On May 20, 2011, David Herro, Morningstar’s International Stock-Fund Manager of the Decade and value investor, appeared on Consuelo Mack’s WealthTrack. Herro manages the Oakmark International fund.
Here are my notes from the interview:
- David Herro’s fund earned 9%+ 10 yr annualized returns.
- Investing in the U.S. is no longer enough.
- What does it take to be successful?
- A sound philosophy
- Discipline – you can’t get rattled. You need patience to make it work. You will be tempted to abandon it at the wrong time.
- Value is something that is cheap based on free cash flow to enterprise value. Value also means a quality business that can generate good long-term results and a management team that can make sound capital allocation decisions.
- People abandon common sense when macro trends disrupt them. In late 2008 everyone knew that the economy was soft, that the consumer was fearful and wasn’t spending. Mr. Market acted as if this was a permanent condition but this was already priced into stocks. Herro bought stocks with a balance sheet strong enough to make it though the recession and business model that would continue making money. The crowd saw a recession and dumped all stocks that were based on consumer spending [Greg Speicher: this is a great example of time arbitrage].
- The value of a business is not based on what it will do over the next few quarters but over the next ten years.
- He is known as a contrarian because often the stocks that meet his criteria have been abandoned. He cautions investors not to conclude that all abandoned stocks are good investments.
- He is finding value in Japan. Even before the earthquake it was trading below book value and 8x cash flow. No one wants anything to do with it. It’s gone from being totally in fashion in the 80’s to totally out of fashion. The corporate behavior of Japanese corporations is improving.
- In Japan, he likes Daiwa Securities. They have brokerage offices all over Japan and they serve as a conduit to invest Japanese savings.
- People make a mistake in not investing in Europe because they treat it monolithically. The individual countries are very different. There is no “one Europe”. Germany is growing strongly. Scandinavia was almost unscathed by the crisis.
- When evaluating a business, you shouldn’t just look at the country where it is based but the countries where the business makes money.
- He only has 2-3% in emerging markets because they are too expensive. People are not looking at what they are buying. The corporate governance in emerging markets is often opaque and sometimes bad.
- Approximately 20% of portfolio company revenues comes from emerging markets and probably a higher percentage of growth. The revenue percentage from these markets will grow over the next five years.
- During the recession, he was optimistic because he felt that emerging markets would ultimately drive global economic growth
- Small caps U.S. stocks are more expensive than U.S. large caps. This is not true internationally. These are more volatile and you need a thick skin if there is an earnings miss. There are opportunities here and small caps should outperform by a few percentage points over time.
- The one stock everyone should look at is Diageo, the world’s largest drink company with a great stable of brands. A lot of people consume alcohol and as people age they go from beer to spirits. There are growth opportunities in emerging markets. The profit dynamics are great and the company is well managed – good at allocating capital – and you can buy it a relatively good valuation of 10x gross cash flow. Unless you think there will be global prohibition, the stock should do well. It’s a good company with moderate long-term growth prospects and minimal financial risk.
Additional info from David Herro/Oakmark International Fund:
Why Japan and Why Now? – 12/16/2010
Oakmark International Fund – Holdings – 3/31/2011