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Yacktman Funds Interview - Great Answers From Great Investors
-The Yacktman Funds seem to contain a lot of “wonderful businesses” as opposed to classic Ben Graham net-net cheap businesses?
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4. Can you walk us through the investment process at the Yacktman Fund?
A: A good amount of the time is spent finding the ideas. You can quickly filter a lot of things out. Once we’ve sifted through the ideas, generally the first thing we do is to read the annual reports and the proxy statements. We try to first get an understanding of the business so the business description section of the 10K is a great place to start. Then we move on to the risk disclosure section. Those are put together by management and lawyers sitting in a room trying to figure out what can go wrong with the business. These people are worried about getting sued so they’ll include the things that keep them up at night or keep them nervous in the disclosure in case something goes wrong.
I read the business description and risk disclosures first and then move on to financial statements and footnotes. We also use sell side research reports for industries we are not familiar with to help us get up to the speed. We also read trade articles or other publications that are relevant to the business. Typically, the last place we go is to the management team because management is usually there to sell you on why to own the stock. It’s much better to analyze what they have done than have them tell you what they are going to do.
We also try to get an understanding of how the businesses have performed historically. For instance, last night we were looking at the operating margins of consumer companies the 1960s and 1950s. We like history a lot because it gives you a great perspective on what might happen in the future.
-We usually buy and sell gradually. For the most part, we are slow in and slow out. Again, we don’t set a price target. Instead, what we do is we’ll make the stock 2% of the portfolio at this price and 3% if it drops further.
-Comparing companies of different industries using P/E or P/S ratio does not help you when you have a business that to earns a dollar and pays out a dollar and another business that earns a dollar and puts 50 cents back to keep up with competition. So when we are valuing a business, we’d like to focus on the forward rate of return. By that I mean if I buy a stock today at this price, what is my anticipation of the return I am going to get in the future? This forward rate of return includes free cash flow yields and anticipated growth rate.
-Furthermore, we will look at historical data and get an idea of how the business has been doing over the past 10 years. What percentage of earnings did they get to keep? We are trying to get a general idea for the future but we are not forecasting. If you are forecasting whether the business is growing at 7% or 8% in the future, you’ve already got a problem. We look at what the mean case scenario is and what the likely distribution of scenarios around the mean case scenario is. If you look at Procter and Gamble, in 20 years they will probably still own Tide, they are probably still going to be in hair and shampoo and they are still probably going to be dominating. You can pretty much forecast to a certain degree of certainty what is it going to be like in 20 years. But you can’t tell what Microsoft or Intel are going to look like in 20 years.
-The lower the ability to forecast the future, the lower the valuation should be. We’ll pay less because there is more volatility associated with it.
-And risk to us is not the risk of the stock price, it is the risk that the business is not performing as we expected. You can have a business that has been doing very well for the past 10 or 20 years but they may not be doing as well in the future. The newspaper business is a good example of this. We had looked at Gannett in the past. In 2004, at the multiple it was trading, you could expect to earn about 8.5 to 9 percent if they can repeat what they have achieved during the past 10 years. At the end of 2004, we were asking what are the odds that this newspaper company is going to keep earning 8-9% in the next 10 years and it was pretty obvious that the business model of the newspaper business is deteriorating and we did not think it was going to earn 8-9% in the future, we quickly threw the idea away.
-8. When you find out that you have made a mistake in your investment analysis, how do you go about exiting the position? Do you sell it right away?
A: As we gathered historical data from the new management team we did not feel confident in so we sold the position. If you think you’ve made a mistake, you should sell right away. Why hold something you are not comfortable with?
A: There are three co-managers of the funds. Where you see positions are very large, it is usually because we have a uniform consensus from the portfolio managers. Very often it is a relatively cheap low risk, high quality stock.
-We actually looked at JC Penney’s debt and we did not invest in it. It will be very hard to get interested in the equity if we passed on the debt.
-15.What advice would you give amateur investors with regard to suppressing the excitement and urge to act?
A: Some of the biggest investment risks come from valuation and businesses that are in highly competitive, rapidly changing markets. We would recommend sizing positions to manage the risk or uncertainty.
-Investing in cigar butts or wide moat? Both are ok if reasonable return can be expected.
