March 17, 2005 — From a clapboard office compound nestled in the northern foothills of the Catskills Mountains, John Fox keeps his sights on the far horizon in overseeing the Fenimore Asset Management Trust Value Fund (FAMVX). The Pennsylvania native relocated to the region in May 2000, when he became co-manager on the offering with Thomas Putnam, who established the fund in rural Cobleskill, NY, in January 1987.
The portfolio, with assets of $686 million, has outperformed its peers over the last decade, registering an average annualized return of 13.5% as of February 28, versus 12.1% for the average mid-cap blend fund. For the five years ended last month, it rose 16.8% annualized, versus a gain of 5.4% for its peers. That put it in second place among its 132 style peers. Over the three years, the portfolio’s annualized 10.3% return only slightly edged out its peers’ 10.1% gain, but its low volatility helped it earn a 4-Star ranking. Standard & Poor’s currently classifies the self-described value fund as mid-cap blend offering on Returns Based Style Analysis.
Fox sees patient, planned stock purchases and vigilant oversight as the surest and safest means of husbanding his clients’ investments in the long term. The co-manager strives to “buy stocks for less than you think they’re worth,” and likens holding them to having a “fractional ownership” in a business. “We don’t consider stocks just pieces of paper, blips on the screen,” he said. “We spend all of our time evaluating them, both the fundamental, financial characteristics of the business and the management.” The co-managers visit each of the 50 companies they own — all stocks of U.S. companies — annually.
In running the fund, Fox draws on his own research as an analyst — he specializes in financial companies — as well as that of his co-manager and two other analysts. The firm also employs a full-time trader. Once Fox has identified a stock that he wants, he is willing to wait as long as two years until it comes into his range.
His patience doesn’t wear out quickly. Holdings may remain in the portfolio six years or longer. The fund’s turnover, which ranges between 8% and 18%, was a mere 9.4% for the year as of Feb. 28, 2005, versus 64.4% for its peers. “As long as management’s doing a good job…and the intrinsic value of the company’s growing, we’d love to hold onto [the stock]” Fox said.
At year-end 2004, the fund’s top five industries were property/casualty insurance (11.4% of assets), machinery and equipment (6.2%), banking (5.2%), pharmaceuticals (4.9%), and construction materials (4.6%). Its cash position, normally 5% to 10%, had risen to 20%, which Fox attributed to two takeovers that had been paid in cash, net investor inflows, and a lack of “bargains” to spend it on.
The top five holdings at year-end were White Mountains Insurance Group (WTM) (7.0% of assets), Brown & Brown (BRO) (4.5%), Ethan Allen Interiors (ETH) (2.8%), Kaydon Corp (KDN) (2.8%), and Barr Pharmaceuticals (BRL) (2.5%).
The fund focuses on companies with market capitalizations between $500 million and $7 billion, with a preference for those between $300 million to $3 billion. “We’re not really hung up on those classifications,” Fox said. “We don’t benchmark to an index, we don’t sector allocate…. We like to say it’s ‘brick by brick.’ ” The fund’s universe comprises mostly small and midsize companies chosen among the Baseline software program’s 7,800 listings.
The co-managers’ approach is “totally bottom up,” Fox said. “We’re aware of the macro environment….But we don’t say, ‘Hey, I think there’s going to be a flat yield curve, so let’s do this.’ “
In deciding to buy a stock, Fox looks first for a business he understands that has a competitive advantage, and then considers its financial attributes. “Even though we’re value managers, we want companies that are growing,” he said. He also wants companies with strong balance sheets and limited debt, good free cash flow, and high returns on invested capital. “We spend a lot of time looking at how they allocate capital,” he said. “What is their track record with acquisitions — which is where a lot of things can go bad.”
A more qualitative measure is gauging character of management. “The simplest thing that you can tell on the surface is, how promotional are they?” he said. “Highly promotional usually does not lead to honesty and integrity.” Fox added that he prefers managers with a “low-key personality” and that over time, their priorities reveal themselves. He sees his job as comparing what managers say with what they do, and to “see how they handle certain situations.”
“If we have those three things — good, understandable business, good financials, capable and honest management, then we like to buy it at a discount to what it’s worth,” he said. “We like to have our cake and eat it too.”
One prescient investment has been property/casualty insurer White Mountains. Fox applauds the company’s management strength and ability to outperform in a tough business. Its book value has seen long-term double digit-growth, he said, while its peers have hung on in the single digits. The stock’s 41% rise in total returns in 2004 made it the fund’s best performer that year.
Vulcan Materials (VMC) is a construction materials company that Fox bought while it was out of favor during the recession that accompanied the September 11 attacks. As he expected, the stock has bounced back with the economy.
In the fourth quarter of 2004, the fund added AmSurg Corp (AMSG), Barr Pharmaceuticals, Forest City Enterprises Inc., and Pediatrix Medical Group (PDX). Fox credits the pre-election damper on healthcare and pharmaceutical stocks for bringing these shares into his “range.”
Fox sees the fund’s buy criteria — high-quality companies whose stock may be purchased at a discount — as a means of controlling risk. He points out that in the 2000-02 bear market, the stocks that suffered most were those that were highly overvalued — technology and Internet issues — and those that had a lot of debt. “So we kind of avoid those two areas,” he said.
Although the fund holds no energy stocks at present, Fox said he does not avoid them. But he does avoid utility stocks, which as regulated businesses don’t tend to bring high returns on invested capital. He also stays away from “exotic, exciting emerging areas” like biotech and high-tech, which have neither “proven businesses or cash flow.” “We like the tried and true,” Fox said.
The decision to sell a stock is based on valuation. If a stock is selling for what he thinks its worth, or more, he will trim his holdings, as he did when he sold about 20% of his Yum Brands shares in 2004. But, he observed, good managers typically raise the value of the company over time — as gauged by its acquisitions, sales, profits, and so on — so its stock doesn’t become overvalued.
Fox estimated that his stock picks are wrong “about 30% of the time,” generally due to misjudging the competitive environment. He cited his 2004 purchase of Callaway Golf (ELY) as an example. On learning of an incipient price war with Taylor Made Group Inc., he closed the position the same year. “We don’t have a stop loss rule,” Fox said, “but those are just ones we feel we made a mistake and we move on.”
Asked for his outlook for the stock market, Fox laughed, “I don’t have one.” But he does see the U.S. economy growing, and expects his companies’ earnings to improve in varying degrees. “We think the environment is fairly positive,” he said. “The negative is higher short-term interest rates — that hurts industries like banking, mortgage origination.” Still, Fox projects that bank earnings may grow 8% to 9%, rather than 10%. And he is unconcerned that his other financial holdings will feel much of a pinch from rising rates.
As for mid-cap stocks, Fox said he doesn’t see a lot of bargains in the market right now. He suspects that returns on mid caps may not be as high as in the past, but he is hardly writing them off. “You’re seeing articles now [saying that] it’s the time to get back into large[-cap] growth,” he said. “We have no idea — we look at it on a business-by-business basis.”
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