Value Doesn’t Always Come Cheap
When it comes to stock analysis, affixing valuation can be as much art as it is science.
“There’s no magic in how we look at valuation,” Voorhis says. He notes that he and his colleagues look at the usual metrics including price-to-earnings, price-to-sales, price-to-EBITDA, price-to-cash-flow and the like. But cheap valuation metrics are sort of like empty calories when a company has lousy growth prospects.
“We pay a lot of attention to valuation, but we don’t want a portfolio that’s crowded with those sectors of the economy that will shrink as a percentage of GDP over time,” Voorhis says.
He notes that Dodge & Cox analysts probe deeper to flesh out a fuller picture of valuation beyond typical generally accepted accounting principles, or GAAP. “GAAP accounting is really based on thinking about firms in the physical world and takes into account capex and depreciation, and doesn’t take into account spending on innovation,” Voorhis states. “It’s often important to disaggregate companies and look at different parts of the business that may have different characteristics. You might have one part of the business generating earnings and cash flow, and another part that’s in investment mode and losing money.”
He adds that while not every company in the Stock Fund’s portfolio jumps out as being a value stock in a traditional sense, the fund’s overall valuation discipline comes into play when viewed across the entire portfolio. According to Morningstar, the fund holdings sport lower price-to-earnings, price-to-book and price-to-sales measures than the overall large-value category. Meanwhile, the portfolio registers higher historical earnings, sales and cash-flow growth rates than the category average.
Avoiding Groupthink
Dodge & Cox is part of the asset management industry’s old guard. Formed in 1930 by Van Duyn Dodge and Morrie Cox, the San Francisco-based firm managed nearly $365 billion as of the first quarter. Two-thirds of that was parked at its seven equity and fixed-income mutual funds. The rest resided in separately managed accounts for institutional clients and in UCITS funds for clients outside the U.S.
Barret says he doesn’t know for sure if the team-based approach to fund management has been in place since the start, but it has been that way for as long as anyone at the company can remember. The number of people on a particular fund’s investment committee varies from six to eight members.
“Our view is that there are real benefits to the investment committee,” he says, offering that it leads to thoughtful, independent judgments derived from a collective knowledge base. The Stock Fund’s investment committee typically meets every Tuesday morning, but it can meet more often during times of market turbulence. That said, they say they don’t make knee-jerk investment decisions based on sudden market events.
“Talking to each other usually picks up when things are more volatile and there’s more to discuss when there are current events influencing our portfolio holdings,” Barret says. “But the cadence of our investment meetings hasn’t significantly changed.”
As Voorhis describes it, during those Tuesday meetings an analyst proposes that the fund should buy Company X or add to Company Y. They have a detailed presentation that investment committee members read in advance. The members come in with questions and then discuss and debate an idea. Ultimately, they take a vote and abide by the outcome.
“We’re able to have those discussions in a pretty forthright manner because we’ve known each other for decades, and can go into a committee meeting and completely disagree about something but come out and have lunch together,” Voorhis says.
He notes this is a process they try to refine over time because they’re aware of some of the pitfalls associated with a team-based decision-making process. Barret adds that they’re very conscious of trying to remove behavioral biases from the process.
“There can be pitfalls in investment committees in terms of groupthink and anchoring and cascade effects,” he explains. “And over time we’ve been deliberate in trying to address potential behavioral biases. For the voting, we use a two-stage, blind voting process where people have to think about a problem over a period of days, not minutes. People can adjust their opinions based on new information. Also, we all vote anonymously.”
Bottom-Up
As of the first quarter, the Stock Fund had a roughly 12% stake in non-U.S. equities. Voorhis says the team likes having a small portion devoted to overseas stocks for diversification purposes, but the fund limits that exposure to large, multinational companies with listed American depositary receipts that trade on the New York Stock Exchange.
The firm’s bottom-up research approach means the team focuses more on individual securities than on broad sectors when making investment decisions. “We can form narratives around sectors, though sectors don’t tell you that much,” Barret says. Instead, he adds, the team seeks to evaluate companies by evaluating various factors that can influence performance among players in a specific sector.
He points to four positions in four different industries that were added to the Stock Fund in the first quarter—Gaming & Leisure Properties (a REIT), General Electric, UBS Group and Zimmer Bioment (a medical device maker)—as representative of the firm’s bottom-up approach to identifying value investments.
“Over the past year, a lot of the opportunities we’re finding in new positions have been idiosyncratic in a wider variety of industries that reflect the market reality,” Barret says.
And given how the financial markets have performed so far this year, they’ll likely find many other idiosyncratic investment opportunities.