Bill Nygren Market Commentary | 4Q21

Theme and Background

This chapter lays the foundational exposition of Oakmark’s investment philosophy, aiming to explain why the firm adheres to its long-term, value-oriented approach amid current market conditions characterized by rampant speculation and a severe disconnect between price and value. The report opens with a quote from Warren Buffett and highlights anomalies where "prices are completely detached from value," such as cryptocurrencies whose value cannot be defined (ranging from $0 to $500,000) yet are still bought at $50,000, and a bankrupt company’s stock surging from $2 to $70.

Core Thesis

Oakmark’s central investment argument is: The stock market is not fully efficient; price and value frequently diverge, and investors can exploit this divergence through rational analysis and long-term forecasting to generate excess returns. The firm explicitly rejects the "efficient market theory," arguing that most market participants are driven by emotion rather than precise calculations of future cash flows. Counterintuitive judgments include: 1) Value investing can encompass "growth" companies like Netflix and Alphabet; 2) The market often overreacts to "disruption risk," leading to severe undervaluation of traditional sectors (e.g., banks, energy).

Key Arguments and Data

The report supports its views with multiple specific cases and data:

• Market Inefficiency Cases: A cryptocurrency bull admits value is undefinable (between $0 and $500,000) yet is willing to buy at $50,000; a CEO believes his company’s stock at $140 is overvalued, only for it to later rise to $1,000; another near-bankrupt company’s stock jumps from $2 to $70.
• Value Investing Practice: Oakmark’s portfolio holds bank stocks with P/E ratios half that of the S&P 500; energy companies trade at single-digit P/E ratios.
• Accounting Adjustment Logic: For Netflix, customer acquisition costs and subscription pricing must be adjusted; for Alphabet, R&D spending on "other bets" like Waymo should be added back, and cash should be valued separately (otherwise, valuing cash at a normal P/E ratio equates to "buying a dollar for pennies").
• Macro Risk Handling: The firm assumes the economy will return to "normal" within two years, so abnormal economic conditions have minimal impact on valuations (only a two-year gap in normal cash flows). During the 2020 COVID-19 pandemic, the firm was bullish on financial and travel-related businesses, believing normalcy would return within a few years; in response to the Omicron variant, it only slightly lowered valuations for travel-related businesses (delaying normal demand to 2023).
• Disruption Risk Mitigation: Through long-term forecasting (rather than low P/E ratios), peer debates, and a "devil’s advocate" review mechanism. For example, the market’s pricing of fossil fuel and internal combustion engine businesses implies that renewable energy and electric vehicles will be adopted "faster than we think," but Oakmark believes investors are overreacting.

Companies/Assets Involved

Company/Asset	Role and Key Data	Bullish/Bearish
Cryptocurrency	Value undefinable ($0-$500,000), speculative case	Bearish (not buying)
Bank Stocks	P/E ratio half that of the S&P 500, undervalued due to trauma from the 2008 financial crisis	Bullish
Energy Companies	Single-digit P/E ratios, undervalued due to a decade of poor performance and excessive capital spending	Bullish
Netflix	Requires adjustment of customer acquisition costs and subscription pricing, analogous to cable companies 30 years ago (per-user value around $1,000)	Bullish
Alphabet	Adjusted search business P/E ratio below the S&P 500; loss-making businesses like Waymo need separate valuation	Bullish
General Motors	Has R&D investments in electric and autonomous driving, market overlooks value of emerging businesses	Bullish
Fiserv	Its Clover platform (small business merchant acquisition) is overlooked by the market	Bullish

Investment Insights

• Directional Advice: Investors should actively seek targets with significant divergence between price and intrinsic value, rather than chasing market hotspots. Focus on sectors and companies undervalued due to historical trauma (e.g., banks, energy) or accounting rule distortions (e.g., Netflix, Alphabet).
• Operational Strategy: Adopt a long-term forecasting framework (assuming the economy returns to normal within two years), capitalize on market overreactions to disruption risk (e.g., fossil fuels, internal combustion engine businesses), and pay attention to management actions that return value to shareholders through share buybacks and dividends.
• Risk Control: Manage disruption risk through peer debates, devil’s advocate reviews, and a margin of safety where the purchase price is significantly below intrinsic value.

---

Theme and Background

This section discusses Oakmark's investment methodology and talent mechanism, focusing on how it attracts and retains value-investing talent through a unique career path for analysts (non-promotion to fund manager), thereby supporting a long-term, fundamentals-driven investment strategy. The author argues that the current market exhibits an enormous price gap between growth stocks and low-P/E stocks, which is unsustainable and expected to reverse.

Core Views

• Talent mechanism as an investment advantage: Oakmark has established a dual-track career path, allowing analysts to achieve equivalent economic returns without becoming fund managers, making it an ideal destination for value-investing analysts and significantly reducing turnover.
• Stocks far superior to bonds: The dividend yield of the S&P 500 has matched the 10-year Treasury yield, but stock dividends and earnings expectations will grow, so equity investors will outperform bond investors over the next decade.
• Low-P/E stocks will return: The strategy of "buying hot companies at any price" over the past decade is unsustainable. The price gap between growth stocks and low-P/E stocks has become abnormally large, and the author believes a reversal is reasonable and highly likely.

Key Arguments and Data

• Valuation comparison: The dividend yield of the S&P 500 is comparable to the 10-year Treasury yield, but stocks have earnings growth potential, while bond yields are fixed.
• Market structure: Oakmark's portfolio does not hold the "concept stocks" favored by financial media, but instead focuses on traditional businesses and low-P/E companies.
• Historical analogy: The author uses the metaphor of "a stone in the yard worth $0 to $500,000, but someone is willing to sell it for $50,000" to satirize the absurdity of current market pricing for assets like cryptocurrencies—buyers, knowing the value is uncertain, still pay high prices.

Companies/Assets Involved

Company/Asset	Role	Key Data	View
S&P 500	Market benchmark	Dividend yield = 10-year Treasury yield	Superior to bonds, but not optimal
Oakmark Portfolio	Investment target	Low P/E, traditional businesses	More attractive than the S&P 500
Cryptocurrency (metaphor)	Speculative asset	Value between $0 and $500,000, but some willing to buy at $50,000	Pricing logic is absurd, speculative risk is high

Investment Implications

• Directional judgment: Investors should reduce holdings in growth stocks and concept stocks, and increase holdings in low-P/E, traditional business value stocks, as the current price gap between growth and value stocks is at historical extremes, with a high probability of mean reversion.
• Talent and performance correlation: When selecting funds, attention should be paid to whether their talent mechanism is stable. Oakmark retains senior analysts through a dual-track career path, and such a long-term stable research team is the foundation for sustained excess returns.
• Time dimension: The short-term market is unpredictable, but over a 5-10 year horizon, fundamentals (earnings, dividend growth) will dominate returns. With current low bond yields, stocks (especially undervalued ones) are a better long-term allocation choice.