Really Big Ideas : For Oakmark's Sanborn, the Focus Is on Finding Value in Large Companies

L.A. Times Archives

Feb. 11, 1997 12 AM PT

Few stock pickers have had a better run in the 1990s than Robert Sanborn. Notwithstanding a subpar 1996, his Chicago-based Oakmark Fund ranks in the top 1% of all growth mutual funds over the last five calendar years, with a total return of 214%.

Sanborn, a 39-year-old father of twin toddlers, doesn’t look for youngsters when it comes to investing. He generally buys well-run, seasoned companies that he judges to be selling below their true worth.

Sanborn says he continues to find bargains even with the stock market near record heights. He was interviewed by Russ Wiles, a mutual funds columnist for The Times.

Times: Oakmark Fund’s performance lagged in 1996 after several great years. What happened?

Sanborn: The short answer is that we messed up on our cable TV holdings. We owned several stocks in the sector too long. When Bell Atlantic’s proposed purchase of Tele-Communications Inc. fell apart [in 1994], we should have carefully reexamined the potential because when deals like that fall apart, it usually means the buyer has discovered something that it doesn’t like.

That said, I really expect to have years when we’re in the bottom quartile [of fund performance], most likely at times when the market is buoyant. But rather than feeling we have to beat the market averages each year, our attitude is to invest well, to invest wisely.

Times: Is it fair to label you a “value” investor?

Sanborn: We certainly are hard-core value investors. But we don’t utilize some of the traditional measures, such as low price-to-earnings ratios and price-to-book ratios, or high dividend yields.

We have five guidelines for selecting stocks. The first relates to the value of the business. We frame the investment process as buying a piece of a business for the long term. A company’s underlying value is what a rational businessperson would pay for the business if he or she understood it well.

Second, we look for owner-oriented management. We want the top executives to own shares in the company, so that they have an incentive to increase per-share values over the long run. Today, with all the pressures put on managements, companies are more owner-oriented than they were 10 years ago. Some CEOs who ran big companies 10 years ago--Roger Smith at General Motors, for example--would never make it in today’s world.

Times: And the other guidelines?

Sanborn: Concentrate as much as possible in a small number of stocks. We like to see our top 20 holdings comprise at least 65% of the fund’s assets. They weigh in at about 72% currently.

The fourth criterion is to trade as little as possible. Our turnover ratio is about 20%, which is well below average. And the fifth factor is that we do our own stock research in house. We don’t rely on Wall Street at all because we don’t trust outsiders.

Times: Most of your top holdings are well-known companies. Has Oakmark always focused on large stocks?

Sanborn: Yes. We started the fund on Aug. 7, 1991, with $1 million. I bought seven stocks that day, and four were very large companies, including Philip Morris, which remains a top position. Because of the large size of the fund and with the concentration that we take, we have to focus on stocks with market capitalizations above $1 billion. We still own smaller companies in the fund, but in all honesty they don’t exert much of an impact anymore.

Times: You didn’t mention earnings growth among your guidelines.

Sanborn: Right. We don’t even look at earnings per share. The problem with EPS is that it fits the accounting criteria, but it’s not what an owner would look at. When you buy a business, you don’t examine the accounting earnings; you look at the cash flow, which you can take home.

Of the 20 top holdings in the fund, at least half of those companies have had meaningful noncash charges that understate EPS. First USA, for example, always has had a high P/E, reflecting huge noncash charges. But its price-to-cash flow ratio always was modest, making it a far less expensive stock than it appeared.

Times: Considering that First USA and Mellon Bank both are among your top holdings, are you still finding attractive values in the financial-services industry?

Sanborn: Yes. First USA is a credit-card company that’s being acquired by Banc One. Mellon is one of the larger banking firms. It generates a relatively high percentage of its income from fees, thanks largely to its ownership of the Dreyfus mutual funds. Mellon also has a very solid management team, and the company, I think, could be an acquisition candidate.

Financial-services stocks weigh heavily in the fund. We think the industry is undervalued and that many companies are being driven to increase the scale of their operations through consolidations.

Times: How about a favorite stock outside of financial services?

Sanborn: Philip Morris is our top holding. I catch a lot of heat on it because of the tobacco controversy, but we can’t impose any political beliefs on the fund. As a stock holding, this is the best business I’ve ever encountered. I’ve owned it personally since 1982, and it was the first stock I ever bought for the fund. Philip Morris has the best management team I’ve ever encountered. This company was global long before globalization was in vogue. And it always has been big on diversity and meritocracy, including many minorities and women in management positions.

Times: Aren’t you concerned about smoking-death litigation?

Sanborn: Yes, but you have to weigh that against the company’s strengths. Over the last 10 years, Philip Morris has increased its operating profits per share, cash flow per share and revenue per share at higher rates than Coca-Cola. Yet Coca-Cola trades at 18 times cash flow, while Philip Morris trades at six times.

And I think people underestimate what Philip Morris can do if the litigation environment turns very sour, such as raising prices to pass along some of the legal costs or pulling out of certain markets.

Times: How about a stock that’s neither a pariah for socially conscious investors nor one that’s involved in a merger?

Sanborn: Black & Decker’s a good example. We’ve doubled our position in it over the last two months. As you know, the stock market over the past two years has been keyed on momentum. It’s reminiscent of the Nifty Fifty era of the late ‘60s, when growth stocks got bid up to high prices.

The flip side has meant that any company that stumbles in terms of earnings gets pummeled. Such was the case with Black & Decker, which announced that its profits for 1996 would rise only 15%, rather than the 20% that the company originally expected. So the firm reported disappointing news, but I’m confident it’s a one-time event. Meanwhile, the stock fell from $45 to $30 on that news, over a week or so.

Times: Do you worry much that the market overall is too frothy?

Sanborn: I’m torn. I look at the ebullience and think the market just can’t keep going up. Then I look at the companies and the political environment worldwide, and I conclude that things are good. [U.S.] companies are being run better than ever. Mergers are still happening in the public market at higher prices carried forward by people who know what they’re doing. So there are positive factors to contrast with my feeling that we need a correction.

I wouldn’t be surprised if we have a fairly big correction, but I’d still rather own my pieces of businesses than hold cash over the next five years.

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(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Oakmark Fund

Strategy: Seeks long-term capital appreciation by investing primarily in large companies whose shares are judged to be undervalued.

VITAL STATISTICS

Year-to-date total return: +6.3%

1996 total return: +16.2

5-year total return, through 1996: +213.6

Avg. growth stock fund, 5-year total ret.: +87.1

Five biggest holdings:

1. Philip Morris 2. First USA 3. Mellon Bank 4. Black & Decker 5. US West Media Group

Sales charge: none

Assets: $4.3 billion