Yacktman Funds Interview - Great Answers From Great Investors
-The Yacktman Funds seem to contain a lot of “wonderful businesses” as opposed to classic Ben Graham net-net cheap businesses?
-
4. Can you walk us through the investment process at the Yacktman Fund?
A: A good amount of the time is spent finding the ideas. You can quickly filter a lot of things out. Once we’ve sifted through the ideas, generally the first thing we do is to read the annual reports and the proxy statements. We try to first get an understanding of the business so the business description section of the 10K is a great place to start. Then we move on to the risk disclosure section. Those are put together by management and lawyers sitting in a room trying to figure out what can go wrong with the business. These people are worried about getting sued so they’ll include the things that keep them up at night or keep them nervous in the disclosure in case something goes wrong.
I read the business description and risk disclosures first and then move on to financial statements and footnotes. We also use sell side research reports for industries we are not familiar with to help us get up to the speed. We also read trade articles or other publications that are relevant to the business. Typically, the last place we go is to the management team because management is usually there to sell you on why to own the stock. It’s much better to analyze what they have done than have them tell you what they are going to do.
We also try to get an understanding of how the businesses have performed historically. For instance, last night we were looking at the operating margins of consumer companies the 1960s and 1950s. We like history a lot because it gives you a great perspective on what might happen in the future.
-We usually buy and sell gradually. For the most part, we are slow in and slow out. Again, we don’t set a price target. Instead, what we do is we’ll make the stock 2% of the portfolio at this price and 3% if it drops further.
-Comparing companies of different industries using P/E or P/S ratio does not help you when you have a business that to earns a dollar and pays out a dollar and another business that earns a dollar and puts 50 cents back to keep up with competition. So when we are valuing a business, we’d like to focus on the forward rate of return. By that I mean if I buy a stock today at this price, what is my anticipation of the return I am going to get in the future? This forward rate of return includes free cash flow yields and anticipated growth rate.
-Furthermore, we will look at historical data and get an idea of how the business has been doing over the past 10 years. What percentage of earnings did they get to keep? We are trying to get a general idea for the future but we are not forecasting. If you are forecasting whether the business is growing at 7% or 8% in the future, you’ve already got a problem. We look at what the mean case scenario is and what the likely distribution of scenarios around the mean case scenario is. If you look at Procter and Gamble, in 20 years they will probably still own Tide, they are probably still going to be in hair and shampoo and they are still probably going to be dominating. You can pretty much forecast to a certain degree of certainty what is it going to be like in 20 years. But you can’t tell what Microsoft or Intel are going to look like in 20 years.
-The lower the ability to forecast the future, the lower the valuation should be. We’ll pay less because there is more volatility associated with it.
-And risk to us is not the risk of the stock price, it is the risk that the business is not performing as we expected. You can have a business that has been doing very well for the past 10 or 20 years but they may not be doing as well in the future. The newspaper business is a good example of this. We had looked at Gannett in the past. In 2004, at the multiple it was trading, you could expect to earn about 8.5 to 9 percent if they can repeat what they have achieved during the past 10 years. At the end of 2004, we were asking what are the odds that this newspaper company is going to keep earning 8-9% in the next 10 years and it was pretty obvious that the business model of the newspaper business is deteriorating and we did not think it was going to earn 8-9% in the future, we quickly threw the idea away.
-8. When you find out that you have made a mistake in your investment analysis, how do you go about exiting the position? Do you sell it right away?
A: As we gathered historical data from the new management team we did not feel confident in so we sold the position. If you think you’ve made a mistake, you should sell right away. Why hold something you are not comfortable with?
A: There are three co-managers of the funds. Where you see positions are very large, it is usually because we have a uniform consensus from the portfolio managers. Very often it is a relatively cheap low risk, high quality stock.
-We actually looked at JC Penney’s debt and we did not invest in it. It will be very hard to get interested in the equity if we passed on the debt.
-15.What advice would you give amateur investors with regard to suppressing the excitement and urge to act?
A: Some of the biggest investment risks come from valuation and businesses that are in highly competitive, rapidly changing markets. We would recommend sizing positions to manage the risk or uncertainty.
-Investing in cigar butts or wide moat? Both are ok if reasonable return can be expected.
