We did a summary of this interview with David Herro in VII but since Oakmark likely purchased a reprint – readers can now view the entire interview. Check it out below.
The keys to investment success, says David Herro, are skill in valuation and having the discipline to actually buy low and sell high. He would know.
David Herro: Courage of Convictions
He’s seen it all from his vantage point as one of the industry’s top international investors – Morningstar named him Foreign Equity Manager of the Decade in 2010 – but even David Herro is impressed with the level of economic turbulence today. “There’s always a lot going on,” he says, “but we’re probably closer to a peak than a trough on that front right now.” Herro has proven more than capable in navigating turbulence. He manages or co-manages some $55 billion for Chicago based Harris Associates, and the Oakmark International Fund he’s run since 1992 has earned a net annualized 10.6%, vs. 6.4% for the MSCI World Index (ex U.S.). Among areas of upside he’s uncovering today: luxury autos, farm machinery, asset management and private banking.
Business quality wasn’t as important to you starting out in 1986 as it has become. Describe that evolution.
David Herro: Starting out I was a Graham and Dodd investor, focused on low price/earnings ratios, good balance sheets and high dividend yields. The problem with that is you can get caught in too many value traps. I concluded I was better off focusing primarily on two key variables in weighing investment attractiveness: company valuation and business quality.
Quality to me is a company’s ability to intelligently allocate capital and generate good economic returns from its businesses. If they’re proficient in allocating capital and they earn good returns, that means they’re going to grow value per share. That growth of value over time is the best catalyst to get price and value to converge.
Even with an avowed quality focus, your contrarian nature still appears well intact.
David Herro: We’re very focused on paying a cheap price, and that only comes about when there’s some short-term challenge. I was in Hong Kong and Japan earlier this month and ran into a fellow investor talking about a slow, beaten-up sector he was avoiding like the plague. Well, that’s exactly where you should be looking!
An excellent example is CNH Industrial [CNHI], the big maker of farm equipment and heavy-duty trucks. The stock is weak in large part because we’re going through a tough period in agricultural commodity prices, which has put pressure on farm incomes and therefore on farm equipment spending. We recognize there’s going to be a cycle, there always is, but agriculture is a great long-term growth story given economic and demographic change around the world. But Mr. Market doesn’t have a lot of patience – he’s focused on the fact that farm prices are down today.
We recently bought shares in Melco Crown Entertainment [MPEL], one of six license holders to own and operate casinos in Macau. Macau-related stocks have been hit by a variety of concerns regarding corruption, visa restrictions, credit conditions and regulatory changes. None of that, however, impacts our view that the Macau gambling market is a double-digit grower long-term as increasing supply is comfortably absorbed by insatiable gambling demand from China’s rising middle class. This is a typical type of idea for us:
there’s an industry under pressure, we find a player in it with distinguishing features we find appealing, and we place a bet that short-term problems are not indicative of structural tailwinds going forward.
Let’s take a brief tour of the world. The most obvious first stop is Europe, the home to more than 75% of your Oakmark International Fund portfolio.
David Herro: We’ve always had an important stake in Europe, but today is around the peak. The simple reason is that we’re just finding very little value outside of Europe. The mistakes people make about Europe are, one, assuming that it’s one uniform market and, two, that a company domiciled there earns all its profits in stagnant markets. We’re trying to take advantage of those generalizations.
See full PDF here – 14-1230_ValueInvestorInsight_CourageOfConvictions_Herro