Feb. 2, 2004 — George Davis Jr. doesn’t care how big or small a company is, as long as its top and bottom lines have the potential to grow and he can buy its stock on the cheap.
The $49 million Hotchkis & Wiley All Cap Value Fund/A (HWAAX) that Davis runs with Joseph Huber will hold companies of any size. What concerns the managers more is finding shares trading for less than what they think a business is intrinsically worth. Ultimately, they want those that are inexpensive relative to a company’s earnings, cash flow or book value.
At the end of last year, the stocks in the fund’s portfolio were trading at 13 times projected earnings, on average, while the Standard & Poor’s 500 index sported a P/E of 17.6. The median market cap of the fund’s holdings was $9.6 billion, putting the offering in large-cap territory.
One-year-old Hotchkis & Wiley All Cap Value was the best performer among large-cap blend funds in 2003, when it returned 69.6% and its peers gained 27.6%. By comparison, the S&P 500 was up 28.7%. The fund is too new to be ranked by Standard & Poor’s.
In picking stocks, the managers also scan for strong, sustainable cash flow and margins, as well as sound balance sheets. “We love dividends, although they’re not a requirement for gaining entry to the fund,” adds Davis.
Not many companies make their way into the portfolio. It held 22 late last month. This concentration is intended to make stock analysis easier, and to enable winners to significantly boost the fund’s returns, Davis says.
A major contributor to the fund’s performance last year was Sears,Roebuck (S). The retailer was the fund’s No. 1 stock at the end of 2003.
Sears sold its credit card operations last spring and used the proceeds from the deal to buy back its stock, a move “which is very attractive to us,” Davis says. On the retail side, the chain has been working to beef up margins, he notes.
Davis cites Electronic Data Systems (EDS) as an example of the kind of stock the fund owns. The managers bought a stake in the computer services company last year, and it held third place in the portfolio at the end of December.
Davis says he likes the company because it is involved in some very large projects that will provide it with a revenue stream going forward. Electronic Data Systems’s earnings currently are lower than Davis thinks they should be, but investors can take advantage of the stock’s 2.5% dividend yield while they wait for profits to pick up, he says.
A small company with the financial characteristics the managers favor, Davis says is, WCI Communities (WCI), a home building and real estate company that ranked fourth in the portfolio at the end of last year.
Davis believes WCI’s land holdings, mainly in Florida, are undervalued. Also, the company has been benefitting from the revival of the U.S. economy, he says.
The managers focus on individual companies, so the fund’s sector weights are a result of their stock selection. Financial services companies accounted for 41.6% of its assets at the end of the fourth quarter. Holdings included Allmerica Financial (AFC), MetLife Inc (MET), and Prudential Financial (PRU).
Huber and Davis will sell a stock if it becomes pricey, or if a company’s financial fundamentals weaken. But they aren’t quick to unload a stock, and look to hold investments for 3-4 years, Davis says. Hotchkis & Wiley All Cap Value’s turnover rate in 2003 was 11%, one-sixth that of similar funds.
Although stocks should enter and leave the portfolio at a relatively leisurely pace, Davis says, he acknowledges that the portfolio’s narrow focus could change the fund’s results rapidly, because a big loser might weigh it down just as a big gainer might pull it higher.
“We take pretty large positions in a number of smaller number of holdings, so you’re going to have high volatility in the returns of this fund,” Davis says.
He maintains, however, that the fund’s emphasis on value, combined with intensive research conducted by its team of portfolio managers and analysts, will “bias us to outperform over the long term.”
– Richard Diennor