Theme and Background
This chapter explores investment strategies under current market valuation levels in a Q&A format. The author argues that while stock returns over the past six years are unsustainable, equities remain attractive relative to bonds. The core question is: How should investors adjust asset allocation in a high-valuation environment?
Core Views
- Stocks are not extremely expensive: The current P/E ratio of the S&P 500 is only slightly above its long-term average (median around 15x), not at bubble levels.
- Bond risks are underestimated: In a low-interest-rate environment, the real return (inflation-adjusted) of bonds is uncertain, and prices may decline before maturity.
- Investors should revert to long-term asset allocation targets: Rather than blindly buying or selling. For those who overweighted stocks in 2008, a modest reduction is appropriate; but for those who reduced positions then, they should still buy now to restore target allocations.
Key Arguments and Data
1. Yield comparison between stocks and bonds:
- The current yield of the S&P 500 is higher than that of the 10-year Treasury (approximately 2%), with earnings and dividends expected to grow.
- Bonds offer a certain nominal return, but real returns are eroded by inflation; stocks provide inflation protection.
- The author expects stocks to outperform bonds by 4–5 percentage points over the long term.
2. AIG valuation analysis:
- As of the end of March, AIG’s book value was $80 per share, but excluding AOCI and DTA, it was only $61.
- The current stock price of $58 is below the adjusted book value, and the author believes an insurance company’s brand value should exceed book value.
- Assuming annual earnings of $6 per share over the next seven years, total earnings of $42 will exhaust tax loss carryforwards, converting DTA into cash; unrealized bond gains will also be realized. GAAP book value would then rise to $122, and the stock price could double.
- Management’s share buybacks (when the stock is below book value) can further enhance per-share book value.
3. NOV investment logic:
- NOV is a leader in deepwater drilling, but current industry activity is sluggish.
- The company has a strong balance sheet, and its stock price is below book value.
- It is expected that oil prices will rise in five years, driving a recovery in drilling activity, and NOV will benefit from increased market share and return on capital.
- Even in the current environment, the aftermarket business remains profitable, and per-share book value continues to grow.
4. FNF spin-off logic:
- The market assigns a much higher valuation multiple to data company Black Knight (BKF) than to insurance companies, and the spin-off will unlock hidden value.
- The title insurance industry is undergoing continuous consolidation, improving the competitive landscape, but the current low mortgage volume and high refinancing share (purchase transaction revenue is twice that of refinancing, with 50% higher profit margins) obscure these improvements.
Companies/Assets Involved
| Company |
Role |
Key Data |
View |
| AIG |
Insurance company |
Book value $80 (GAAP), adjusted $61; stock price $58 |
Bullish: Below book value, buybacks will boost per-share value, potential to double in 7 years |
| NOV |
Oilfield services company |
Stock price below book value; strong balance sheet |
Bullish: Cyclical trough, deepwater drilling leader, awaiting industry recovery |
| FNF |
Title insurance leader |
Industry leader; BKF spin-off |
Bullish: Spin-off unlocks value, industry consolidation improves competitive landscape |
Investment Implications
- Overall stocks: Current valuations are reasonable, and investors should revert to long-term asset allocation targets rather than panic-selling due to short-term gains. For underweight investors, now is still a good time to buy.
- AIG: Current price is below adjusted book value, and management’s buyback strategy will accelerate per-share value growth, suitable for long-term holding.
- NOV: The oilfield services industry is at a cyclical trough, but the company has solid finances and a stable market share, making it suitable for counter-cyclical positioning.
- FNF: The spin-off of BKF will unlock valuation, and the long-term competitive landscape of the title insurance industry is improving, but normalization of the mortgage market is needed.
Theme and Background
This chapter discusses three core stocks held by the Oakmark Fund: Fidelity National Financial (FNF), Amazon (AMZN), and the energy stocks Apache (APA) and Chesapeake (CHK). Through a Q&A format, the author elaborates on the valuation logic, business model advantages, and investment strategies under commodity price volatility for these companies, with the core emphasis on long-term holding and contrarian investing.
Core Views
- FNF (Title Insurance): The author believes the market underestimates the long-term profitability of the home purchase business relative to the refinancing business. Although refinancing volumes may fluctuate in the short term, the profit margins on title insurance for home purchases are far higher than those for refinancing over the long run. Therefore, FNF's long-term revenue and profit margins will both improve significantly. The author is willing to invest for this high-probability but time-consuming outcome, in stark contrast to most investors who focus only on the short term (within one year).
