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Michael Sandler of Clipper Fund

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Quick Take:Value funds have done better than most U.S. stock funds lately, but Clipper Fund (CFIMX) holds the record as the best-performing large-cap value fund (+18.3% annualized) for the ten-year period through last March. Lead manager Michael Sandler is the first to admit that recent results can skew relative standings, although Clipper has also held its own lately, rising 11.9% for the one-year period through April, while the average large-cap value fund fell 6.8%.

Sandler may be modest — “I can’t guarantee that our future returns will look as good” — but he traces his fund’s sucess to waiting patiently for leading companies to stumble. Betting on bad-luck stories, Sander says he “constantly tries to look beyond the chasms for intact franchises that will emerge stronger.”

Sandler has found promising turnarounds in many sectors, although he isn’t comfortable with tech or biotech companies. True to his dictum that periods of panic selling often represent buying opportunities, Sandler recently picked up Tyco International (TYC), believing its cash flows will be solid down the road.

The Full Interview:

S&P: Why is the fund’s long-term record so strong?

SANDLER: Recent returns can often affect your long-term record. For instance, our numbers didn’t look so good during the tech bubble when we refused to play the technology card. The best-performing managers over the long term are willing to differentiate themselves from their benchmarks.

While I can’t guarantee that our future returns will be as good, I think our returns so far have come from consistently looking for leading companies whose stock is trading at a discount to their business fundamentals.

S&P: Are you a deep value or a relative value investor?

SANDLER: We take an absolute value approach rather than a relative value approach. That means we don’t look for stocks that are undervalued relative to overvalued markets. We try to decide what a company is worth regardless of the economic environment, interest rates, or foreign exchange rates.

S&P: How do you find undervalued companies?

SANDLER: We visit companies, kick their tires, and tear their businesses apart to understand the underlying fundamentals. We start with a small team. When someone on our team comes up with an idea, we pick a devil’s advocate to challenge the proponent’s assumptions to make sure we’re not missing anything.

S&P: Do your holdings have common characteristics?

SANDLER: Most of our companies throw off more cash than they consume, so we try to make sure the managements are wisely investing that excess cash. To do that, we spend a lot of time with managements asking them where they want to take their companies over the longer term.

When we look at a potential holding, we first consider what is today’s value of the company’s future cash flow? Cash flow helps you look beyond a company’s earnings to its true fundamentals. At the end of the day, a company is going to get into trouble if it isn’t generating more cash than it consumes.

S&P: Would you describe some holdings that meet your cash-flow criteria?

SANDLER: Fannie Mae (FNM) and Freddie Mac (FRE) have gained market share by adding portfolios to their balance sheets rather than simply guaranteeing mortgage payments. Both companies have very high margins.

Philip Morris Cos. (MO) also has high margins in several businesses, and its stock has handily outperformed the S&P 500 over the past 20 years.

S&P: These companies are fairly unique situations due to the legal problems of Philip Morris and the implied government guarantees behind Fanny Mae and Freddie Mac.

SANDLER: Most of our holdings have investor concerns swirling around them, whether political or financial. For example, McDonald`s Corp. (MCD) doesn’t have political risks, but there are concerns about mad-cow disease, the slowing global economy, and the strong U.S. dollar. We try to look beyond the chasms for intact franchises that will emerge stronger.

S&P: You have a concentrated portfolio with low turnover. Are there relatively few companies that meet your criteria?

SANDLER: We don’t get that many good ideas a year, and we want to focus on our best ones. We’re willing to stick with a holding that stays undervalued for some time. There are quite a few companies that throw off excess cash, but there aren’t a lot that are cheap enough.

Share prices have come down recently, but we still haven’t found a lot of undervalued companies. In previous downdrafts, we saw more interesting things.

S&P: Are there any common sector or industry trends in your current holdings?

SANDLER: We purchased several REITs when they were undervalued in late 1999 — the polar opposite of the bubble. Currently, our largest sectors are consumer durables, consumer nondurables, and financial services. We’re bottom-up managers, so we don’t look for certain sector characteristics. We’ll buy companies in any sector as long as we understand what they’re doing and how much they’re worth.

S&P: Do you avoid any industries?

SANDLER: We don’t understand most, but not all, technology companies. We also feel uncomfortable about biotechnology.

S&P: What are your largest holdings?

SANDLER: As of March 31, they were Freddie Mac, Philip Morris, Fannie Mae, Interpublic Group of Cos. (IPG) , and American Express (AXP). These positions haven’t changed very much lately.

S&P: What have you purchased recently?

SANDLER: In the first quarter, we bought some Tyco International (TYC) when there was a lot of panic selling, which is usually the best time to buy. We still think it’s undervalued. Tyco’s management is trying to unlock shareholder value, and its future cash flows look strong.

S&P: Have you sold anything lately that reached your goals for it?

SANDLER: We continually face that decision. We just sold Johnson & Johnson (JNJ), a very fine company, after holding it for four or five years, when its stock price rose sharply. We also sold United Technologies (UTX) when it hit our estimate of its intrinsic value three or four months after we bought it following September 11.


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