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Profit Guru Bill Nygren

Profit Guru Bill Nygren

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Published by ekramcal

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Published by: ekramcal on Nov 29, 2008
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Po Guu
calm andcollected
th urr rk uri hs hrw up   f irsig ppruiis,sys Bi nygr f okrk S Fu
mh ekru Hqu & n mhkshi
 
59
12 December 2008
Oulook PrOfit
T
he only investors who belong in the stock marketare investors who can take a long-term time hori-zon,” declares Bill Nygren, und manager o theOakmark Fund and the Oakmark Select Fund.There’s no time like the present to drive home the truth o that statement. Even as short-sighted investors stampedeor the exits amid a growing global nancial crisis, valueinvestors like Nygren, 50, are gearing up to do what theydo best – buy into undamentally sound, long-term busi-nesses at relatively cheap prices.Nygren’s rst brush with the world o investment tookplace at Northwestern Mutual Lie, which he joined as ananalyst in 1981. Two years later, he moved to investmentrm Harris Associates. Today, Nygren is director at therm, and his career graph depicts a steady climb. It wasater being named director o research in 1990 that Nygrenpushed his rm to create a und that would manage assetsin a much more concentrated ashion than those handledby other money managers. That idea came to ruition in1996 when the Oakmark Select Fund was created.Interestingly, Nygren never promised extraordinarygains rom his unique style o investment: instead, he toldhis bosses that over the next ve years, they could prob-ably hope to see one exceptionally good year, one year that would ‘hopeully, not be horrible’, and threeyears o mediocre returns. Happily or ev-eryone involved, the und experienced veexceptionally good years: since inception, ithas handed in a 29 per cent return (annu-alised) compared with the S&P 500’s 11.5per cent and 16.8 per cent a year return orthe S&P MidCap 400. In act, so impressive was the und’s perormance that it rankedamong the top 1 per cent o all unds trackedby
 Morningstar
, a und tracker, duringthe period.To date however, the und’s perormanceis more modest, but still creditable with an11.9 per cent return (annualised). As o to-day, Bill manages $3.6 billion worth o assetsunder the Oakmark Fund and $2.5 billion inthe Oakmark Select Fund.Nygren’s investment style is simple: hebuys stocks when they all to or below 60per cent o the estimated business value and sells them when they hit 90 per cent. To calculate business value, heuses the discounted cash fow (DCF) method, eschewed byother value investors. He says, he understands the prob-lems in depending solely on DCF to estimate business value, but points out that his rule about buying only whenstocks all to 60 per cent o business value itsel oers acushion against making grave mistakes in calculatingbusiness value.Nevertheless, this astute investor has made his shareo mistakes. Ater the tech bubble (which Nygrendid not participate in) burst, value investors ound ahappy hunting ground in nancial stocks. Many o them believed that these stocks were intrinsicallyhigher than the prices they were trading at. Nygren wasone o them. But that was a bet time proved wrong, as therisks attached to these stocks were ound to be greatlyunder-estimated.Nygren had bought into regional bank Washington Mu-tual (WaMu) enthusiastically (at one point, the stock ac-counted or 15 per cent o Oakmark’s portolio), promptedby bullishness on the institution’s retail asset base whichhe thought was not ully valued by the markets. Whenthe credit crisis ripped through the nancial sector, thebank’s operations crumbled and it had to le or bank-ruptcy. Nygren openly admits he made a mistake with Wamu. “Selling was the right decision, but by the time wesold, the damage had been done,” he wrote in his latestund note to investors. Ironically Wamu’s retail bankingassets were sold to JP Morgan (another Nygren hold-ing) beore it went belly up. In an interview with
OutlookProft
, Nygren explains what went wrong with Wamu, hisoverall investment strategy and his take on the US econo-my and stock markets.
What is your prediction or the US stock markets ?
I think it’s very hard to predict what is going to happenin the short run; the longer you stretch your horizon, theeasier it becomes to orecast. I you think about a ve-year time rame, it’s sae to assume that P/E ratios goback to normal and it’s pretty easy to assume that theeconomy will go back in ve years to something resem-bling normal growth rates. In 2009, it is easy to assumethat corporate earnings will be down a little bit and may-be even that investors will award an above-average mul-tiple to earnings, but I have a very hard time making thatprediction.Thinking ve years ahead, I think corporate earnings will be higher, P/E multiples or the S&P500 will be higher and that will create verygood returns rom the US stock markets.These returns will oer a very substantialpremium relative to xed-income markets,especially treasuries. So we think this a very attractive opportunity or investors tocommit new capital, with the caveat that in- vestors who worry about day-to-day pricefuctuations should stay away. Regardless o the opportunity, the only investors who be-long in the stock market are investors whocan take a long-term time horizon.
Where do you see value emerging in the USequities now?
First, I’d like to say that I nd the S&P 500attractive across the board. To me, this isnot a time when only one or two sectors arecheap and the rest o the markets are air-ly valued. This is a time when most large-cap US stocksappear to be selling well below business value.In concept, I would say the characteristic that is mostovervalued in today’s market is saety: look at treasurybills that yield almost nothing and how large the premi-um is or holding long-term corporate bonds instead o long-term treasury bonds. Within equity markets, compa-nies that have perormed the best have been those thathave seen the least volatility in their business models. Ibelieve it is becoming increasingly dicult to justiy own-ing those stocks versus the rest o the market where pric-es have come down sharply.
Could you elaborate on your investing strategy?
There are three things that we look or when consideringinvesting in any company. First, the stock price should beat a signicant discount to the intrinsic business value.To us, the intrinsic value would be the highest price anall-cash buyer would pay or the entire business and stillmake a reasonable return on investment. For most large-cap companies that we invest in, it’s not very dierentrom estimating the discounted cash fow (DCF) to esti-mate the intrinsic value o the stock. For smaller com-panies, it could end up being dierent as we explicitly
 This is anattractiveopportunity tocommit newcapital, withthe caveat thatinvestors whoworry aboutdaily priceuctuationsshould stayaway
 
consider the synergies a buyer o the entire businesscould achieve. For large-cap companies, we basically lookat a price that is at a signicant discount to the DCF valu-ation.
 