- Amazon (AMZN): The author argues that Amazon's Marketplace business is not a weakness but rather a core advantage of its business model. By allowing third-party sellers to compete on its platform, Amazon effectively acts as a "mall owner," collecting commissions akin to "rent." This model carries lower risk and is more stable than direct sales, and it should command a higher valuation multiple.
- Energy Stocks (APA/CHK): The author believes that in the context of significant oil price volatility, the behavior of energy company management is more important than oil price forecasts themselves. The reason for choosing Apache and Chesapeake is that their management teams are willing to repurchase shares or sell assets when stock prices are depressed, thereby enhancing per-share value, whereas most energy company management teams focus solely on scale expansion.
Key Arguments and Data
1. FNF's Long-Term Valuation Logic:
- Core Difference: The profit margins on title insurance for home purchases are far higher than those for refinancing. Therefore, even if refinancing volumes return to historical averages, FNF's revenue and profit margins will still improve due to the growth in the purchase business.
- Time Horizon: The author is willing to invest for a "high-probability but time-consuming outcome," while most investors are unwilling to hold a stock for more than one year.
2. Amazon's Business Model Advantage:
- Cost and Pricing: Amazon leverages its scale to achieve cost advantages and trades low profit margins for high growth, convincing consumers that its prices are better than those of most retailers.
- Nature of Marketplace: The Marketplace business accounts for over 40% of Amazon's total unit sales. When third-party sellers offer lower prices, consumers get better deals, while Amazon collects commissions (similar to "rent") as the platform operator without bearing inventory risk. The author believes this model is more akin to a "royalty stream" and should command a higher valuation multiple than a retailer.
- Valuation Metric: The author uses the price-to-sales (P/S) ratio as a valuation metric for the retail industry, arguing that Amazon's P/S ratio should be higher than that of traditional retailers because its growth primarily comes from cannibalizing traditional retail market share.
3. Investment Logic for Energy Stocks:
- Unreliability of Oil Price Forecasts: The author does not focus on oil price forecasts because oil prices are the largest single variable determining the intrinsic value of energy companies and are difficult to predict. Over the past year, oil prices have fluctuated between $40 and $100; at $40, most companies were nearly worthless, while at $100, they were worth several times more.
- Long-Term Equilibrium Price: The author estimates the long-term market-clearing oil price using two indicators:
- Forward Futures Prices: When spot prices fell to $40, five-year futures prices remained above $60.
- Marginal Supply-Demand Analysis: Producers need oil prices around $70 to achieve sufficient returns on new investments.
- Management Behavior is Key: The reason the author chooses APA and CHK is that their management teams are willing to repurchase shares or sell assets when stock prices are depressed, thereby enhancing per-share value. In contrast, most energy company management teams focus solely on scale expansion.
Companies/Assets Involved
| Company |
Role and Key Data |
Bullish/Bearish |
| Fidelity National Financial (FNF) |
Title insurance company. The author believes its long-term revenue and profit margins will improve due to growth in the purchase business, contrasting with the market's short-term focus on refinancing volumes. |
Bullish |
| Amazon (AMZN) |
E-commerce and cloud services giant. The Marketplace business accounts for over 40% of unit sales. The author believes its business model is more akin to a "mall owner" and should command a higher valuation multiple. |
Bullish |
| Apache Corp. (APA) |
Energy exploration and production company. Management is willing to repurchase shares or sell assets when stock prices are depressed to enhance per-share value. |
Bullish |
| Chesapeake Energy Corp. (CHK) |
Energy exploration and production company. Similar to Apache, management behavior is the key reason the author chooses it over other energy stocks. |
Bullish |
Investment Implications
- Implications for FNF: Investors should focus on the long-term structural growth of the home purchase business rather than short-term fluctuations in refinancing volumes. Being willing to invest for a high-probability but time-consuming outcome is key to generating excess returns.
- Implications for Amazon: The Marketplace should not be viewed as a threat to Amazon's direct sales business but rather as a lighter-asset, higher-margin business model. Investors should focus on its potential for "rental" income as a platform operator, rather than solely on its profit margins as a retailer.
- Implications for Energy Stocks: In an industry with severe commodity price volatility, management's capital allocation capabilities (e.g., buybacks, asset sales) are more important than predicting oil prices themselves. Investors should seek companies willing to enhance per-share value when stock prices are depressed, rather than those blindly pursuing scale expansion.