Tip:
Highlight text to annotate it
X
[music]
[music]
[music]
[music]
[music]
[music]
[music]
[music]
CONSUELO MACK: This week on WealthTrack, why two value investors who have weathered the
market storms are now expecting calmer seas, but keeping some sails trimmed just in case.
Polaris Capital Management’s Bernard Horn and Thunderstorm Capital’s John Dorfman
on their search for global value are next on Consuelo Mack WealthTrack.
[music]
[music]
[music]
[music]
[music]
[music]
[music]
[music]
SPONSOR: The company keep is also the company we keep.
Together we'll provide lifetime guarantee income and investments solutions.
PROMOTION: Hello, I'm Consuelo Mack. I want to tell you about a new opportunity to watch
Consuelo Mack Wealthtrack before the program appears on public television.
As a subscriber you can see programs 48 hours in advance of the general public and also
find timely interviews and commentaries exclusive to Wealthtrack Premium subscribers.
go to wealthtrack.com for more information.
[music]
[music]
[music]
[music]
[music]
[music]
[music]
[music]
[music]
[music]
Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Are we on the road to
a back-to-normal market? That is the view of this week’s WealthTrack guests. Both
are seasoned value investors who believe there are opportunities galore in global markets.
Individual investors, however, are not buying it. They have been net sellers of stocks and
net buyers of bonds for months. They are still psychologically damaged from their experience
of the last decade.
A couple of charts provided to me by David Darst, Morgan Stanley’s chief investment
strategist and asset allocation guru, illustrate why. Take a look at what investors experienced
with U.S. financial stocks. On a total return basis, with dividends included, the Dow Jones
U.S. Financials Index increased five fold from the mid-nineties to 2006, only to plummet
76% from peak to trough during the financial correction. Then there’s the performance
of a so called “defensive” stock group: drug companies. Darst’s chart notes that
from 1994 to 2000, the Dow Jones U.S. Pharmaceuticals Index increased nearly 7 fold with dividends
included. From their peak in the beginning of this decade to their trough in 2009, they
fell 56%- disconcerting to say the least! Is it any wonder that individuals are leery
of stocks?
These are exactly the times when veteran investors find long term value. This week’s WealthTrack
guests are seasoned practitioners of the art. Bernard Horn is president and portfolio manager
of Polaris Capital Management, from which he runs the Polaris Global Value Fund, a finalist
for Morningstar’s 2006 International Stock Manager of the Year award among several other
recognitions for his long term track record. Horn uses both fundamental and quantitative
analysis to scour the globe for value.
John Dorfman, chairman of Thunderstorm Capital, has been managing individual and institutional
portfolios at his firm since 2000, far outpacing the market in the process. John was a colleague
of mine many years ago at The Wall Street Journal before switching into money management
where he worked for several years with legendary value investor, David Dreman before founding
Thunderstorm Capital. He continues to write a syndicated column. I began the interview
by asking Bernard Horn why he felt we were finally returning to a back to normal market.
BERNARD HORN: A normal market in statistical terms, without getting too technical for your
listeners, means that you’ve got sort of a bell-shaped curve of stock performance with
the right hand side kind of stretched out a little bit, so a few really good returns
and then kind of things go up and down. In any given year, you’d expect to have a return
of about six percent after inflation, plus or minus 20%. Now, that’s normal. So what’s
not normal? Basically, the period from the early ‘90s through 2006, when markets kind
of were very powerfully going up almost all the time, that’s a little bit abnormal.
CONSUELO MACK: And that’s the kind of markets that we all loved, of course.
BERNARD HORN: Because most investors remember the thing that’s most recent, and quite
frankly, that was a very long period of time, you know, more than a decade. If that’s
your experience in the market, you think that that’s just going to continue forever. You
know what? It doesn’t. And right now we have a market where things not only can go
up, but they can go down. And we have a business cycle, and we have a lot of other things in
the economy worldwide, that are kind of driving expectations and greed and fear up and down.
So I think this is a very normal market and quite frankly, for value investors, this is
a great market.
CONSUELO MACK: So John, what’s your take? Are we in a back-to-normal market?
JOHN DORFMAN: Well, I think we’re still locked into the fear quadrant right now after
the gray period that Bernie just described. We then had a decade, the ‘00s, from 2000
to 2009, where the market declined close to one percent a year.
CONSUELO MACK: That’s not normal.
