When looking at the holdings, purchases, and sales of our Ultimate Stock-Pickers each quarter, we pay close attention to the sector allocation decisions being made by our top managers, especially those instances where they happen to be overweight the market. With the performance of most stock portfolios measured against a benchmark, such as the S&P 500 Index, fund managers tend to be very cognisant of the weighting of their portfolios relative to the index. Even our top managers, who by and large are bottom-up stock pickers, will have an idea where they are overweight (or underweight) the market and by how much. That's not to say that they are actively managing their portfolios to the benchmark (which is something that some managers will do), it's just that they are aware of where they are relative to the market.
Bruce Berkowitz, for example, the manager of the Fairholme fund, is fully aware that his stock portfolio is heavily weighted in Financial Services. For much of the past year, Berkowitz has been deliberately increasing his holdings in Financial Services companies mostly at the expense of Health Care and Industrial Materials names. Significant new money purchases of American International Group, Goldman Sachs, Citigroup, Bank of America, Morgan Stanley, Regions Financial, and CIT Group over the past year exemplify the type of buying activity that has been going on in the Fairholme fund. By the end of the most recently reported period, Berkowitz had more than three quarters of the fund's stock portfolio invested in Financial Services stocks, which is a big overweight position relative to the S&P 500 Index, where Financial Services made up around 17% of the benchmark at the end of the third quarter. This is just about the biggest commitment we've seen to any one sector by a manager in a very long time.
While one could always point to Berkshire Hathaway, where Financial Services makes up 41% of the stock portfolio (and Consumer Goods accounts for another 42%), it should be remembered that aside from its $55 billion stock portfolio, the insurer held about $36 billion in fixed income securities and another $25 billion in other investments (which include equity and fixed income securities tied to investments Warren Buffett made in Goldman Sachs, General Electric, Swiss Re, and Wrigley in the months leading up to and following the collapse of the credit and equity markets in 2008). And this doesn't even include Berkshire's ownership of Burlington Northern Santa Fe, MidAmerican Energy Holdings, and a collection of more than 70 other subsidiaries operating in a wide array of industries, which collectively are worth somewhere in the neighbourhood of $80 billion. While Berkowitz does have more than one third of the Fairholme fund invested in fixed income and cashlike securities, we don't feel that he has the same degree of diversification in his holdings.
Looking at the sector weightings of our Ultimate Stock-Pickers relative to the S&P 500 Index, our top managers are more heavily overweight in Consumer Goods and Financial Services than they are in any of the other sectors. If we were to exclude Fairholme from the aggregate holdings of our Ultimate Stock-Pickers, given its heavier concentration in Financial Services stocks, the percentage of holdings dedicated to Financial Services drops 2 full percentage points. While this represents a significant shift in the allocation of their stock holdings, the remaining managers were still more heavily overweight in Consumer Goods and Financial Services than they were in any of the other sectors after excluding Fairholme from the mix. This is not a new development for our Ultimate Stock-Pickers, which have been overweight these two sectors for the entire time we've been tracking their holdings, purchases, and sales. It should also be noted that these were the only sectors, other than Health Care, where our top managers were actually increasing the amount they were overweight the market over the last few years.
Given this level of commitment, we were interested in the purchases that our Ultimate Stock-Pickers were making most recently in these two sectors. While it would certainly be worthwhile to look at the top holdings in each sector, the fact that almost all of our top managers follow buy-and-hold strategies makes it more likely that meaningful positions in Consumer Goods and Financial Services were acquired in past periods rather than in the last six months. Berkshire Hathaway's large stake in Coca-Cola, for example, was established in the 1980s, with Buffett holding firm with his holdings through both good times and bad at the beverage giant. Looking at meaningful purchases made during the most recent period should provide us with a much better opportunity of finding stocks that are investable than looking at their top holdings in each sector alone.
Of the top 10 purchases made by our Ultimate Stock-Pickers in the Consumer Goods sector during the most recent period, just three of them are trading at prices that are close enough to our analysts' fair value estimates to make them approachable. In the process of collecting commentary from our analysts related to these stocks, we came across one more name that they consider to be a best idea right now.
Procter & Gamble Morningstar analyst Lauren DeSanto believes that much like consumers, Procter & Gamble's stock may look down but it is certainly not out for the count. While the stock has recovered from its lows of March 2009, P&G shares have treaded water since the beginning of the year, compared to double-digit gains (on a total return basis) for both the S&P 500 and the consumer goods sector as a whole. Despite this underperformance, she doesn't believe that investors should hit the "reset" button on expectations for P&G's shares. Lauren feels the company has the widest moat in the household products industry because of its tremendous brand portfolio and the marketing firepower it deploys in support of its brands. In her opinion, no other consumer product firm can claim as many dominant category market shares, or has the extensive geographic brand reach, that P&G does. Lauren remains confident that the firm's plans to reinvigorate top-line and earnings growth will start to bear fruit once the economy improves further.