Our basic strategy is to buy a company only when itis trading at 60 per cent o its value and to sell them whenthey achieve 90 per cent.The second criterion is that a company’s growth plusdividend should at least match the gure or the market. We don’t care in what orm our returns come, via growth orcapital gains, but we want the combination between divi-dend yield and expected growth in business value to atleast match what we receive in the S&P 500.The third thing that we look or is companies that view their shareholders as partners. We like them to think asowners and not proessional managers and that especiallycomes into play when they consider business opportuni-ties. Whether it’s about selling business units or perhapseven the entire company or re-purchase shares versusmaking acquisitions to grow the business, we want man-agement to take the course o action that maximises pershare business value. We also want them to eel the responsibility o communi-cating to us, the owners, as candidly as possible and oertimely explanations o results without hurting their com-petitive positions. It’s only when we have all these things– a discounted value, a value that is growing over time anda shareholder-oriented management – that we can take along-term time horizon that gives value investors a signi-icant advantage, because the longer it takes or the stockprice to catch up with the business value, the higher thebusiness value will be.
 You have said that you look or businesses that haveachieved large increases in value and whose stockshave under-reacted. How do you identiy and measurethis increase in value?
Generally, this would be either a corporate event (such asa division sale), improved earnings or improved balancesheet. Value change resulting rom transactions is a goodhunting ground because changes in value can be largeand can happen quickly. Measuring how value chang-es rom balance sheet improvement that occurs overtime requires simply looking at the change in net debtper share. An improvement in earnings per share is equally easyto measure, but then some judgment needs to be ap-plied to determine whether or not the improvement issustainable. Corporate transactions involve comparingproceeds rom a division to its estimated value whileacquisitions require examining both the acquired proper-ties and the consideration given in return (or example i stock is issued, one has to consider whether it was issuedat a premium or discount to the intrinsic value).In the end, value estimation has to be an ongoing pro-cess, and always requires estimating the value o each as-set a company owns, subtracting claims that are senior toequity against those assets, and dividing what remains bythe share base.
A lot o value investors believe the discounted cash flow(DCF) method is not a good way to calculate growthrates or the near and long term. What do you think andhow do you calculate value?
I think the most important thing is to use multiple meth-ods o valuation and make sure they converge to the samebusiness value. DCF is denitely not an exercise in pre-cision, that’s why we demand such a high gap versusour business value estimates. We approach it by lookingat comparisons o similar businesses that have been ac-quired, the price-to-sales ratio it was sold at, the price-to-cash fow, P/E, P/B etc. We try to nd the metric buyers in that industry wouldtypically use to identiy business value. We look at wherecomparable companies are trading in the markets and welook at a dividend discount valuation. I you see radicallydierent gures o business value with dierent meth-ods, that’s a good indicator that some o your assumptionsare inconsistent between models. In act, by looking atmultiple models and orcing them to come to similar con-clusions, I think we probably decrease the probability o having one minor error infuencing our business valueestimates too strongly.
How much weight do you give to past fnancials andtrack records?
 Every time we look at a business, we try to ascertain how sustainable their results are: a company that has a goodtrack record earns a substantial premium to its cost o capi-tal. Beore we orecast that to continue, we have to be as-sured that there is a sustainable competitive advantage. Theeasiest example o that would be branded consumer prod-ucts. A brand is a very valuable asset, but is usually not onthe balance sheet. We do study historical track records, and I would say thatit is a very good way o judging the management team. Welook or companies that try to maximise business value orshareholders. We also look at not just the records the manag-ers have in their current jobs but also in their previous ones. When the CEO brings in a new CFO, we look at how capital was allocated at the rm where the CFO came rom.I the management team has been working at the samecompany or a long time, then we would give more weight tothe long term-track record o the company.
Oulook PrOfit
12 December 2008
60
Po Guu
 
Po Guu
8 
On BAR AC K OB AM A
Look ingat Obama’sadvisors , I think, t hey will ensure hatever  policies come out of t he Obama administ ation donot hav e unintended negativ e consequences onthe mark ets
8 
On M ARK ET S FI VE Y EARS F ROM N OW  
Corpor ateearningswill be higher, P/ E multiples f or the S&P 500will be higher and that w ill cr eatever  y good  etur ns and oer aver  y substantial premium relativ e to x ed-income mark ets
8
On H IS I NV ST INGSTR AT EGY  
Basicstrat egy is tobuy a company only when it is trading at 60 per cent of itsvalue and tosell when they achiev e 90 per cent 
 
8 
OnVALUE IN VESTORS 
“Value investorsusually havesus picions about theability of com panies t o perfor m d amatically bette than heir com pet itors. The y don’t l ike t o pro ject s  penor mal grow th f or v ery l ong and that makesit  much harder to j ustif  y pa yingabove-aver age mul tiples
Nygren Says

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