Top fund manager Bill Nygren says that valuations don’t look bad in the stock market, and in his second-quarter letter he offers a few reasons why investors are mistakenly viewing stocks as pricey.
Bargains may not abound the way they did a few years ago, but top fund manager Bill Nygren says he’s still finding plenty of stocks to buy.
Looking for strong dividend stocks? Some top fund managers are finding them in an unlikely place: the tech sector.
Top fund manager Bill Nygren says he’s continuing to find the best value in the market in the financial sector.
While the much-maligned sector isn’t the sexiest right now, Nygren says that doesn’t matter to him. What does matter is value. “We own the financials because they are the cheapest stocks with the highest quality management,” he told CNBC. “We don’t wake up in the morning thinking we want to put money to work in boring industries. But when you see valuations that are less than book value, less than 10 times earnings, to us that looks really, really attractive compared to a market at about 16 times earnings.”
Nygren also likes the tech sector, but not the hot, trendy upstarts. Instead he’s high on the likes of Oracle, Microsoft, and Intel. As for financials, he’s particularly keen on Bank of America.
Worried about the end of quantitative easing? Top fund manager Bill Nygren isn’t.
In an interview with MoneyLife’s Chuck Jaffe, Nygren says that his firm’s five-year-holding-period, value-focused, bottom-up approach means that the exact timing of the tapering of the Federal Reserve’s bond-buying program “ends up not really being an important factor,” adding, “We certainly think the markets can handle it.”
Nygren says his firm tends to go into areas where there is controversy today, but where five years down the line normalcy should return. Today he sees opportunity in financials and some cheaper tech stocks. “Our expectation is that, over time, ‘normal’ returns to the market,” he says.
As for what to expect in 2014 for the broader market, Nygren says that such short-term forecasting is nearly impossible. But he does say that he thinks many people are still underinvested in stocks and that valuations are not unreasonable. “I think it’s a tough burden on the person who wants to argue that they shouldn’t own stocks,” he said, adding that bonds rates are so low that he doesn’t think they are worth the principal risk.
Bill Nygren, whose Oakmark Select fund is in the top 2% of its peers over the past 5 and 15 years, recently talked with CNBC about his approach and some of his favorite current stocks. “When you’re a long-term value investor like we are at Oakmark, we end up buying things that had been disappointing for others,” he said, discussing why his fund owns beaten-down Qualcomm shares. He also talks about some of his fund’s big financial holdings, including Bank of America and CapitalOne.
Five years after the collapse of Lehman Brothers sparked the financial crisis, many investors still don’t trust bank stocks. Top fund managers Bill Nygren and David Ellison think that is part of why it’s time to buy them.
“The stocks are still low because investors don’t trust that the earnings will recover fully,” Ellison tells Renal and Urology News. (An odd source, we know, but they have a solid ‘Money’ section.) He notes that bank stocks are trading at about 110% of book value, on average, well below the 180% levels seen in typical bull markets. He thinks we are in the early part of a long-term recovery in which bank earrings and share prices will jump, comparing the current environment to the start of a strong banking cycle that started in the early 80s. Banks have been making good loans and cleaning up their balance sheets in the post-mortgage-meltdown world, he says.
Nygren, meanwhile, says bank loan volume remains low, but should pick up as the economy continues to improve. Even if it doesn’t, he says some banks, like Bank of America, should still be able to grow earnings.
When companies put cash to work to increase shareholder value, it can be a very good thing. But top fund manager Bill Nygren says certain types of cash deployers are looking more attractive than others right now.
“One of the things we think investors have gone a little excessive on is bidding up companies that pay high yields, good income generators,” he recently told CNBC in discussing high-dividend stocks. “And we think it’s interesting that companies that have been large share re-purchasers — effectively, it should be the same to an investor whether the money comes back as money or share repurchasers. But those stocks aren’t as expensive, so we like the big share repurchasers.”
Nygren also talked about his overall patient approach, saying that he has an average holding period of about five years. “Investing’s not supposed to be fun,” he said. And he talked about some stocks he’s high on, including financials like Bank of America, JPMorgan and Capital One.
Have rising bond yields made stocks less attractive? No, says top fund manager Bill Nygren of Oakmark.
In his second-quarter client letter, Nygren discusses the “Dividend Discount Model” his firm uses to assess stock values. According to the model (one of several Oakmark uses), the combination of dividend yield and dividend growth must be equal to an investor’s required return. The required return, he says, is a combination of a “risk-free asset” (Nygren uses the 7-year Treasury) and a risk premium. “The premise of the Dividend Discount Model is that a rational investor must get paid to accept the risk inherent in owning a stock rather than owning a risk-free bond,” he says.
Oakmark’s historical analysis finds that equity investors usually demand that an average stock earn about five percentage points more in expected return than the 7-year Treasury, Nygren says. So if the bond yield is 4%, the combination of dividend yield and dividend growth should be at least 9%. Currently, the 7-year Treasury is just below 2%.
“For four years we have been saying that bond prices are not being set by long-term investors, so instead of using the actual interest rate, we’ve used a 3% floor,” Nygren says. “This way, our equity valuation estimates have not inflated to what we see as unsustainably high levels. Instead, we believe that stocks were, and continue to be, somewhat undervalued relative to a seven-year government bond that yields 3%. Even after the recent increase in interest rates, the seven-year has moved only a little more than halfway back toward our floor of 3%. So the declining bond market has not at all dimmed our enthusiasm for equities. We are effectively already factoring in the assumption that rates continue their upward march until the seven-year hits 3%.”
Nygren says another big hit to the bond market would have to occur before it would potentially lower Oakmark’s estimate of equity values. “Rather than panicking about higher interest rates, we are encouraged that investors, rather than traders, are again buying bonds,” he says. “And as investors regain control of the bond market, we wouldn’t be surprised to see rates continue to rise somewhat. Actually, for some of our stocks — especially the financials — we expect that their earnings will also increase as rates rise. So, we continue to believe that equities are attractively priced relative to both their own long-term history and to the opportunities available in the bond market.”