Note to readers: I am writing all these posts very informally. I have found that readers like this the best, and it enables me to take the most notes possible and get them up in real time. I will be updating the presentations in real time, and tweeting, so make sure to check back frequently or on Twitter, Facebook or Feedburner. Also you can check out this website announcement Value Investing Congress Website Announcement.
All notes are the speaker’s own statements, except for my own notes in the brackets.
Ricky Sandler is the Managing Member and Senior Portfolio Manager of Eminence Capital, LLC, an investment manager that employs a ‘quality value’ approach to investing. Before founding Eminence in 1998 Mr. Sandler co-founded and co-managed Fusion Partners, a long / short investment partnership. Prior to that Mr. Sandler was a research analyst covering a wide range of industries and companies for Mark Asset Management, a research-driven investment management organization. Ricky Sandler manages over $3 billion, and has 20% net returns since 1999. Mr. Sandler received a BBA in Accounting and Finance graduating with honors from the University of Wisconsin where he currently serves as a board member for the University of Wisconsin Foundation and as a member of its Investment Committee.
We are a long short hedge fund and run $2.9billion. We are a bottom ups stock pickers but I will talk about some macro thoughts. We have been on average 120% long and 70% short.
We are always net long since the market goes up over time.
Our current exposure is 131% long and 65% short because the market is cheap now.
On long side we buy quality business that is cheap. We focus on businesses improving. Quality means a lot so we use ROIC, high cash conversion, conservative accounting, intrisinc value per share should be growing, good management.
We buy them when they trip or are out of favor, or are hidden.
We do not buy low quality business regardless of price. These companies can become cheaper. It is also harder to analyze whether problems faced will be short or long term.
On the short side we like a disconnect with Wall Street.
We like companies that are facing secular challenges such as technology. Usually the other side of the trade is looking at the valuation.
We like looking at unsustainable earnings, fraud.
We do not short high quality businesses even at high valuations.
There are a lot of opportunities in large caps now. When we started we were finding value in small cap stocks, now the large caps are showing a lot of value.
Over the past ten years large caps have lagged short caps significantly. Even since the end of 2007 large caps have underperformed short caps.
Mid cap stocks have a bit of a premium currently, but large caps are very undervalued based on the past 30 years of data. The largest 1500 stocks are trading at close to an all time low valuation.
Bulls look at stocks as cheap based on interest rates, and bears say forward earnings are expensive, since forward earnings are unknown especially with the current headwinds in the economy.
Over the past 30 years there has not been much difference between earnings growth for small, mid and large caps.
Large caps should trade at a premium due to lower standard deviation. However large caps are trading at a huge discount to small caps.
I think earnings growth will slow, which is a reason to pick large cap stocks.
Dividends are increasingly important due to low interest rates, so large caps have higher dividends.
Fixed income asset allocators will probably buy more large cap for yield.
Investors are scared now, as people come back to stocks they will come back in the most risk averse way, which would be large caps.
High quality businesses are undervalued due to market anomalies. We looked at seven quantitative factors such as high ROE, stable sales growth, margin stability, and cash flow stability and put stocks into deciles. If you owned this basked of stocks you would have returned 2.2% annually over the market for the past 30 years. While junk stocks would have under-performed by 3.5% annually.
On EV/EBIT large cap quality are cheap, and valuation is the same as junk stocks. This doesn’t make sense rationally.
Investor psychology- high quality stocks are not as exciting as small stocks.
Big stocks tend to be less of trader stocks. They tend to be long term stocks but just dont feel as good.
Interestingly high quality stocks only outperform 54% of the time. So it is boring to own them when you only outperform half the time.
CME Group one of our top holdings. CME is one of largest derivities and futures exchange and clearing houses.
They have products including:
Interest rates, energy, equities, FX, commodities, precious metals such as gold.
CME has a natural monopoly. It is either things they own, or develop the benchmark. There have been some challenges over the past years and almost everyone has failed.
High gross margains of over 60%
15% CAGR for 40 years, 18% CAGR over past 10 years. Growth has increased due to increased sophistication of investors and the globalization of markets.
Customers like CME. CME has never had a failure of a trade. They are a clear counterparty on the opposite of every side of the trade, so people have enermous confidence.
Regulators like them. Dodd-Frank wants to move OTC CDOs to exchanges like CME.
They are strong capital allocators; they have bought NYMEX and CBOT, which consolidated their market position. They have taken stakes in Malaysia and Brazil.
CME is coming out with new products. They have come out with weekly options around treasuries, and contracts on emerging market currencies like the Yuan. They have come out with a lot of contracts on shorter term treasuries, sovereign yield spreads, and S&P groups.
Equity and treasuries used to be the only part of asset allocation, now you have more people who want to hedge commodities like gold, corn, interest rates etc.
They have never had more business than they have had in the last three months.
They are expanding their customer base.
Regulatory risk-Dodd-Frank expresses it explicitly that it wants CDOs on exchanges. Other companies will compete but many products are a natural for CME.
Basel III- Goldman Sachs used to hedge their risk, Basel III is going to charge a lot more to keep it on their balance sheet.
People are worried about counterparty risk like a CDO from Morgan Stanley, will go to CME
We think CME will earn about $22 per share this coming year, and the stock is trading at $260. In 2005 it was trading above $700.
It is trading at 11x 2012 EPS and FCF.
Management is beginning to return capital to shareholders.
What makes them the winner over banks? Regulators looking for safety and CME has historically been safe. CME can change margins instantly. Regulators will go with people who have the experience. Even the investment banks will admit this. I dont think Goldman Sachs will start its own exchange.
Lack of tangible assets? I love companies that earn a lot of ROC. Tangible assets like the case of Walmart can be a barrier to entry. However lack of tangible assets can be sign that the truth worth is in the business model, which gives them a competitive advantage.