Editor's note: In today's part two of our U.S. equity roundtable, three value-style managers explain where they're finding bargains.
Glenn Fortin, a portfolio manager with the global equity team at Beutel Goodman & Co. Ltd.
They spoke to Morningstar columnist Sonita Horvitch, whose three-part series
Q:Is the dividend chase over?
Navon: I don't think so, but it's been indiscriminate. You've seen some names pushed to multiples that are unwarranted, given the ability of the companies to sustain let alone grow the dividend.
Fortin: In some areas, investors are being a little more selective. For example, the telecommunications and utilities stocks are trading down because of this.
McKiernan: I have predominantly dividend-paying stocks among my holdings. Some 50% of the total return over time will come through the dividends. In a world of low interest rates and low GDP growth, the importance of the dividend as a portion of total return will increase.
Q:Time to discuss your disciplines.
Navon: In our company analysis, we focus on free cash flows, whether it's paid out as a dividend or used for other purposes in capital allocation. We feel that if a business has really strong returns on capital above its cost of capital, it can grow while still returning cash to shareholders through share repurchases and dividends.
We take a macro prism. We want a weather report before investing. In addition to our focus on free cash flow, we assess the potential downside in each investment. We want to buy businesses at a price that reflects the downside risk. Our investment timeframe is three years. We're looking at mid-teens returns per annum from our businesses.
McKiernan: We like to own high-quality predictable businesses, selling below what they're worth. We err on the side of quality and would rather pay a little more for quality businesses than go down the quality spectrum. Our investment horizon is three to five years.
Fortin: We're value managers and run concentrated equity portfolios with low turnover. Our U.S. portfolio only has 29 names. The top 10 names in
Navon: We have remarkably similar investment styles.
Q:Let's discuss sectors and stocks. Information technology, at a 19.3% weighting in the S&P 500 Index, is the biggest sector.
Fortin: The information-technology sector is undervalued.
McKiernan: It's cheap.
Navon: The businesses are maturing, be it a Microsoft Corp.
McKiernan: So do I.
Navon: The cash flows of these companies are now so strong that with their slower growth, they're beginning to distribute the cash flow back to investors. As a result, there's been a shift in their shareholder base from growth to value investors. The business has become a recurring revenue model.
McKiernan: Our biggest holding in Trimark Global Fundamental Equity is Apple Inc.
Navon: Apple is the biggest holding in CI American Value. One of the smartest things the company did was to have the Apple stores. Apple's customers are loyal or, as the industry puts it, its installed base of users is sticky. They're not going to repurchase all their applications and their music. We like businesses with moats. It doesn't matter that Apple can't grow to the same degree as it has in the past, because the stock is so inexpensive. We've owned the stock since around 2002.
McKiernan: Apple is growing its customer base. What is also underappreciated about Apple is that it's starting to sell into the emerging markets, specifically China.
|Apple Inc.||Microsoft Corp.|
|Dec 11 close||$541.39||$27.32|
|Market cap||$509.3 billion||$230 billion|
|Total % return 1Y*||38.9%||9.5%|
|Total % return 3Y*||41.1%||-0.5%|
|Total % return 5Y*||23.7%||-2.3%|
|All figures in $US|
*As of Dec. 11, 2012
Fortin: We view Apple more as a device company and question its ability to sustain the new-device rollout over time. We own Microsoft and Cisco Systems Inc.
Microsoft is reasonably valued. Its customers face the high costs of switching software and this makes Microsoft almost like a utility. It has a recurring revenue stream like the other technology companies that we've mentioned. It has a growing dividend.
Navon: Microsoft has a dividend yield above 3%. Its dividend payout is relatively modest and it could increase. With its Windows 8, no one is giving Microsoft any credit for its ability to enter the tablet market.
McKiernan: It's getting better at capital allocation. It has made some poor acquisitions in the past.
Q:Financial services, which represent 15% of the benchmark?
Fortin: Our top holding in Beutel Goodman American Equity is JP Morgan Chase & Co.
Navon: Misery loves company. I own it. It has the misfortune of being regulated as a bank. It has excess capital that it's being prevented from distributing to shareholders due to its previous ownership of a small banking institution.
We have avoided money-centre banks. We've felt that they lacked transparency. We own Capital One Financial Corp.
McKiernan: I own financials where there is no potential balance-sheet risk. An example is CME Group Inc.
Navon: We own CME too.
McKiernan: It's a great dividend story in terms of payouts. There's no balance-sheet risk.
Navon: You haven't seen the degree in fall-off in the volume of its transactions that you have seen on the other exchanges.