Quick Take: Kenneth Feinberg and Christopher C. Davis, co-managers of Selected American Shares (SLASX), like to buy companies whose earnings are growing consistently, but that are trading at depressed valuations. For example, it could be because a company is facing some bad news, or because the market is simply overlooking it. Once they buy a stock, the managers like to hold onto it for the long-term.
For the year ended July, the $6.7-billion portfolio gained 17.2%, versus 11.7% for the average large-cap blend fund, and 13.2% for the Standard & Poor’s 500 Index. For the three-year period, the fund rose 2.4% annualized, versus losses of 2.0% for the peer group, and 1.5% for the index. What’s more, the fund has lower volatility than its peer group, lower expenses, and significantly lower turnover.
Feinberg, who joined the fund in May 1998, also co-manages the Davis New York Venture Fund (NYVTX) and Davis Financial Fund (RPFGX) for Davis Selected Advisers, L.P., the investment adviser for the both Selected Funds and the Davis Funds.
The Full Interview:
S&P: What kind of stocks do you look for?
FEINBERG: We invest in mid- or large-cap companies that are trading at modest valuations, but that have long track records of earnings growth and sustainable forward earnings growth rates. We like to hold onto our stocks for the long-term.
S&P: What else characterizes your investment strategy?
FEINBERG: We put great emphasis on meeting with company managements and making sure they are committed to their shareholders. We want to understand a company’s business model, their products, and their competitive environment. We think our investment process ensures stable long-term performance and minimizes risk and volatility.
S&P: What are your ten largest holdings?
FEINBERG: As of June 30, 2004: American Express Co. (AXP), 6.8%; American International Group (AIG), 5.3%; Altria Group (MO), 4.8%; Tyco International (TYC), 4.6%; Berkshire Hathaway (BRK.A), 4.6%; HSBC Holdings (HBC), 3.5%; Bank One Corp. (since acquired by J.P. Morgan Chase), 3.4%; Citigroup Inc. (C), 3.3%; Progressive Corp. (PGR), 3.3%; and Wells Fargo (WFC), 3.2%.
The top ten holdings represented 42.8% of total assets. Typically, our ten largest stocks account for 42% to 48% of assets. The fund currently has 62 holdings. We prefer to keep a relatively concentrated portfolio.
S&P: What are your largest industries?
FEINBERG: As of June 30: insurance, 18.9%; financial services, 16.0%; banking and savings & loan, 15.6%; energy, 7.1%; and consumer products, 4.8%.
S&P: How would you characterize the kinds of companies that populate the portfolio?
FEINBERG: Stocks in our fund typically fall under three categories: The bulk of our assets are invested in the familiar, household names that are strong global leaders; a smaller portion is invested in companies that have strong business fundamentals, but that are less well known, and perhaps overlooked by the general investing public; and the last portion consists of companies whose stocks are facing pressure due to some controversy or negative headlines.
S&P: Can you discuss one of each of these types of stocks?
FEINBERG: American Express, which has been in the fund for 10 years, is clearly a blue chip, global leader. It was under various clouds when we bought it after having been poorly managed by former CEO James Robinson. When Harvey Golub took over the company in 1994, he and Ken Chenault, the current CEO, immediately cut some costs and made the company more entrepreneurial, focusing particularly on their long neglected credit card business, which faced very tough competition. They brought the company out of the doldrums, and their core card business flourished. Over the past decade they have bought back 20% to 25% of shares outstanding. We initially bought the stock when it traded at a 10 P/E, it is now at 19.
Progressive Corp., despite being a highly successful automobile insurer, remains largely unknown to the general public. Progressive, currently trading at a P/E of only 11.2, has delivered earnings that have compounded more than 20% annually over the past 20 years. They have done a fantastic job in growing market share and profitability.
Altria Group became a big position in the fund in early 2000, right after Philip Morris lost a huge Florida class action case in which a $145-billion judgment was assessed. However, Philip Morris was able to appeal and this judgment was overturned, along with several other cases. Although we were closely aware of the ongoing litigation risks, we felt that the stock’s 6 P/E gave it a strong risk-reward profile.
Philip Morris has lost some market share to discount cigarette manufacturers, but Altria has been well managed under the shareholder-oriented CEO Louis Camilleri, who is seeking to break the company up into three parts, including a spin off of Kraft Foods, which is struggling. If he can do this, we think the stock should be worth $75.
S&P: Your top three sectors, which account for 50.5% of the fund’s assets, can broadly be called ‘financials.’
FEINBERG: Yes. Since I have worked here, financial stocks have typically held a prominent position in our fund. Chris Davis’ grandfather, Shelby Cullom Davis, invested exclusively in financial stocks and did extremely well. Financial services products never become obsolete, they are always in demand. Moreover, these stocks always seem to trade at a significant discount relative to the S&P 500 and other businesses with similar growth rates. This is also an industry in which the quality of management is crucial to a company’s success.
S&P: How does this new climate of higher interest rates impact your affinity for financial stocks?
FEINBERG: It is difficult to generalize the impact of higher interest rates on financial companies. For example, higher rates are beneficial for one of our favorite holdings, Golden West Financial (GDW), which provides adjustable-rate mortgages. They are superbly managed, and their earnings have compounded 20% annually over the past 35 years. When interest rates rise, their business soars. Their volume is up 35% this year, while the overall mortgage pie is declining.
Modestly higher interest rates also benefits American Express if it means the economy is stronger. That means corporate spending is increasing, jobs are being created, more cardholders come into being, and credit losses should therefore decline.
S&P: What are your sell criteria?
FEINBERG: We sell when our investment premise has been proved to be wrong . For example, maybe a competitor entered the field and hurt our company’s performance. We sell when an overly euphoric market bids up a stock’s price too high. We also sell when we don’t like the compensation plan for a company’s senior management. They may receive too many option grants, for example, which we view as a “wealth transfer” away from the shareholders.
S&P: Can you cite a stock you have sold off for that latter reason?
FEINBERG: We sold RadioShack Corp. (RSH) last year because their executives were getting option grants valued at between 2.5% to 3%. We told them we didn’t like these payouts since the company was only growing by 10% annually. They also authorized the expenditure of $250 million to build a new headquarters in Texas, which we thought was a waste of money. We disposed of RadioShack because we determined the management only thought of themselves.
S&P: What kind of stocks does the fund typically avoid?
FEINBERG: Today, we do not have significant exposure to technology and telecom stocks because of the fickle nature of their industries and the stocks’ high volatility. If you pick wrong, a tech company’s business can decline by as much as 50% in just one year. Tech stocks tend to trade at too high multiples and are susceptible to sudden earnings decline as well as obsolescence risks. We also avoid cyclical companies like autos, steel, chemicals and metals, since they don’t provide stable earnings. We find it hard to value them.
S&P: Given record high oil prices, would you expect to increase your exposure to energy stocks?
FEINBERG: We have had a significant stake in energy companies, even before the recent spike in oil prices. We like the supply and demand dynamics in the industry. We feel that as long as oil is priced above $30 per barrel, energy companies can exhibit strong earnings, and are cheaply priced today. Some of our favorites in the sector include Devon Energy (DVN), Occidental Petroleum (OXY) and ConocoPhillips (COP). These stocks are trading at P/E’s at 10 or under, so there is a great margin of safety.
Contact Bob Keane with questions or comments at: [email protected].