Mason Hawkins: The Great Dichotomy

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The latest from Mason Hawkins of LongLeaf Partners

The Great Dichotomy
Never in our investing careers has the prospective return on
corporate ownership so surpassed the return on long-term
lending. Never has the risk of permanent capital loss from
long-term lending been so great. Oft-discussed macro fears
and the accompanying market volatility have driven investors
from equities into the supposed security of U.S. government
bonds and other highly rated sovereign and corporate debt.
The January 5, 2012 USA Today headline, “Bonds Outperform
Stocks over 30 Years,” highlighted this flight and was
reminiscent of the 1979 Business Week “Death of Equities”
headline that preceded the high stock returns of the 1980s.
Unlike the double-digit yields that 10-year Treasurys offered in
the early eighties, today’s below 2.0% government yields are
meager competition for the S&P 500’s earnings yield of 7.9%,
the Russell 2000’s 6.4%, and the EAFE’s 9.3%. Moreover, and
surprising to some, equities are even more attractive vis-à-vis
bonds today than at the end of 2008, the worst economic
downturn and bear market in our lifetime. Because of the
large and unprecedented spreads between “safe” lending and
business ownership yields shown above, we believe it is
almost certain investors will begin swapping low or no return
debt instruments for the much higher returns that high
quality equities offer. According to the Wall Street Journal
story on January 13th titled “China Reserve Changes
Weighed,” China has begun to reconsider its approach to
investing its $3.2 trillion in foreign-exchange reserves. The
chairman of China’s largest state-owned bank indicated that
“China may invest more of its…reserves in stocks, enterprises,
and other assets as it looks for ways to boost returns.”

The Opportunity
As indicated in each Fund’s summary table, our largest
holdings’ adjusted FCF yield, which represents how true
business owners would calculate their current FCF yield
ranges between 9.8% and 15.5%, and is growing and after-tax.
Not only are the adjusted yields much more attractive than
the earnings yields of the indices, but the quality of our
businesses far surpasses that of a random collection of
hundreds of companies. We own a select group of industry
leaders with sustainable competitive advantages and vested
CEO and board partners who are building shareholder value.
The Funds are selling at or below a 60% P/V. We expect to
deliver outsized, risk-adjusted returns as our business
franchises continue to produce, grow, retain, and intelligently
reinvest their FCF coupons, and the markets arbitrage our FCF
yields and values to those offered by inferior companies and
low-yielding debt securities.
When our analysts communicate in writing, in the absence of
being able to raise our voices and pound the table to convey
our convictions, we WRITE IN ALL CAPS. As we enter 2012, we
want to express to you our belief that WE OWN SUPERIOR
O. Mason Hawkins, CFA
Chairman & Chief Executive Officer
Southeastern Asset Management, Inc.

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