Ten New-Money Purchases by the Ultimate Stock Pickers
Research In Motion ( RIMM)
Annaly Capital ( NLY)
Conoco Phillips ( COP)
CME Group (CME)
JPMorgan ( JPM)
CH Rbnsn ( CHRW)
J&J ( JNJ)
Looking at the purchases that our Ultimate Stock-Pickers make in any given period, we tend to hone in on both high-conviction purchases and new-money buys. We believe that managers send signals about the level of conviction they have in a position by how much of their portfolio (on a percentage basis) they’re willing to commit to a given name at any point in time. For example, we can generally assume that the managers at FMI Large Cap(FMIHX), which had 5.8% of its stock portfolio invested in 3M Company(MMM) at the end of the September quarter, compared to just 2.3% in Willis Group Holdings(WSH), have a higher degree of conviction in 3M than they do in Willis Group. That said, position size can sometimes be influenced by how much a portfolio manager wants to commit to a particular sector (especially when there are only a few truly investable ideas in that sector). It can also be influenced by large legacy positions that have become difficult to unwind.
We define high-conviction purchases as instances where managers make meaningful additions to their existing holdings, or make significant new-money purchases in names that were not in their portfolio at the end of the previous quarter, with a focus on the impact these transactions have on the overall portfolio. We believe that new-money purchases provide us with the most insight into what our top managers think are the most attractive buying opportunities, as portfolio managers tend to only put money to work in new names when their purchase decision carries a very high degree of conviction. This is based on the belief that it is far easier for investment managers to put money to work in holdings that they are already comfortable with than it is for them to make a bet on a name that would represent a new addition to the portfolio.
When looking at all of these different stock purchases, though, it pays to remember that the decision to buy these securities was made during a prior period. This means that the prices our top managers paid will likely be different from today’s trading levels. As such, a stock that had our managers excited in the latest period might end up being less (or more) attractive, depending on the direction that the markets or the news flow for a particular firm has taken. With the S&P 500 trading in a range of 1,335 to 1,465 during the third quarter, and closing out last week at around 1,360, it is highly likely that some of the prices our managers paid during the most recent period were slightly higher than the prices investors are seeing today. This once again exemplifies our ongoing belief that it is extremely important for investors to assess the current attractiveness of any security they are considering by looking at some of the measures that our stock analysts’ research regularly provides us with, like the Morningstar Rating for Stocks, and the price/fair value estimate ratio.
Like the first quarter of this year (and the fourth quarter of last year), the third quarter was exemplified by a dearth of buying activity (in aggregate) by our Ultimate Stock-Pickers. The list of top 10 high-conviction purchases highlights this fact, as most of the securities purchased during the period had just one or two managers buying shares, compared to prior periods (like the second quarter) when it has taken as many as four managers buying a security to push a name up to the top of the list. This doesn’t surprise us too much, given that global equity markets put in a solid showing during the third quarter, and the fact that investors continued to pull money out of actively managed U.S. and international stock funds during the period. This also helps to explain why we were seeing a bit more selling activity during the third quarter, exemplified by a lot of position-trimming and a few truly meaningful sales, as our managers were likely anticipating a downturn in the markets–given slowing growth in both developed and developing economies, the ongoing European debt crisis, and the upcoming U.S. elections and pending “fiscal cliff”–and were building up cash to meet redemption requests, as well as for future purchases (in a more reasonably priced market).
Looking over the list of top 10 high-conviction purchases we’ve seen so far from the most recent period, one name– Apple(AAPL)–clearly stands out among the rest. This is not only because three of our top managers– Alleghany(Y), Columbia Dividend Income(LBSAX) , and RS Capital Appreciation(RCAPX)–were making meaningful purchases in the name (with Columbia Dividend Income actually making a new-money purchases in the security), but because it is the only stock on the list that is still trading below the $539 per share Consider Buy price our analyst Brian Colello has attached to his fair value estimate. Apple may be the most valuable company (by market cap) that the world has ever seen, but Colello believes that there are still plenty of avenues for growth in the years ahead. He expects tremendous iPhone growth, not only as the smartphone market doubles between 2011 and 2014, but as the iPhone gains share as a result of the ongoing struggles at Nokia(NOK) and Research in Motion(RIMM). Colello feels that iPad revenue should also grow at an outstanding rate, as consumers continue to adopt tablets over, or in addition to, PCs, and the company generates additional sales with the launch of the iPad mini. He thinks that adoption of these devices will raise the switching costs associated with moving to alternative phones and tablets, and Apple’s lock-in via iOS and iCloud could spur market share gains in Mac and potentially any future Apple TV products. With the company looking at a strong iPhone 5 launch into the holiday season, Colello feels that the current share price is not fully reflecting the value that Apple should be able to generate for shareholders in the near- to medium-term.
While not quite making the list of top 10 high-conviction purchases, it is interesting to note that one other company– American International Group(AIG)–had three of our top managers– Diamond Hill Large Cap(DHLAX), Hartford Capital Appreciation (ITHAX), and Oakmark (OAKMX)–making meaningful purchases in the name. As we had noted last quarter, up until this year, only Bruce Berkowitz at Fairholme(FAIRX), Saul Pannell at Hartford Capital Appreciation, and the managers at Mutual Shares(TESIX), were willing to commit capital to the firm, which has been mired in controversy ever since the U.S. government had to bail it out at the height of the financial crisis. With two other managers–Oakmark and FPA Crescent (FPACX)–making new-money purchases in the name during the second quarter, and Diamond Hill Large Cap joining them with a new-money purchase of their own during the third quarter, the number of Ultimate Stock-Pickers holding stakes in AIG has now risen to six.