Theme and Background
This chapter, in a Q&A format, features Oakmark fund managers answering questions from GuruFocus readers, systematically elaborating on the institution's long-term value investing methodology. The core backdrop is the current weakness in the European economy, sluggish auto sales, and widespread pessimism toward the financial sector.
Core Thesis
The author's central investment argument is: Markets often misjudge cyclical negative news as permanent changes, thereby creating value investing opportunities. Counterintuitive judgments include:
- European auto sales are currently below the replacement level for vehicle ownership, but the author believes vehicle ownership will not decline over the long term. Therefore, based on valuations tied to higher sales, many global auto companies are undervalued.
- The price-to-book ratio of the financial sector is 20% lower than that of the utilities sector, yet both have the same return on equity (ROE). The author argues that the market has overpriced regulatory risks.
Key Arguments and Data
- Valuation Methodology: First, calculate unlevered enterprise value, then adjust for debt/cash to derive per-share value. The preferred benchmark is the cash acquisition price of similar companies; secondary references include cross-industry comparable acquisitions, public market comparable companies, and DCF models.
- Time Horizon: Analysts prepare a full two-year financial forecast, followed by a five-year forecast for per-share value growth, totaling a seven-year outlook. In contrast, most analysts use only two years, and market trading operates on even shorter cycles.
- European Auto Case: Current European auto sales are below the replacement level for vehicle ownership, but the author does not foresee a long-term decline. Thus, based on valuations tied to higher sales, global auto companies are considered cheap.
- Financial Sector Data:
- The price-to-book ratio of the financial sector is 20% lower than that of utilities, yet both have the same ROE.
- Current earnings in the financial industry remain suppressed by legacy mortgage losses and legal costs.
- If the economy experiences only moderate growth, financial companies could allocate nearly all profits to dividends and buybacks.
| Comparison Item |
Financial Sector |
Utilities Sector |
| Price-to-Book Ratio |
20% lower |
Benchmark |
| ROE |
Same |
Same |
- Buyback Effect: If IBM uses its free cash flow to repurchase 5% of its shares annually, after 20 years, the outstanding shares would fall to 36% of the current level (0.95^20), not zero. A shareholder holding 1% of shares would see their stake rise to approximately 3% after 20 years, not 100%.
Companies/Assets Involved
- IBM (IBM): Used as a buyback case study, repurchasing approximately 5% of shares annually with free cash flow. The author believes buybacks enhance per-share value but do not reduce shares to zero.
- Global Auto Companies (not specifically named): Based on the judgment that European auto sales will recover, the author considers these companies undervalued.
- Financial Sector Companies (not specifically named): The author views the sector as broadly cheap, with low price-to-book ratios, ROE matching that of utilities, and room for earnings recovery.
Investment Insights
- Focus on Cyclical Misjudgments: Look for industries where the market treats cyclical negative news as permanent, such as the current European auto and financial sectors.
- Emphasize Management Behavior: Invest in management teams that measure themselves by per-share metrics (rather than total size) and pay attention to how they deploy capital (investment, dividends, buybacks).
- Beware of Valuation Traps: When a company generates substantial cash, simply using a P/E valuation can undervalue the cash (especially in a zero-interest-rate environment).
- Difference in Risk Definition: The author defines risk as "loss," not volatility or deviation from an index. Historical data shows that in years when the S&P 500 incurred losses, Oakmark suffered smaller losses.
Theme and Background
This chapter explores Oakmark's investment philosophy in a Q&A format, delving into specific operational aspects such as valuation protection, improvements in investment methodology, cash management, trade execution, dividend handling, manager selection, and sell discipline. The report aims to reveal the practical details within its long-term value investing framework, particularly how to guard against systemic overvaluation risks, continuously optimize decision-making processes, and address differences from Buffett-style "permanent holding" strategies.
Core Views
The author's core investment arguments include:
- Guarding Against Systemic Overvaluation: Two mechanisms are employed—skepticism toward all-stock acquisition transactions and the use of the dividend discount model (DDM) with a floor set for the risk-free rate—to prevent market-wide bubbles from distorting valuations.
