Theme and Background
This chapter examines the stark divergence between market performance and the real economy during the 2020 COVID-19 shock, and analyzes the similarities between the current speculative environment and the 2000 internet bubble. The report argues that despite the S&P 500 rising 18% for the year and the tech-heavy Russell 1000 Growth Index surging 38%, value investing strategies can still generate excess returns by deeply digging into undervalued assets.
Core Views
- Market speculative sentiment is approaching the peak of the 2000 internet bubble, but the financial stocks (the largest holdings) in the Oakmark portfolio still trade at single-digit P/E ratios, in stark contrast to speculative sectors.
- Facebook is one of the most undervalued tech giants today, with an adjusted real P/E of just 17 times, below the overall S&P 500 level, making it a "cheap" asset.
- The "new normal" will largely revert to the old normal; except for irreversible digital trends, most behavioral changes driven by the pandemic (e.g., remote work, contactless facilities) will not become permanent.
Key Arguments and Data
1. Facebook's "Sum-of-the-Parts Valuation" Logic:
- Nominal valuation: Stock price $273, expected 2021 EPS $10.47, implying a 26x P/E.
- Cash adjustment: After deducting $29 per share in cash, the actual cost is $244/share, corresponding to a 23x P/E.
- WhatsApp value: Since its acquisition in 2014, users have grown 4x. Based on the per-user valuation at the time of acquisition, its current value is $31/share; this valuation is reasonable when estimated using forward revenue multiples.
- AR/VR investment: Approximately $5/share invested, with current losses of at least $1/share.
- Final adjustment: After subtracting the $36 value of WhatsApp and AR/VR from the stock price and adding back the $1.50 loss, the core Facebook/Instagram business effectively costs $208/share. Based on expected 2021 EPS of $12, the P/E is just 17x.
2. Historical Comparison:
- After the 2000 internet bubble burst, undervalued out-of-favor stocks still outperformed the broader market. Currently, most financial stocks in the Oakmark portfolio (e.g., Ally Financial, Bank of America) trade at single-digit P/E ratios.
3. Sustainability of Digital Trends:
- Video streaming (Netflix, YouTube) replaced linear TV during lockdowns; online retail (Qurate Retail Group) eroded physical store market share.
- Financial digitization: Online transaction costs are far lower than those of physical branches, benefiting holdings such as Ally Financial, Bank of America, Capital One, Citigroup, and Wells Fargo.
Companies/Assets Involved
| Company |
Role |
Key Data |
View |
| Facebook |
Core holding |
Adjusted P/E 17x; WhatsApp user growth 4x; AR/VR loss $1/share |
Strongly bullish, believes the market undervalues its sum-of-the-parts |
| Netflix |
Beneficiary of digitization |
Video streaming market share growth |
Bullish (already held) |
| Alphabet |
Beneficiary of YouTube |
Video streaming + digital advertising |
Bullish (already held) |
| Charter Communications |
Internet service provider |
User growth during lockdowns |
Bullish |
| Comcast |
Internet service provider |
Same as above |
Bullish |
| T-Mobile |
Internet service provider |
Same as above |
Bullish |
| Qurate Retail Group |
Online retail |
Shift from physical stores to online |
Bullish |
| Ally Financial |
Financial digitization |
Online transaction cost advantage |
Bullish |
| Bank of America |
Financial digitization |
Same as above |
Bullish |
| Capital One |
Financial digitization |
Same as above |
Bullish |
| Citigroup |
Financial digitization |
Same as above |
Bullish |
| Wells Fargo |
Financial digitization |
Same as above |
Bullish |
Investment Implications
- Go long on undervalued tech giants: Facebook's adjusted P/E is just 17x, far below the S&P 500's 22x+, and its spun-off assets (WhatsApp, AR/VR) have not yet been priced in by the market. Investors should focus on the cash flow generation capability of its core advertising business (Facebook/Instagram).
- Go long on financial digitization: Bank stocks (Ally, Bank of America, etc.) benefit from structural advantages of lower transaction costs and low interest rates, with current single-digit P/E ratios providing a margin of safety.
- Beware of speculative bubbles: Avoid chasing high-valuation tech growth stocks (e.g., those in the Russell 1000 Growth Index with 38% gains), and prioritize companies with strong cash flows and reasonable valuations.
- Maintain "strong views, weakly held": Stay bullish on digital trends (e.g., streaming, online retail), but continuously verify data (e.g., user growth, cost changes) and promptly correct mistaken judgments.
