Value Investor Insight
We assume taking a longer-term perspec-tive has proven painful at times over thepast year.DH:
Of course. We were early into finan-cials as we thought valuations got so farremoved from what we expected “nor-mal” to eventually be, but as you know,the gap got painfully wider before it start-ed to turn the other way. We spoke withyou about Credit Suisse [CSGN:VX] in January [
, January 30, 2009] and thestock proceeded to fall another 30% byMarch, to less than 22 Swiss francs. Sincethen it’s up more than 150% [to a recent56.65 Swiss francs].Another similar example is Allianz[ALV:GR], the giant German insurer andfinancial services company which manyU.S. investors know as the parent compa-ny of Pimco. We’ve always considered itwell-managed, but it got painted with thesame brush as all financial companies asthe crisis unfolded and its stock gotcrushed. But we saw them taking steps tofocus on their core strengths in propertyand casualty insurance, life insurance andasset management, while getting out of businesses like commercial banking. Wealso saw them benefiting over time fromthe extreme distress of one of their largestglobal competitors, AIG.Our feeling then – which hasn’tchanged – was that Allianz would be verywell positioned to come out of the crisisin a strong competitive position with alot of earnings leverage. Of course, themarket couldn’t have cared less aboutany of that in November of last year or inMarch of this year, when the shares wentbelow
50. The stock has come back toaround
80, but we still have a big posi-tion because we believe the intrinsicvalue based on normalized earnings iscloser to
Do you still consider Credit Suisse sharesattractive?DH:
Yes. Its tier-one capital ratio is over15%, its private-banking franchise goesfrom strength to strength and its invest-ment bank has survived relatively intactin a business in which a lot of big com-petitors have disappeared. We sold someshares as the price increased – maintain-ing around a 3% portfolio position – butwe still believe the sum-of-the-parts valueis closer to 115 Swiss francs.
Talk about one financial that didn’t workout so well, the U.K.’s Lloyds.DH:
One of the more common unhappyreasons we sell is if management provesnot to be the worthy steward of our cap-ital that we thought. Lloyd’s did some-thing colossally stupid in buying a finan-cial train-wreck called HBOS lastSeptember. Lloyds was a company thatcould have come through the crisis almostunscathed, but they stole defeat from thejaws of victory by buying HBOS. We lostmoney on it, but the only consolation isthat we got out when the shares werearound £1.20 and it’s now trading under£0.90. You have to be able to take a lossin this business – we ended up puttingthat money mostly in other financials likeCredit Suisse or BNP Paribas, which havedone very well.
How do you organize your researcheffort?DH:
We have eight people focused oninternational research, with seven of ouranalysts responsible for at least two dis-tinct geographic regions. We’re abso-lutists, so we don’t want people to saythings like “this is cheap for a Germancompany,” but instead focus on whetherit’s an attractive international idea.We do some regular quantitativescreening for what looks cheap and of good quality – say, looking at enterprisevalue to EBITDA relative to return onequity. For things that look attractive, ournext step is to interview management andtry to fully understand the return charac-teristics of the business and how manage-ment makes capital-allocation decisions.
Is interaction with management more dif-ficult outside the U.S.?DH:
There are still language barriers,particularly in Japan, but that’s gottenbetter over the years as English hasbecome firmly entrenched as the interna-tional language of business. Culturally, insome parts of the world we’re up againsta kind of social-democracy attitude, thatsays shareholders are equal constituentswith employees and customers and sup-pliers and banks. I don’t ascribe to that atall, so in some cases we have some con-vincing to do. Most often, if that attitudeis too prevalent we just won’t be veryactive.
Your portfolio is heavily weighted toestablished rather than emergingeconomies. Why?DH:
For our type of investing, whichinvolves buying big stakes in companiesand investing for the long term, we needtransparency and a firmly established ruleof law. If we can’t believe the financialstatements or we see too much risk of therules being changed after the game starts,the whole exercise is pointless. As aresult, we won’t invest in Russia. We’vealso never owned a mainland Chinesecompany, because most of them are con-trolled by the state and there’s too muchpotential conflict between shareholderand state interests. Say the governmentwants independence in inter-coastal ship-ping, so directs a shipping company tobuy ships that might produce lousyreturns. That’s terrible for shareholders.Our emerging-markets exposure hasbeen as high as 25%, but is now for bothour large- and small-cap funds in the 4-6% range, with most of that in Mexico,South Korea, Israel and Malaysia. Themost-asked question I get in the past threeor four months is, “Why aren’t you moreheavily in emerging markets, don’t you
We’ve never owned a mainlandChinese company – there’s toomuch potential conflict betweenshareholders and the state.