JOHN DORFMAN: Right. That’s not normal either. And it was partly, you know, two sides of
the same coin: the great returns of the ‘80s and ‘90s led to the sub-par returns because
we really got over valued in 2002. Stocks were selling at 30, 31, 32 times earnings.
That was a lot to correct. And now we’ve corrected it, but investors are still, I feel,
frozen in fear. So I do think that over most long periods the market has returned, in nominal
terms, nine to ten, 11%.
CONSUELO MACK: Right, in real terms six percent, as Bernie said.
JOHN DORFMAN: Exactly. I think we’ll get back to that now.
CONSUELO MACK: We are getting back to that now, you think? What about volatility? The
kind of volatility that we’ve seen, this risk-on, risk-off market, are we going to
see the kind of fat tails, as they say, the extremes of up and down markets in very short
periods of time? Bernie, is that something we’ve got to learn to live with as well?
BERNARD HORN: I think, again, it’s probably part of the normal fluctuations in markets
and I think what people are afraid of is that this whole concept of risk-on, risk-off, means
that all things go up and down at the same time. And there’s a little bit of that that
goes on in certain sub-periods during the year or the quarters or the weeks. We have
spikes of correlations and then they kind of dissipate as the underlying economy continues
to kind of drive valuations.
CONSUELO MACK: So, John, volatility, is that just a way of life or what?
JOHN DORFMAN: It usually is a way of life. We had a couple of years of low volatility
and everyone wishes that were the norm, but it’s not. And I think we’ll see volatility
in 2012 and in 2013. We had a nice first quarter in 2012 and I wouldn’t be surprised if by
September we were back to zero. We’ll get Congress on display showing its statesmanship
as it wrestles with the budget and that will…
CONSUELO MACK: That’s a nice way of putting it.
JOHN DORFMAN: …not make investors happy. We, also in 2013, will have the yanking away
of a very substantial fiscal stimulus that you’ve had the last couple of years, so
I think there will be a lot of volatility in 2012 and 2013, but that doesn’t necessarily
mean that they will be down years for the year as a whole.
CONSUELO MACK: So Bernie, one of the things that you said earlier, which caught my attention,
was that it’s a great market for value investors. How so?
BERNARD HORN: A couple of reasons. Whenever markets do fluctuate, whenever you do have
volatility, it means that when things go down, they may go down more than the actual performance
of the cash flows, are really going to go down in the future. And so whenever you have
that mismatch where the value of the firm doesn’t really reflect the true cash flow
earning power of that company- that’s the investment opportunity. We have this schizophrenic
relationship with volatility. We want things to go down so that they’re cheap enough
for us to buy. On the other hand, nobody wants their portfolio to go down. So we just kind
of have to live with this volatility and, quite frankly, if one expects the volatility
and you change your thinking to say, “Okay, I know something is going to happen and it
may be bad,” and just kind of wait for it and be very patient about it, then you can
say, “Oh, gee, this is a great opportunity to buy.” That’s the way we think of the
world.
CONSUELO MACK: You’re both value investors and so, John, in addition to volatility, which
can create prices that are lower than what a company should be selling for, what are
some of the other things that you look for in the market on kind of a day-to-day basis?
JOHN DORFMAN: Well, in simple terms, we love to try to buy good companies on bad news.
And people overreact to recent events. They overreact to salient events and make a big
impression on them.
CONSUELO MACK: So you look for bad news. And I have to ask you, John. There are many screens
that you use, but there are a couple of screens that you told me about, you know, speaking
of kind of bad news, and one of them is the low PE outlier stocks. Some research that
you’ve done, do you want to tell us about that?
JOHN DORFMAN: Sure. For about a dozen years I’ve been tracking the very lowest PEs in
the market among stocks of a certain size and whose debt does not exceed equity. And
you have a several hundredfold return on these stocks over that period, despite a gigantic
decline in 2008. Now, these are risky stocks and they’re risky stocks whose problems
are usually very well known. I wouldn’t advise someone to go out and make a whole
portfolio out of these stocks because they tend to be clustered in certain industries.
We just find it forces us to look at some stocks that are very highly unpopular. And
there’s a lot of academic literature showing the bottom quintile, the bottom decile by
PE out performs the rest of the market.
CONSUELO MACK: And Bernie, I know that you’re both a quantitative analyst and a fundament
analyst as well. You screen 33,000 stocks at any given time. So what are the kinds of
things that you look for? What’s your definition of the search for value?
