Value Mgr Doubles S&P Over 15 Years: His Picks
The managers of the $14 billion deep value/contrarian FPA Crescent mutual fund spent the third quarter increasing their stake in Microsoft (MSFT) and Oracle (ORCL). And we’re not talking about some small nibbles. The 28% increase in Microsoft shares brings FPA Crescent’s stake to more than 7% of the fund’s assets -- the largest position in the fund. A 20% rise in its Oracle share count brings the Ellison ship to more than 5% of FPA Crescent’s investment portfolio. Add in a 3.5% stake in Cisco Systems (CSCO) and it’s clear long-time manager Steven Romick, and new co managers Mark Landecker and Brian Selmo are finding plenty to like in easy-to-beat-up old tech.
For the record, they didn’t add to the Cisco stake in the third quarter -- giving it a small profit-taking trim. Interestingly the FPA Crescent managers didn’t trim their Google (GOOG) shares in the third quarter, which now account for more than 3% of fund assets. It will be interesting to see in next quarter’s portfolio report if Google’s surge, after reporting third quarter results, induces the manager’s to trim at all.
FPA Crescent first bought Google in the first quarter of 2012 and last added to the position a year ago. Google has certainly paid off quickly for the patient fund managers -- and swamped the performance of Microsoft and Oracle since all three were sharing space in the portfolio.
But right now it’s Microsoft and Oracle that are deeper conviction stocks.
A quick detour to explain why it’s worth taking a dive into the FPA Crescent portfolio. Romick has generated a 10.2% annualized return over the past 15 years, about double the return of the S&P 500 over that stretch. What’s really impressive is that the fund is a mash up of bonds, stocks and cash; so its essentially delivered impressive equity returns without impressive equity volatility. This year the fund has managed a 16% gain, a bit behind the 20% rise in the S&P 500.
Before you scoff, you need to appreciate two things: that came while lugging around a 30% cash position -- earning nada -- because the managers can’t find enough good values. And the managers aren’t sweating lagging in a strong market. Their long-term outperformance comes from participating in the upside and outperforming in down markets. To grasp why the fund's picks do so well, it helps to have investment research tools
As explained previously, the managers aren’t expecting some epic growth resurgence for Old Tech.
Rather, they see super-cheap stocks that have very sticky business lines. As Romick recently discussed with Morningstar (MORN), while Windows 8 and the unimpressive Surface tablet get plenty of (deserved) bad ink, what gets less attention is that there are 750 million people around the globe using Microsoft Office. It’s the business side of Microsoft’s operations -- which FPA puts at 75% of the company's operations -- that FPA Crescent is paying attention to. (Full disclosure: Morningstar is an investor in YCharts.)
In that Morningstar interview Romick also explained the managers bend over backward to conservatively value the old techsters. They recognize that given their massive cash inflows, acquisitions are part of the businesses -- and they are careful to make sure that their financial analysis includes that ongoing expense. Romick told Morningstar: “…we actually budget that M&A and reduce our earnings, almost as a second R&P expense. So our earnings tend to be lower than the consensus estimates.” Even so, he says the stocks are still selling at single-digit PE ratios based on their acquisition cost.
YCharts’ PE ratios for the old-techsters aren’t at single digits, but you can clearly see what’s so appealing. At a time when the S&P 500 is trading at a 16 PE based on 2013 estimates, and the info tech sector is at 14.8, the Microsoft, Oracle, Cisco triumvirate are indeed cheap.
And it’s not as if they are in some operational free fall. As shown in this chart, Microsoft has had revenue and profit growth plenty of S&P 500 companies would drool over:
And for all the noise that Oracle is having a tough time transitioning to the cloud business model, it’s not exactly imploding either:
Maybe they stay cheap for a long time. But when a fund with FPA Crescent’s bona fides makes ‘em such a high conviction investment, it seems worth consideration that there is unappreciated value here. One valuation metric the team has referenced in the past is EV/EBIT. Microsoft and Oracle haven’t budged, while Google has seen a sharp rise since early 2012 when FPA Crescent first bought in:
There’s also a pretty decent shareholder return story with both Microsoft and Oracle. Microsoft has one of the most consistent and impressive dividend growth stories in the tech sector, and right now there’s a 3%+ dividend yield.
Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at firstname.lastname@example.org. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.
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