- Sell Discipline Outweighs Tax Deferral: The author explicitly opposes Buffett-style "permanent holding" strategies, arguing that selling a stock when it reaches 90% of intrinsic value and reinvesting the after-tax proceeds into a stock valued at only 60% of its intrinsic value yields returns far exceeding the benefits of tax deferral.
- Rejecting the Mix of Momentum and Value: Combining price momentum with value investing is deemed dangerous, but the author accepts "momentum" in analysts' fundamental judgments (i.e., dynamically adjusting valuation targets based on the latest information) to overcome anchoring bias.
Key Arguments and Data
- The Pitfall of All-Stock Acquisitions: The author notes that over a decade ago, internet companies used overvalued stocks to acquire other firms. If such transactions are used as comparables, many internet companies would be mistakenly perceived as "cheap." Oakmark focuses only on the multiples of cash-based acquisitions by buyers, thereby gaining a more sober valuation perspective.
- Protection from the Dividend Discount Model: When privatization transaction prices appear too high relative to the DDM model, Oakmark does not adopt these comparables. Additionally, to prevent the DDM from outputting inflated valuations due to bond market overvaluation, the author sets a floor for the risk-free rate.
- The Mathematical Logic of Selling and Reinvesting: The significant gap between the selling price (90% of value) and the repurchase price (60% of value) is considered by the author sufficient to offset the loss from capital gains taxes. This forms the core logic behind the "no permanent holding" stance.
- Analyst Anchoring Bias: Historical data shows that analysts exhibit anchoring bias in their responses to fundamental changes, meaning their adjustments to valuation targets are insufficient. Before buying stocks with declining valuations or selling stocks with rising valuations, the author forces analysts to fully incorporate the latest information.
Companies/Assets Involved
This chapter does not mention specific companies or assets, focusing primarily on investment methodology and operational principles.
Investment Insights
- Beware of Misleading "Comparable Transactions": When seeking valuation anchors, investors should prioritize cash-based acquisition transactions over stock-based ones, as the latter may distort comparability due to the buyer's overvalued stock.
- Establish a "Safety Valve" for Valuation Models: In a systemic overvaluation environment, proactively set floors for model parameters (e.g., the risk-free rate) to prevent model outputs from being hijacked by market sentiment.
- Adhere to Sell Discipline: For value investors, there is no reason to hold reasonably valued stocks indefinitely due to tax deferral. The key lies in identifying undervalued alternatives and calculating the net benefit of after-tax reinvestment.
- Distinguish Price Momentum from Fundamental Momentum: Avoid chasing stock price trends, but dynamically track and adjust judgments on company fundamentals to prevent missing buying or selling opportunities due to anchoring on old valuations.
Theme and Background
This chapter explores Oakmark’s investment philosophy and practical experience in a Q&A format. The author responds to market skepticism about current high profit margins, shares the investment masters he most admires, key career mistakes, and best investment cases, and discusses how amateur investors can screen actively managed funds.
Core Thesis
The author’s central judgment is that current high profit margins are primarily structural rather than cyclical, making the associated profitability sustainable. He presents a counterintuitive view: the cost of “inaction” errors (missing opportunities) in investing is greater than that of “action” errors (incurring losses). The best investment opportunities often arise in areas the market overlooks or worries about due to short-term negative factors.
Key Arguments and Data
- Profit Margin Structure Theory: The author argues that rising profit margins are structural, driven by:
- A shift from low-margin “metal bending” to high-margin “intellectual property”
- A transition from manufacturing to services
- A move from U.S. operations to international operations
- Lower tax rates
- Investment Master Selection: The most admired is Michael Steinhardt, for achieving a 25% annualized compound return over 28 years, along with his concepts of “variant perception” and “resetting to zero.”
- Biggest Investment Mistakes:
- Action Error: Failing to foresee the 2008 housing crash, misjudging that low interest rates would stabilize home prices.
- Inaction Error (more costly): Buying Apple at under $100 in January 2009, with the stock subsequently rising 8x, but only building a half position in the Oakmark Fund and completely missing it in Oakmark Select.
- Best Investment Case: Liberty Media (spun off from Telecommunications, Inc. in 1991). By valuing assets on a sum-of-the-parts basis, the author found asset value was 3 times book value, and liabilities were significantly overestimated. The fund ultimately held 20% of the company’s shares, achieving roughly 20x returns after 7 years.