BERNARD HORN: We have a very strict definition of value discipline, and that is that a company,
for us, has to be priced so that our expected return on it is going to exceed the normal
expected return on an index fund. So if an investor wants to kind of keep even with the
market they should put their money in an index fund and our job, of course, is to beat that
return.
CONSUELO MACK: So the normal expected return of an index fund would be …
BERNARD HORN: Six percent.
CONSUELO MACK: That six percent.
BERNARD HORN: After inflation and over long periods of time. So for us, why would we buy
a company that is priced to give us a six percent return? Investors don’t need us
for that. They just go buy an index fund. So the only time that a company makes sense
to look at, for us, is when it’s priced below the expected value of the future cash
flow in such a way that it gives us an expected return that’s higher than that six percent.
And we have various ways of doing that across the hundred or so countries that we can invest
in.
CONSUELO MACK: What’s interesting is that when I talked to you earlier, you said of
those 33,000 some odd companies that you screen, that you’re looking at now a universe of
about 2,000 that really represent true value, and that’s two or three times-- I mean the
normal is like 500 stocks at any given time. So what’s going on? Why is the market creating
so much value now and where is that value being created?
BERNARD HORN: Well, that’s a good question, so really, since the end of 2008, the markets
took two or three standard deviation evens; they were down 40, 50%, and that created a
lot of opportunities. Prior to that, on our normal screens, we get 400 or 500 companies.
Now we’re getting 1,900, 2,000 companies. And it’s really persisted since 2008. So
a couple of reasons for that. One, investors remain pretty fearful. Any time you have kind
of a down quarter or market, like we did in the third quarter of 2011, it just, you know,
hits on that nerve that everybody felt so raw in the crash in 2008 and early 2009. So
investors really are reluctant to bid up prices of stocks to level. So those remain good value.
As far as where the values are in the world, it’s really scattered about the world. As
far as the size of companies are concerned, the mega cap stocks that everybody’s putting
money into, typically they are not the most under valued companies in the world.
CONSUELO MACK: Even now? Because, you know, most value investors I talk to are saying
there’s mega cap, U.S.-based companies with emerging market exposure that are the biggest,
greatest value today.
BERNARD HORN: We certainly have mega cap stocks in our screens but they’re not dominated
by mega cap stocks. If you look at the growth of the world and the investment opportunities,
it’s really occurred over the last ten years in the companies that are $2 to $5 billion
of size and lower. So that’s where there are a lot of new companies, because they’ve
just been created, you know, China, India, Brazil, and so forth.
CONSUELO MACK: And what, two thirds of these 2,000 names are international stocks, right?
They’re not U.S. based or…?
BERNARD HORN: Absolutely. The new growth in the world economy going forward for the next
25 or 30 years, is going to be kind of outside the developed world. And as we know, lots
of small and medium sized companies, that’s where the job growth is created, that’s
where the disruptive technology comes and, you know, so that’s where we see there to
be future opportunity but most of these companies are just not well followed. They’re very,
very good value. These are the sectors. So the small, medium size companies are great
value. Of course, financials have been really beat up pretty badly- a lot of good values
there. Some of the Scandinavian banks, for instance, that have kind of been thrown out
with the bathwater, have really sailed through this without any credit problems to speak
of. And they are collecting a lot of the deposits that are being withdrawn from some of the
other European banks, so they really represent not only companies that have good funding
sources, but they also represent great value.
CONSUELO MACK: So, John, small, midcap banks, European, I mean are these areas that you’re
investing in?
JOHN DORFMAN: Well, I typically prefer small and midcaps because they’re less followed.
There’s more of an opportunity to find an undiscovered gem. The past year and a half,
I’ve found more values than I usually do among the big caps because small caps had
run up so much in the preceding dozen years. One industry I like a lot right now is auto
and auto-related because it’s on the comeback trail and people aren’t willing to believe
it yet. Everyone is so skittish, as Bernie pointed out. Car sales have climbed back to
about $14 million a year, car and truck sales in the U.S.; $18 million was the highest we
ever got. We were down to about $8 million during the depths of the worst times. And
the news has been coming in well.
CONSUELO MACK: And the companies just aren’t reflecting it?
JOHN DORFMAN: The stocks are not really reflecting it, and people still think of them as having
all the problems they used to have when those problems had been partially ameliorated. The
legacy healthcare costs, the excessive labor costs, those have been ameliorated for the
auto companies, including for General Motors through its bankruptcy. So that’s one that
appeared on the screen you were talking about a few days ago. We own it for clients. It
was weak last year but has been coming back strongly this year.