Kimberly-Clark Like other firms in the household and personal product industry, Kimberly-Clark continues to face numerous headwinds. Consumer spending remains soft, and commodity prices, despite falling from unprecedented highs, remain elevated above long-term averages. Despite these conditions, our analyst Erin Swanson believes that Kimberly-Clark should still be able to generate steady returns with its portfolio of market-leading essential products. Kimberly-Clark is a leading seller of health and hygiene products, with a collection of top brands that includes Huggies, Pull-Ups, Kleenex, Cottonelle, Kotex, and Depends. While the firm has been able to withstand competitive pressures by continuously introducing value-added benefits to its products, it has become increasingly difficult for Kimberly-Clark to ignite consumer demand in developed markets, leaving it more dependent on developing and emerging markets--like Brazil, China, India, and Russia--for growth.
Avon Products With an infrastructure capable of supporting long-term growth, bright international prospects, and a business model that generates strong returns on invested capital, Erin also believes that Avon will continue to reward investors over time. While the company has not been completely immune to the headwinds created by the global economic slowdown, she feels that the company's long history of managing through global economic disruptions, and the fact that Avon is more focused than ever on controlling costs and empowering its sales representatives around the world, should allow the firm to successfully navigate its way through the current crisis. Erin also believes the increased emphasis Avon has placed on enhancing the value the firm provides to its base of independent distributors--through improved compensation, shorter selling cycles, and online tools--should enhance sales growth once global economic conditions improve.
Colgate-Palmolive Much like the three other Consumer Goods stocks we've highlighted, Colgate-Palmolive has not been immune to the slowdown in consumer spending that followed in the aftermath of the collapse of the equity and credit markets more than two years ago. Morningstar analyst Lauren DeSanto expects the firm to face a challenging sales environment in developed markets, where it has taken an increased level of promotional spending to reach cash-strapped consumers, as well as developing and emerging markets, where the global economic slowdown has impacted not only consumer spending but the value of currencies in some countries. Increased competition has also put Colgate on the defensive in many markets that were traditional strongholds for the firm. That said, Lauren notes that history has shown periods of temporary weakness like we are seeing right now have proven to be rare buying opportunities for this high-quality long-term performer.
Of the top 10 purchases made by our Ultimate Stock-Pickers in the Financial Services sector during the most recent period, just three of them are trading at prices that are close enough to our analysts' fair value estimates to make them approachable. Much as we did with the Consumer Goods sector, in the process of collecting commentary from our analysts, we came across one more name that they consider to be a best idea right now.
Bank of America Despite being in the headlines once again for problems associated with mortgages (from foreclosures to putbacks and ongoing lawsuits), Morningstar analyst Jaime Peters believes that Bank of America's retail banking and wealth management businesses are endowed with competitive advantages that should allow the company to eventually outearn our estimate of its cost of equity. Some of the bank's relatively unattractive business lines are actually supporting the firm while it works to turn around its business. On top of that, Jaime believes that GSE-based mortgage putbacks will be manageable, with the bulk of the losses already taken, and that private-label putback losses are likely to be manageable due to the bank's core earnings power. Simply put, she feels that the market is focused on sizable but manageable short-term problems at Bank of America and seems to be ignoring the long-run fundamental advantages of the business that stand behind her narrow moat rating.
Bank of New York Mellon Morningstar analyst Michael Kon believes that Bank of New York's unmatched market share in the global custody business garners it a wide economic moat. He notes that demand for third-party custody and fund administration services, the bank's prime business, is on the rise as more and more investment managers prefer to outsource their back-office functions. With regulatory requirements making it more complex and expensive to manage an investment management firm, Michael expects the tailwind that exists for this industry to grow and believes that Bank of New York will grab a disproportionate share of any new business. He also feels that the bank's competitive position in the issuer services segment is even more compelling, with the firm being the largest provider of trust-related services to fixed income and equity issuers around the world, with no contenders in sight.
J.P. Morgan Chase Morningstar analyst Jaime Peters believes that J.P. Morgan's discipline and strong balance sheet created an opportunity for the bank to take advantage of the credit crisis rather than become a victim of it. A combination of savvy acquisitions (Bear Stearns and Washington Mutual) that filled holes in its investment bank and retail operations, along with the bank's ability to attract new customers, has increased J.P. Morgan's per-share earnings power. That said, she remains cautious about the opportunities the firm has in the long run. Jaime believes much of J.P. Morgan's success is attributable to well-known CEO Jamie Dimon and his tight grip on the risks that the company takes on as a whole, which could unravel should Dimon either retire or leave. She also sees the firm grappling with a grab bag of operations that may lack the profit potential of its more focused peers. If J.P. Morgan can continually hit its goals--which will require discipline and a close eye on risk--Jaime thinks the stock could be a winner for investors.
Wells Fargo Jaime also views Wells Fargo as one of the clear winners to come out of the financial crisis. She notes that the firm's purchase of Wachovia, which finally gave it a national footprint, as well as its package-based sales approach and concentration on getting every customer's deposit account, should allow it to continue to achieve a stable, and higher-than-average, net interest margin going forward. Jaime likes Wells Fargo's simple but effective strategy of building deep customer relationships and keeping a close eye on credit quality. While the headwinds from financial reform and higher capital requirements are likely to dent returns on equity slightly, she believes that Wells Fargo will continue to produce enviable, peer-leading returns well into the future. With regulators poised to give the green light to healthy banks that are looking to pay higher dividends, Jaime feels that Wells Fargo could be one of the first domestic banks to announce a hefty dividend increases sometime in early 2011.
Disclosure: Greggory Warren owns shares in the following securities mentioned above: Procter & Gamble, Avon Products, and Colgate-Palmolive.