Theme and Background
This chapter examines whether the impact of the COVID-19 pandemic on areas such as travel, office work, and consumption is permanent. Oakmark argues that the market has broadly overestimated the persistence of the "new normal" and underestimated the speed of returning to the 2019 model in 2022. The report notes that the valuation gap between value stocks and growth stocks remains at historically extreme levels, and the rebound in value stocks has only just begun.
Core Views
- Travel will rebound strongly: Leisure travel is "delayed" rather than "gone," and business travel will regain momentum in 2022. Zoom cannot replace in-person meetings.
- Remote work is unsustainable: Employees like it, but employers have already identified efficiency losses. Netflix's Reed Hastings believes corporate culture has been damaged by remote work, and employees will return to the office immediately after vaccination. Oakmark expects most companies to require employees back in the office in the second half of 2021.
- 2022 will be more like 2019: Advertising, corporate IT projects, hospital elective surgeries, interest rates, employment, and economic activity will all return to normal. Oakmark considers itself a "contrarian" outlier but adheres to "strong opinions weakly held."
- The value stock rebound is far from over: Over the past four years, the Russell 1000 Growth has delivered twice the return of the Russell 1000 Value. In the fourth quarter of 2020, value stocks outperformed growth stocks by only about 5 percentage points, which is barely visible on a long-term chart. Value stocks remain far cheaper and will benefit more from a "return to normal."
Key Arguments and Data
- Travel: Leisure and business travel nearly ground to a halt in spring 2020. Business travel has barely recovered, while leisure travel has been mainly limited to short trips or camping. Oakmark believes consumers have not found substitutes, so leisure travel will rebound strongly, potentially exceeding trend levels due to the carryover of unused vacations.
- Remote work: A USA Today survey shows 44% of remote workers report improved work-life balance. However, Oakmark points out that employers face difficulties in onboarding, cross-training, performance evaluation, special projects, and more. Netflix's corporate culture has been damaged by remote work.
- Value vs. Growth: If one had invested in the Russell 1000 Growth instead of the Russell 1000 Value four years ago, their capital would have doubled. In the fourth quarter of 2020, value stocks outperformed growth stocks by only about 5 percentage points, a "barely visible fluctuation."
| Indicator |
Data |
| Proportion of remote workers reporting improved work-life balance |
44% |
| Cumulative excess return of Growth over Value over the past four years |
Approximately 100% (capital doubled) |
| Value outperformance over Growth in Q4 2020 |
Approximately 5 percentage points |
| Oakmark's expected timeline for companies to require return to office |
Second half of 2021 |
| Oakmark's expected timeline for business travel recovery |
2022 |
Companies/Assets Involved
- Beneficiaries of travel recovery: American Express, Apache, Booking Holdings, Concho Resources, Diamondback Energy, EOG Resources, General Dynamics, GE, Hilton, MGM (bullish)
- Beneficiaries of the end of remote work: Bank of America, Citigroup, Wells Fargo (due to office building mortgages), CBRE Group (commercial real estate services), Keurig Dr Pepper (office coffee) (bullish)
- Beneficiaries of dining out: Booking Holdings (OpenTable), Constellation Brands (beer), Bank of America, Wells Fargo (restaurant mortgages) (bullish)
- Beneficiaries of advertising/IT/healthcare/insurance/rates/employment/economy: Alphabet, Facebook (advertising); DXC Technology, Gartner, Workday (corporate IT); HCA Healthcare (elective surgeries); AIG, Reinsurance Group of America (mortality); financial stocks (interest rates); banks (employment); cyclical stocks (economic activity) (bullish)
- Oakmark Bond Fund: Managed by Adam Abbas, employing the same valuation methodology as equities. Current duration is significantly lower than peers and will remain so until interest rates (adjusted for inflation) return to historically normal levels. The author personally invests cash in this fund and has not reduced stock holdings.
Investment Implications
- Go long on the "return to normal" theme: Focus on sectors such as travel, commercial real estate, banks, advertising, corporate IT, elective surgeries, and insurance. These assets are currently priced at extremely low valuations, and market consensus is overly pessimistic.
- Go long on value stocks, short on growth stocks: The valuation gap between the Russell 1000 Value and the Russell 1000 Growth remains at historically extreme levels, leaving significant room for a value stock rebound. Oakmark believes the value stocks in its portfolio will benefit more than the index.
- Go long on rising interest rates: The Oakmark Bond Fund maintains a low duration, betting on interest rates (adjusted for inflation) returning to historically normal levels. This benefits financial stocks and banks.
- Beware of remote work concept stocks: Demand for remote work tools like Zoom will decline as employees return to the office. Oakmark's portfolio holds 0% in Zoom.