are today, 37 years later, and I’m still in the same spot.
Graham & Doddsville: It sounds like you had the Ben Graham value mentality early on and you were drawn to the statistical and the numerical side of things. But obviously Oakmark is known for not only being a value investor, but also looking for high quality businesses that are well positioned. Could you talk a little bit about kind of how that transition emerged for you and maybe delve into the strategy at Oakmark?
Bill Nygren: I think part of it is just how business has evolved more than how we have evolved. If you look back to Graham’s time, businesses were hard asset-based. Fixed assets on the balance sheet were depreciated and there was a reasonably good correlation between stock prices and book value because competitive advantages that didn’t get represented on the balance sheet tended to be relatively temporary. A textile company that was first to invest in the newer, faster looms for a few years would have a competitive cost advantage. They would do really well, then their competitors would make the same investment and they were back to the same lousy commodity-based business that they had always been in.
But looking for discounts to book value tended to identify average businesses that were out of favor. If you did that and were patient and waited for a reversion to the mean, you could be successful. In the early 1980s, Warren Buffett was instrumental in expanding the universe of what we called value. He invested in a consumer business that left a lot of his followers scratching their heads because it sold at a multiple of book value. Buffett’s comment was, “If you look at the assets on the balance sheet, you won’t even find brand value, and that’s more important than any of the assets that are listed on the balance sheet.” That started a move in the value community to look for important assets that weren’t part of book value.
It could be real estate that was at a historical cost and today was worth way more than it was when it went on the balance sheet. It could be brand value that was created through advertising, which was expensed and not capitalized. The same applies to customer acquisition costs and R&D expenditures, which not only didn’t increase book value, but also depressed earnings. At Oakmark, we were always open to the idea that GAAP accounting was not a perfect measure for how business value was growing.
One example from the early days of Oakmark in the early 1990s is the cable TV industry. We were seeing a lot of private market transactions taking place at enterprise values of $1,000 a subscriber or 11x EBITDA. These were companies that didn’t look cheap on net income or book value, but there was clearly business value there. We went through and reconstructed income statements and balance sheets acknowledging that customer acquisition costs had very long-term benefits and that depreciation of cable in the ground was occurring at a much more rapid rate on the accounting statements than it was in real life. If you made the accounting match real life, these companies had real book value and real earnings.
We also felt that way about a company like Amgen where very heavy R&D spending was depressing earnings and making it look very expensive relative to the pharma industry. But if you looked at enterprise value to EBITDA plus R&D, Amgen looked much cheaper than the pharmas and it also had much longer patent protection and much better growth ahead of it. That ability to make exceptions to GAAP metrics when we don’t think GAAP reflects the real world carries through to today to positions that are important to us, like Alphabet, where its spending on “Other Bets” goes through the income statement, depresses earnings by something like $6 a share and is not reflected on the balance sheet.
If Alphabet were investing with Kleiner Perkins instead, it wouldn’t be called an expense and there’d be an asset on the balance sheet called venture capital investments. But they do it themselves, which we think is even better because it helps them hire higher quality engineers. But as a result, it depresses the earnings and inflates the stated P/E multiple. Once you adjust for that and the cash on the balance sheet, which earns almost nothing today, you see that you’re really not paying much more than a market multiple for the Search business.
Another example is Netflix, which very strongly rhymes with the way we thought about cable TV companies. It isn’t reporting much in the way of income and its book value is relatively meaningless. A similar company like HBO got purchased by AT&T as part of Time Warner for a value of a little more than $1,000 per subscriber. On that basis, Netflix stock looked very cheap and based on the subscribers they were adding every year, it was selling at a single-digit multiple of the value it was adding. We don’t think of value and growth as opposites. Growth is a positive characteristic in a company and as long as you don’t overpay for it, it’s a nice thing to have.
We also owned Apple for a long time, although we finally sold it last quarter. Almost the entire time we owned the company, it was selling at less than a market P/E multiple, yet it was always the first question we got asked by clients or consultants. “How can a value manager own a growth company like this?”
If we can get growth and not overpay for it, that’s a huge positive. I think there are mischaracterizations of how value managers should think—that we should be confined into this universe of subpar businesses that are destined to fail in the long term. That’s not how we at Oakmark think of value at all. We believe there’s a way to value a business fundamentally and if we can buy a stock at a big discount to that value, whether it’s a low P/E or a high P/E, it’s a value stock.
Read the full letter here.