- Sources of Stock-Picking Philosophy: Benjamin Graham’s The Intelligent Investor, and Professor Steve Hawk’s teaching method at the University of Wisconsin, which combined practice with academia.
- Screening Fund Managers: Look for the same traits as in investment company management: a track record of personal and organizational success, a rational and disciplined investment philosophy, a strong team, and alignment with shareholder interests (significant personal investment in the fund).
Companies/Assets Involved
| Company/Asset |
Role and Key Data |
Bullish/Bearish |
| Apple |
Case of a missed opportunity. Stock price < $100 in January 2009, later rose 8x. Oakmark only built a half position. |
Bullish (but underweight) |
| Liberty Media |
Best career investment. Spun off in 1991, asset value was 3x book value, liabilities were overestimated. Final return roughly 20x. |
Bullish (heavily held) |
| Telecommunications, Inc. |
Parent company of Liberty Media, later acquired by AT&T. |
Neutral (as transaction context) |
| Michael Steinhardt |
Most admired investment master, 28-year annualized return of 25%. |
Positive reference to his philosophy |
| Warren Buffett / John Templeton |
Also admired as great value investors. |
Positive reference to their philosophy |
Investment Insights
1. Beware the cost of “inaction”: For targets meeting investment criteria, be willing to take heavy positions to avoid missing substantial gains due to insufficient allocation. This requires decisive action when opportunities are identified.
2. Focus on structural changes: Do not simply assume high profit margins are unsustainable; analyze whether there are structural drivers behind them, such as a shift from low-margin to high-margin businesses (e.g., intellectual property, services).
3. Seek opportunities where “no one is looking”: The best opportunities often lie in areas the market overlooks due to short-term negative sentiment (e.g., spin-offs, companies with complex asset structures). Deep digging requires unconventional methods like sum-of-the-parts valuation.
4. Long-term holding and patience: Oakmark’s average holding period is 5 years, emphasizing the unexpected value added when management acts like owners. Investors need sufficient patience for value to return and should avoid panic redemptions due to poor short-term performance.
Theme and Background
This section presents the holdings disclosure and index explanation for the Oakmark funds as of September 30, 2013. The report lists the allocation percentages of the Oakmark Fund and Oakmark Select Fund in specific stocks, along with the definition of the price-to-earnings (P/E) ratio and an explanation of the S&P 500 Total Return Index. This content primarily serves as compliance-related holdings data disclosure, rather than investment analysis.
Core Viewpoint
This section contains no investment viewpoint. The content is solely a factual statement of holdings data, without any investment thesis or market judgment.
Key Arguments and Data
- Oakmark Fund Holdings (as of September 30, 2013):
- International Business Machines Corp.: 0% of net assets
- Apple, Inc.: 1.7% of net assets
- Liberty Interactive Corp., Class A: 1.9% of net assets
- AT&T Corp.: 0% of net assets
- Oakmark Select Fund Holdings (as of September 30, 2013):
- International Business Machines Corp.: 0% of net assets
- Apple, Inc.: 0% of net assets
- Liberty Interactive Corp., Class A: 4.6% of net assets
- AT&T Corp.: 0% of net assets
Companies/Assets Involved
| Company/Asset |
Fund |
Allocation Percentage |
Role/Judgment |
| International Business Machines Corp. |
Oakmark Fund / Oakmark Select Fund |
0% / 0% |
Not held |
| Apple, Inc. |
Oakmark Fund / Oakmark Select Fund |
1.7% / 0% |
Held only by Oakmark Fund |
| Liberty Interactive Corp., Class A |
Oakmark Fund / Oakmark Select Fund |
1.9% / 4.6% |
Held by both funds, with a higher allocation in the Select Fund |
| AT&T Corp. |
Oakmark Fund / Oakmark Select Fund |
0% / 0% |
Not held |
Investment Implications
This section contains no investment implications. The data is solely a historical record of holdings and does not constitute current investment advice. Investors should note that allocation percentages may change over time, and the disclosed information does not reflect the funds' future trading decisions.