Dear Fellow Investors,
It is human to want to win and we are pre-programmed as children to get what we want quickly. Then we become adults in need of good investment returns and we are forced to operate in longer time frames of five to ten years. Only mavericks want to do what is needed.
As contrarians running a large-cap value strategy, our stock-picking discipline is organized around taking regular maverick risk on companies which meet our eight criteria and are being shunned by investors for whatever reasons that preoccupy them today. We like to think in terms of the warts or blemishes which the market considers permanent among companies suffering from temporary setbacks.
David Einhorn's Greenlight Capital returned -2.9% in the second quarter of 2021 compared to 8.5% for the S&P 500. According to a copy of the fund's letter, which ValueWalk has reviewed, longs contributed 5.2% in the quarter while short positions detracted 4.6%. Q2 2021 hedge fund letters, conferences and more Macro positions detracted 3.3% from Read More
Another investment veteran, Rob Arnott of Research Affiliates, defined this type of risk-taking in an interview with Barron’s:
One of the things I find very interesting is an investor’s tolerance for maverick risk. Let’s say the stock market’s up 20%. And you’re invested in emerging markets, and they go nowhere. How distressed will you be at that opportunity cost? If you’re like most investors, you pay close attention to what happens to U.S. stocks and bonds, and not much attention to anything else. If that’s so, then chances are pretty good that you won’t have a lot of tolerance for maverick risk, or performance dissimilar to the markets that you’re focused on. If you’re willing to tolerate results that are very different from your next-door neighbor or your peers, then you can make bigger bets.
Mr. Arnott has made a successful career out of providing asset allocators inexpensive ways to obtain factors which can contribute to outperformance. In theory, maverick risk comes from how much your portfolio deviates and your willingness to look extremely foolish for an extended time period. It is measured by what is called active share, or how much or little overlap your portfolio has with the index by which you are measured.
What Arnott is getting at is that the psychology of investment markets and the U.S. stock market is a key component of future outperformance.
In the history of our discipline, we have taken maverick risk on Home Depot (HD), eBay (EBAY), Starbucks (SBUX) and other consumer stocks at the 2009 market bottom. We deviated from the S&P 500 Index by having 30-40% of our portfolio betting on consumers who were mortified by the financial meltdown.
In 2012, we loaded up on the seemingly crippled major banks like Bank of America (BAC) and JPMorgan Chase (JPM), when regulators were bearing down on them, housing was in the basement and Jamie Dimon was chasing “whale trades.” You have to be a maverick to sit with these securities going down or nowhere while seemingly wart-less stocks in other sectors are already receiving the stock market’s adulation.
We thought it would be helpful to run through a few of the maverick risks among our holdings which appear especially attractive to us at current prices. Remember, we expect the new ones to make us look foolish for a while!
Our eight criteria gives us a maverick approach in how to view them. Discovery Communications (DISCA) is trading at a heavily-disregarded 7x next year’s earnings. It does not have the optics the market currently desires of top-line revenue growth, nor the cool factor that some folks believe is found in Netflix (NFLX). What it does have is the best lineup of owned, non-scripted programming which allows it to distribute agnostically to any platform in the world. This causes high and consistent levels of free cash flow and profitability around its business model.
The price of Walgreens (WBA) has enough headwinds to turn anyone into a conformist. Even with having to fight the drug pricing conversation and online competitive threats, Walgreens generates approximately $7 billion in free cash annually, has a 19% return on equity and a 3.35% dividend. It is a dividend aristocrat, by virtue of raising the dividend for 44 consecutive years. Now that is a maverick.
Lennar (LEN) is the nation’s second largest home builder. They own a huge number of buildable lots and are prepared to build and deliver 50,000 homes in 2019. Corelogic reported recently that over 25% of millennials are considering a home purchase in the next 12 months. We are mavericks, because we have been betting that this huge and self-absorbed group of people will get onto the family formation train and buy houses in the 90% of the country where it is affordable. Lennar has real assets and trades at 10x 2019 profits.
Lastly, Occidental Petroleum (OXY) is a new name to the portfolio, and it took a maverick approach in purchasing Anadarko Petroleum. In doing so, it is taking on significant amounts of debt, but also a portfolio of extremely valuable Permian Basin assets that it should monetize, while it reinvents itself into a global low-cost producer of oil with scale.
After all, Chevron offered $33 billion to buy the stock of Anadarko, when OXY traded at a $50 billion market cap. OXY owns both companies today and OXY trades at a $40 billion market cap now. This means that you can get Anadarko and OXY, which the market thought was worth north of $70 billion, for $40 billion. OXY took on a lot of debt to buy it, just as Chevron would have. Therefore, if Warren Buffett ends up happy about having warrants to buy OXY at $62.50 per share, how happy might we end up in this maverick risk.
In conclusion, we are regular takers of maverick risk in our stock-picking discipline and with value as far out of favor as it is today, we like our opportunity set.
Tony Scherrer, CFA
The information contained in this missive represents Smead Capital Management’s opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
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