CONSUELO MACK: So that’s one of the low PE stocks. You’ve got another screen as
well which talks about, really speaks to where the herd is going and that’s one that you
compared and have over the last 12 or so years, the most loved stocks by analysts, and the
most hated stocks by analysts. What does that screen show?
JOHN DORFMAN: The lesson I hope people will draw from this is that they should do their
own independent research and not rely on analysts to pick their stocks for them. When analysts
herd, they typically do not create value. I’ve looked for about the last dozen years,
every January, at the beginning of the year, at the four stocks analysts love most, and
the four that they hate most, and those that they love most have severely underperformed
the market, and have been beaten by those that they hate most. But both groups, the
loved and the hated, have underperformed the S&P 500. So, if you see 12 analysts unanimously
recommend a stock and there are no dissenting votes, or if you see five or six analysts
say to sell a stock- you never get much more than that because Wall Street doesn’t like
to do sell recommendations- if you see unanimous sell recommendations, neither of those is
really a good sign, but I actually look for stocks where opinion is mixed, where there’s
a difference of opinion, because the truth ultimately is not going to be an average.
The truth is independent of how many people believe it.
CONSUELO MACK: So John, what is your sense of the value that is available in the market
today to long-term value investors?
JOHN DORFMAN: I think there certainly is value. I’m not finding as many values as he is....
CONSUELO MACK: As Bernie.
JOHN DORFMAN: …because my portfolios are more concentrated in the United States. I
like some of the golds. I think some of the pharmaceutical companies are under valued.
CONSUELO MACK: So let me stop you on the golds. These are gold mining stocks?
JOHN DORFMAN: People love ETFs that own gold.
CONSUELO MACK: Yes, GLD, for instance, right.
JOHN DORFMAN: GLD for most. Those ETF companies have to buy the physical gold and they have
to buy it from someone. The mining stocks have not kept pace with the price of gold
by any means, for a number of reasons. But I think that’s been true to an extent that
now creates an opportunity, where typically companies like Newmont and Barrick, both of
which we own, have a glamour premium associated with them and you’re paying 22, 25, 29 times
earnings to own these stocks. Well, right now you can get both of those stocks for under
15 times earnings. So the glamour premium has been rubbed off because the gold stocks
have not performed as well as the metal. I think this is a good time, personally, to
buy those big producers.
CONSUELO MACK: Gold stocks, mining stocks, any thoughts on those, Bernie? Is that an
area that’s showing up on your screens or?
BERNARD HORN: We do like mining stocks in general, but we’re even more excited about,
generally speaking, materials companies. I certainly would agree with John on the fact
that the gold mining companies are a much better value than gold itself. We clearly
see the materials sector as being a very interesting microcosm of what’s going on in the world-
the global economy as a whole- because you have the developing world, just the sheer
weight of a couple of billion people in China and India, against the weight of the 300 million
people in the US and a few hundred million people in Europe; the demand that this large
population base has on the world’s supply of raw materials, is just pushing the prices
of those up as they advance their economies.
CONSUELO MACK: What lessons did you learn from the financial crisis? Are you doing anything
differently, John, than you did before?
JOHN DORFMAN: We had more healthcare than we normally do. We had more utilities than
we normally do, because we normally don’t have any. And we had more cash than we normally
do, 15%, which for me I thought was huge. I think if I ever, God forbid, again see signs
on the wall like we were seeing in late 2007, early 2008, I’d probably do more of those
kinds of defensive maneuvers.
CONSUELO MACK: Any lessons that you learned and that you’re applying today, Bernie?
BERNARD HORN: You always go through an experience like that and learn something from it, so
we’re mixing a lot more healthcare companies into the portfolio now, looking for inconsistencies
in market logic- like the large pharma stocks are trading lower because there’s a patent
cliff and all their drugs are going to go generic.
CONSUELO MACK: That’s what’s out there. That’s the theory that’s out there.
BERNARD HORN: The fear that’s creating all these values in large pharma, branded pharma
stocks.
CONSUELO MACK: How important are dividends to you, Bernie? Is that part of this calculation
as well, and is it an important one or not?
