Kevin Holt manages large cap value assets aggregating about $20 billion on behalf of funds giant Invesco Ltd. (NYSE:IVZ). The Invesco Comstock Fund, which he has co-managed since 1999, has delivered net annualized returns of 7.7% over this period, compared to 4.7% from the S&P 500 (INDEXSP:.INX).
Kevin Holt’s Investment philosophy
“We typically hold our positions for at least four or five years – most investors don’t have the inclination or stomach to do that,” says Holt in the latest issue of Value Investor Insight.
And that’s born out of the two cornerstones of his investment process.
The first objective is to accurately assess the value of a company over an investment cycle, ignoring short-term bad news and market pessimism.
The second task, and evidently the more difficult one, is to hold onto that investment mustering all his patience and conviction while the target company returns to normalized earnings and growth.
Holt admits candidly, “For four of the five years I typically own something, I’m usually miserable.”
Large caps are favorite hunting grounds
Describing US traded stocks of market capitalization in excess of $5 billion as his preferred “opportunity set,” Holt says he picks stocks on an individual basis and separate from any macro views. Stocks that appear inexpensive in the context of their historical valuations are possible candidates for investment by Holt.
To determine whether a stock is inexpensive, he examines its metrics such as ‘price to earnings levels’, ‘price to book value’ or ‘enterprise value to sales,’ and whether these are historically low in absolute and relative terms. Detailed fundamental analysis then seeks to uncover the reasons for the historically low valuation.
“We’re also trying to zero in on the three or four issues that have made the stock cheap and whether the market may be misreading or misinterpreting them,” says Holt.
He also says he is fairly indifferent to the quality of a business. “Nobody actively seeks out bad business,” he says, “but we are willing to invest in lower-quality businesses if the price is right.”
He acknowledges that meeting company management would be necessitated only if the company has issues that need to be addressed on a priority basis with an action plan for their solution.
Interestingly, Holt also examines the manner that compensation is paid to management. “In particular, we want executive pay to be based on return-on-capital-type metrics rather than on earnings growth or the stock price,” he clarifies.
Current sectors of interest
Energy, big banks and pharmaceuticals currently engage Holt’s interest. In pharma, Holt is attracted by companies such as Merck & Co., Inc. (NYSE:MRK) and Pfizer Inc. (NYSE:PFE), which have undergone massive cost cutting and R&D rationalisation, but whose new drug pipelines could be a storehouse of value.
“So while Merck today still trades at a discount to long-term averages, it has immunotherapy cancer drugs that may have efficacy across a number of cancer types, which would be revolutionary. We’re getting the upside from that type of thing for free,” says Holt.
Among big banks, Citigroup Inc (NYSE:C) is one of his largest holdings.
Holt acknowledges that big banks operate today in a radically changed environment as far as profitability is concerned, but feels that the market is not properly discounting what profits could accrue in the future on a normalized basis.
Citi’s current organization structure comprises its core banking operation and the segregated Citi Holdings assets. Holt says the two units generate ROE of 13% and 6% respectively. “But it’s not rocket science to assume that on a normalized basis, Citi will earn at least the 13% ROE its core business is generating in a tough environment today with an expense base we believe is much higher than it needs to be,” he observes.
With a 13% ROE, he estimates that Citi should trade around 1.3 X of its tangible book value. However, at around $ 49, the bank is trading at only 85% of its TBV. Add to that the prospect of excess capital generated by the bank of around $ 50-$ 60 billion in the coming three years, which would likely be returned to shareholders in various forms, and Citi becomes a justifiable longer-term investment.
“This is typical of what we own, with not a lot to get excited about in the near future, but trading at 50% of what we believe it can be worth three to five years out,” says Holt.
How to manage the misery
“If you truly have conviction in the intrinsic value, you’re willing to average down when things go against you and to persevere until you’re proven right. When you are right, the misery is forgotten,” advises Holt.