Longleaf Partners Fund only purchases stocks that trade at deep discounts, but buying opportunities are dwindling fast Value investors don’t have it easy these days. With the S&P 500 at record highs, investors who prefer cheap and unpopular stocks are finding that the number of buying opportunities is dwindling fast.
Just ask Mason Hawkins and Staley Cates at Memphis-based Southeastern Asset Management, who oversee the respected Longleaf Partners Fund, which focuses on mid-cap and large-cap U.S. companies.
The fund’s performance has smashed the S&P 500 over the past five, 15 and 20-year periods through a tremendous commitment to buying stocks that trade at a deep discount relative to their intrinsic value.
But what bargains did the fund managers scoop up in the first quarter? Nothing.
“Following the market’s appreciation over the last few years and with little volatility in the quarter, no new names met our investment criteria,” they said in a management discussion that accompanied Southeastern’s latest quarterly report.
Instead, they have taken a strong liking to cash, which now accounts for a remarkable 27 per cent of the fund’s $8.2-billion (U.S.) portfolio after jettisoning holdings in DIRECTV (NASDAQ:DTV) and Vulcan Materials Company (NYSE:VMC).
That’s extraordinarily high. A year ago, cash accounted for 17 per cent of the portfolio; and at the start of the bull market in 2009 the fund was all-in, with cash at just 1.6 per cent.
Today’s hefty cash level also stands in stark contrast to most of the rest of the world. According to a recent global money manager survey by Bank of America, the average allocation to cash is just 5 per cent.
Canadians can’t buy the U.S. Longleaf fund, but they can mimic its approach to the market – and Mr. Hawkins and Mr. Cates are certainly worth taking seriously.
They are rigid in their appraisal of stock values, focusing on free cash flow, net asset value and industry comparisons to come up with a figure that serves as an estimate for what a stock is worth.
They prefer to buy a stock that trades at 60 per cent or less of its estimated intrinsic value. Ideally, the stock price then rises, eliminating the discount.
The approach has been working well over the longer term. Over the past five years, the Longleaf Partners Fund has beaten the S&P 500 by 16 percentage points and over the past 15 years it has doubled the performance of the benchmark index with a gain of 185 per cent.
The problem is that even in the fund’s portfolio of relatively cheap stocks, values are rising sharply.
The fund managers estimate that the 14 stocks in the fund – including Loews Corporation (NYSE:L), Chesapeake Energy Corporation (NYSE:CHK), Level 3 Communications, Inc. (NYSE:LVLT) and FedEx Corporation (NYSE:FDX) – trade well above 70 per cent of intrinsic value. In early 2009, the fund traded at just 35 per cent of intrinsic value.
The fact that the fund managers are not finding anything to add to the portfolio today doesn’t sound like a ringing endorsement for the five-year-old bull market.
“We will maintain our long-term perspective as we have in the past, and patiently wait to buy names that qualify rather than force the cash into less discounted or lower-quality companies that would increase the risk of permanent loss,” they said in their management discussion. However, their patience could come at a price if stocks continue to rise deeper into record territory.
Although the Longleaf Partners Fund has returned 18.7 per cent over the past year, the return has lagged the S&P 500 over the same period because of the fund’s rising allocation to cash. Value investing always requires a strong stomach, and record-high stock prices don’t make things any easier.