Value Investing

Fidelity Contrafund Hit Hard By CMG Bet

Fidelity Contrafund performance review for the fourth quarter ended December 31, 2015.

Fidelity Contrafund Investment Approach

  • Fidelity Contrafund is an opportunistic, diversified equity strategy with a large-cap growth bias.
  • Philosophically, we believe stock prices follow companies’ earnings, and those companies that can deliver durable multiyear earnings growth provide attractive investment opportunities.
  • As a result, our investment approach seeks companies we believe are poised for sustained, above-average earnings growth that is not accurately reflected in the stocks’ current valuation.
  • In particular, we emphasize companies with “best-of-breed” qualities, including those with a strong competitive position, high returns on capital, solid free cash flow generation and management teams that are stewards of shareholder capital.
  • We strive to uncover these investment opportunities through in-depth bottom-up, fundamental analysis, working in concert with Fidelity’s global research team.

Fidelity Contrafund

Fidelity Contrafund – Performance Review

The Fidelity Contrafund’s share classes finished the fourth quarter with mid-single-digit gains, but trailed the benchmark S&P 500® index due to subpar security selection. The overall environment this quarter was generally supportive of the faster-growing, best-of-breed companies we prefer, as was the case throughout 2015, as the fund strongly outperformed the S&P 500® for the full year.

Versus the benchmark, the biggest detractor the past three months was security selection in consumer discretionary, especially our stake in Chipotle Mexican Grill. The stock fell sharply this quarter because multiple cases of food-borne illnesses were traced to the restaurant chain. The company, which has grown rapidly on the appeal of its “food with integrity” strategy, in December lowered its fourth-quarter forecast for same-store sales, and analysts downgraded the stock. Shares returned about -33% for the quarter, closing at $480.

We held steady our investment in Chipotle, a longtime holding, deciding to hang in there, based in part on management’s focus on productivity and comparable-restaurant sales.

Within information technology, we were hurt by our underweighted stake in Microsoft. Shares of the software giant gained 26% this quarter, driven by better-than-expected profit and increasing sales of cloud-computing software, including its Microsoft® Office 365 productivity suite.

Our underexposure to Microsoft reflected our concern about the company’s absence of a presence in mobile phones, which now account for more than half of all Internet-connected devices. A lighter-than-benchmark investment in General Electric also worked against our relative result the past three months. Shares of GE advanced about 24% for the quarter, reaching a seven-year high. One of the 10 largest companies in the U.S., GE has been refocusing on its core industrial businesses while selling off its financing assets.

We added a bit to our stake in GE, in part because we liked the firm’s decision to sell most of its financial businesses, but remained considerably underweighted as of December 31. Lastly, the fund’s cash position – 4% of assets, on average – was a modest relative detractor in a rising market.

Fidelity Contrafund

Turning to relative contributors, Alphabet provided the biggest boost. Shares gained 22% for the quarter, driven by better-than-expected third-quarter financial results, largely due to strength in its mobile-search business. The parent company of Google, formed in early October to separate its main online business from its many tertiary business lines, also announced plans to buy back about $5.1 billion in stock. The company also benefited this quarter from continued cost-control efforts under CFO Ruth Porat.

Alphabet was the fund’s largest holding (combining its Class A and Class C shares) at period end, based on our view that the company possesses a best-of-breed product suite and dominant market position in the mobile advertising category, both of which we believe could bear fruit over the long term amid increasing global Internet usage.

Elsewhere within technology, Facebook shares rose about 16% for the three-month period, largely ahead of better-than-expected revenue and an increasing number of new advertisers on its social-networking platform. The company reported continued growth in the number of people using its service, as well as increased per-user revenue metrics, especially in the U.S. and Canada. Facebook was among our largest positions and, along with Alphabet, one of what we consider to be “franchise” tech companies the fund emphasized.

That’s also true of online retailer, a company that generated strong revenue growth in a low-inflation world. Its shares rose 32% for the quarter, as the firm reported a second-straight surprise quarterly profit, backed by higher sales and driven by tight cost controls that benefited gross profit margins. The company reported a 79% sales increase and a strong profit from its Amazon Web Services division, which offers cloud-based computing power to both startups and established companies. Our exposure to Amazon increased a bit this quarter.

In energy, we made a good call in avoiding pipeline operator and index component Kinder Morgan, as its stock was hurt by the pullback in energy and a glut in U.S. oil and natural gas production. Shares returned -45% the past three months. We avoided it because the fund is positioned for continued weak performance in the energy sector.

Fidelity Contrafund

Fidelity Contrafund – Outlook and Positioning

The U.S. economy continued to improve during the fourth quarter, buoyed by low interest rates and inflation, and was a standout compared with others. Shares of faster-growing companies, particularly in the technology sector – historically an area of strength for the fund – performed comparatively well.

In this environment, we continued to focus on finding companies with improving growth prospects that seemed overlooked by the market. Management teams, for the most part, continued to do a good job containing expenses and controlling capital expenditures. Many, but not all, are boldly pursuing mergers and acquisitions.

Fidelity Contrafund prefers faster growers, and the portfolio is positioned for an environment in which earnings growth is a prominent driver of stock performance, as was the case the past three months and throughout 2015, in contrast to the prior year.

Fidelity Contrafund

Information technology remained the fund’s largest sector allocation in both absolute and relative terms, as we believe many top companies here have the potential for significant growth.

The Fidelity Contrafund emphasizes what we consider to be franchise companies in technology, including Alphabet and Facebook, both of which we felt could continue to grow their revenues from online advertising as consumers search the Web more often from their smartphones.

Facebook, a notable contributor the past three months, is a huge global phenomenon and a very profitable business, and our view is that it can grow rapidly for the next several years. It was among our largest holdings the past three months and remained so at period end after a modest boost in the fund’s exposure.

Fidelity Contrafund

Berkshire Hathaway, a detractor this quarter, remained among our largest holdings. We continued to like the insurance-focused conglomerate’s ability to generate high free cash flow from its diverse portfolio and then to redeploy that capital in an effective manner for shareholders. We believe stock prices follow earnings, so we tend to hold a stock when we see multiyear tailwinds such as a strong competitive position and an ability to grow in a capital-efficient way.

We continued to avoid the utilities sector due to its persistent capital-intensive business models and regulatory pressure. We prefer fast growers, and historically utilities haven’t grown quickly. This positioning modestly helped relative performance in the fourth quarter, as this group trailed the benchmark. At period end, our view was that utilities stocks traded at price-to-earnings premiums relative to their history.

Fidelity Contrafund

Energy remained the fund’s largest under-weighting throughout the fourth quarter. Many stocks in the sector were still reeling from the huge sell-off we saw as crude prices retreated, largely on concern about China’s economic slowdown. We will continue to closely monitor developments here, looking for companies that may be down and out but also have improving fundamentals.

The fund’s exposure to international economies was minimal, with most foreign investments based on stock-specific drivers rather than regional theses. Economic conditions in Europe and China remained challenged, limiting attractive investments in these areas, in our view.

We plan to stick to our strategy of focusing on best-of-breed companies that are committed to gaining market share and possess sustainable, long-term competitive advantages.

Fidelity Contrafund