BERNARD HORN: I think that the whole concept of a dividend, which is a share of a company’s
cash flow, is critically important. I think people have to really understand that because
companies can raise prices over time, and that way they can keep the real value of their
cash flow growing, and to the degree that an investor can participate in that, or just
a concept of it, is really critically important for people to understand, compared to a ten-year
government bond, which has a fixed interest payment for ten years. Because think of an
investor, aged 60; the average life expectancy is 85, and with technology and healthcare
and the miracles of modern medicine, it’s not unusual for us to expect that people could
live into their 90s. So if you’re 60, you have a 30-year investment horizon. Think of
what has transpired since you were 30 leading up to age 60. There’s a long term investment
horizon, especially with interest rates where they are right now. When I got into the business
in 1980, I had a lot of widows come to me with their investment portfolio that had been--
bonds that had been purchased at three, four, five percent interest in the ‘60s, and then
interest rates went way up into double digits, their bond portfolios were absolutely decimated.
CONSUELO MACK: Do you want to add anything to that, John?
JOHN DORFMAN: The only thing I’d add is that dividends have another useful purpose,
besides the fact that they can grow over time and they make an important contribution to
total return, and that is they’re a good sincerity barometer. Ninety percent of managements
talk bullish, but if they mean it, then the board of directors should be willing to preserve
or expand the dividend. It’s a good indication that they believe in the sustainability of
their own company’s earnings.
CONSUELO MACK: In that respect, do you look for companies that are paying dividends? Is
that an important marker for you as well?
JOHN DORFMAN: It is one of the things we look for and it’s sort of one of our decision
entry points, in some cases; for example, Johnson & Johnson and Intel, rising dividends
were an important thing that led us to hold those two stocks.
CONSUELO MACK: So let me ask each of you for the One Investment for a long-term diversified
portfolio, and John, I might as well start with you.
JOHN DORFMAN: I’ll do Newmont Gold (NEM), Consuelo, because in addition to the arguments
for gold made earlier in this program, governments on both sides of the Atlantic are printing
a lot of money and will have to continue to for the next several years, whether all the
decisions that led to this were wise or unwise is besides the point, they are printing a
lot of money. They will continue to print a lot of money. A certain number of investors
are going to lose faith in paper currencies, including both the euro and the dollar, and
this will be experienced by us as, “Oh, look, the price of gold is rising.” We want
to experience it as, “Look the dollar is falling,” because we’re not as aware of
that. It’s like a fish being aware of water. But what we’ll notice is that the price
of gold is rising because people have lost some faith in paper currency, so for a five-
or ten-year horizon, I think Newmont is the one I would pick.
CONSUELO MACK: All right, Bernie?
BERNARD HORN: I would go back to my earlier comment which his that the demographics, in
the healthcare business really are pretty powerful and a company like Teva Pharmaceutical
(TEVA), which not only has great generic exposure, but also has a budding branded product line,
will be a great place to put some money for a while; very good value, it’s got an awful
lot of growth and you’re not really paying for it at this point.
CONSUELO MACK: So Bernie Horn, it’s great to have you hear. Thank you so much for joining
us on WealthTrack. And John Dorfman, it’s wonderful to have you on WealthTrack as well.
JOHN DORFMAN: Thank you.
CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one
suggestion to help you build and protect your wealth over the long term. This week’s Action
Point is: consider some simple rules of investing that have been successfully applied by this
week’s WealthTrack guests. Contrarian John Dorfman buys good companies on bad news and
regularly looks at out of favor companies for investment ideas. Bernie Horn looks for
opportunities internationally, especially in emerging markets, and focuses on smaller
companies, because that’s where the growth is. Simple tips for successful long term investing.
Next week on WealthTrack we will be talking to Financial Thought Leader Jim Bianco, who
regularly challenges the conventional wisdom on Wall Street. We’ll find out what myths
he is shattering now. If you want to see our WealthTrack interviews ahead of the pack,
subscribers can do so 48 hours in advance. To sign up, go to our website, wealthtrack.com.
You can also watch previous shows and find past One Investment and Action Point recommendations
there. And that concludes this edition of WealthTrack. Thank you for watching and make
the week ahead a profitable and a productive one.
[music]
[music]
[music]
[music]
[music]
[music]
[music]
[music]
SPONSOR: Additional funding provided by: Loomis-Sayles - investors seeking the exceptional
opportunities globally. The Wintergreen Fund - your home for global
value. Research Affiliates - Efficient index foreign
inefficient market.
[music]
[music]
[music]
[music]
[music]