Yacktman 3Q 2011 Letter: "It's Almost All About The Price"

From the most recent Yacktman quarterly letter:

On Price/Quality
One of the common phrases we use at our firm is, "It's almost all about the price". Often, the most important variable in having a successful investment and managing risk is the price paid for a security. Many of our top holdings are now at lower prices than they sold for five or ten years ago even though the earnings of the businesses are significantly higher today.

Although price is typically the most important investment consideration, we also like to invest in businesses we think have the ability to perform in both good and bad economic times. These companies often have dominant market share in products that are inexpensive and consumed frequently or as part of a monthly subscription. Examples include PepsiCo selling snack chips and beverages, News Corp selling television content, and Microsoft selling software. PepsiCo, News Corp, and Microsoft are among our largest holdings because each company has a good business and is selling at a very attractive price.

Some may get caught up in a good story about a stock and forget the role that price plays in regulating risk.

A somewhat awful sounding story behind a decent business with real fixable problems can become a good investment at a low enough price (collapsed economic moats excluded). Just pay a price that provides at least an acceptable return if nothing great happens and a very nice return if things go better than most expect.

At the same time, an outstanding business with a terrific story can become an awful investment if the price paid for the stock is too high.

Wal-Mart (WMT) wasn't a terrible investment a decade ago because the business didn't end up doing well.

In fact, Wal-Mart tripled its earnings per share in the decade that followed. Shareowners were compensated poorly because they paid a price far above intrinsic value. So the inevitable result was little to no return for getting it right. If things had gone poorly for Wal-Mart a really bad result would have occurred. Both outcomes are just the opposite of what an investor should be attempting to accomplish.

I suspect there are a few high multiple stocks right now that will similarly have terrific business performance over the next decade but shareowners will be compensated poorly for it, or worse, experience permanent capital loss.

Price regulates risk.

On Pepsi
PepsiCo declined more than 11% during the quarter amid short-term business struggles and general market declines.  At the end of the quarter, PepsiCo's shares traded at lower prices than they did three years prior, even though earnings have increased by more than 35% since that time.  PepsiCo now sells for less than 13 times our estimate of next year’s earnings which we think is very inexpensive given the quality and predictability of its businesses.

How persistent the earnings of a business is gets revealed in a financial crisis. There are many good examples but lets again use Wal-Mart. The company's earnings per share did not drop off at all during the crisis. In fact, Wal-Mart's earnings is roughly now 50% above its peak pre-crisis level.

Microsoft (MSFT) is another good example:

In 2006, Microsoft earned $ 12.6 billion or $ 1.20/share.

Its share price at the end of 2006 was $ 29.86/share with $ 3.24/share in net cash.

Enterprise Value:  $ 29.86/share - $ 3.24/share = $ 26.62/share

So $ 26.62/$ 1.20 = 22x multiple

In the fiscal year 2011 that ended in June, Microsoft earned $ 23.2 billion, nearly twice as much as 2006. On a per share basis because there are far fewer shares outstanding that translates into $ 2.69/share or much more than twice as much. Shares outstanding has fallen from 10.53 billion shares to 8.49 billion shares or by nearly 20%.

Its share price as of yesterday was $ 26.53/share with $ 5.35/share in net cash.

Enterprise Value: $ 26.53/share - $ 5.35/share = $ 21.18/share

So $ 21.18/$ 2.69 = 7.9x

Microsoft's business is substantially more valuable per share today than back in 2006. The stock has gone nowhere but that's because, like many large cap stocks, the multiple has contracted.

A company that has more than doubled its earnings per share since 2006 is selling at less than an 8 multiple of trailing earnings.

With a multiple that low not much good has to happen. That kind of multiple suggests that earnings will be diminished rather substantially in the coming years.

If earnings do not shrink, and Microsoft does a decent job in capital allocation, returns have a good chance of being just fine. Add in even modest growth and the situation becomes very attractive.

So what is the consensus expectations for Microsoft's fiscal year 2012 and 2013 earnings/share?


It's not that Microsoft is my favorite business or stock by any means.

Maybe their earnings will, in fact, actually shrink in a material way.

It's just that sometimes it makes sense to step back a bit.


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Yacktman 3Q 2011 Letter: "It's Almost All About The Price"
Yacktman 3Q 2011 Letter: "It's Almost All About The Price"
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