Peter Quinn, co-manager of UAM Funds: Clipper Focus Portfolio/Instl (CLPRX), tries to get behind the fog of accounting statements by looking at cash flow, rather than just reported earnings. Quinn believes investing has become more difficult because the lure of growing earnings has made investors "intent on equities at any cost."
Quinn's focus on cash flow may have shielded him from some of his peers' missteps, since UAM Clipper Focus led among large-cap blend funds for the one-year period through this past March. During that time, the fund was up 53.9%, while its counterparts fell 20.0%.
The fund's portfolio is very focused, with a limit of 15 to 35 holdings. Its top holdings are Philip Morris (MO), Federal Home Loan (FRE), and McDonald's Corp. (MCD). The largest sectors in the fund are food and tobacco, real estate investment trusts (REITs), and mortgage finance.
Bill Gerdes of Standard & Poor's FundAdvisor recently spoke with Quinn about his investing approach, and the stocks and sectors he likes now. Edited excerpts of their conversation follow.
Q: What are your investment goals?
A: We look for industry-leading companies by determining their appropriate values, based on free cash flow. We calculate cash flow, starting with net income and then subtracting capital expenditures, acquisitions, and increases in working capital.
Not hidden by accounting conventions, free cash flow shows how much a company actually generates. Looking at cash flow, we can decide if there's an opportunity in an out-of-favor company. As a cross check, we consider what a company would be worth if it were acquired.
Q: How concentrated is the fund?
A: Historically, we've had 15 to 35 holdings. There aren't many industries with a lot of opportunities. For example, we hadn't found any attractive investments in the technology sector, despite the market downturn.
Q: What is the fund's cash weighting?
A: We never have more than 5% of our assets in cash. The fund is focused in terms of being fully invested as well as the number of holdings.
Q: What are the fund's largest sectors?
A: Food and tobacco, 25%; REITs, 19%; and mortgage finance companies, 13%. Last year, REITs were trading at historically attractive levels.
Q: Does investing in industry leaders generally lead you to large companies?
A: We don't consider companies with market caps below $2 billion. This past year, some industry leaders lost market capitalization, even though their revenues stayed high. One example is Tyson Foods (TSN), which dominates the poultry business. We thought its cheap stock price made it an attractive investment, but we usually stick with larger companies.
Q: What would be a typical holding?
A: American Express (AXP) is a newer name in the portfolio. It has a strong position in credit cards, which is a wonderful generator of cash. We also liked its exposure to financial services and its management, which is using cash flow to benefit shareholders.
Q: Why has the fund done well in the past one-year period?
A: Many other funds were punished by focusing on the Internet and a few growth leaders, because they paid too much attention to reported earnings. While most money went into technology, a lot went to other areas, resulting in few attractive investments. Stock prices still haven't fallen to the point where we can invest indiscriminately.
Q: What are your largest holdings?
A: Our top five holdings are Philip Morris, Federal Home Loan, McDonald's, Sara Lee (SLE), and Pitney Bowes (PBI).
Q: Would you reconsider your McDonald's position if hoof-and-mouth disease spread to the U.S.?
A: Hoof-and-mouth disease in the U.S. would have a short-term impact on McDonald's, so if its franchise was still strong, we would see it as an opportunity. We're long-term investors with a 40% turnover.
Q: What's behind your investment in Sara Lee?
A: Sara Lee is a high generator of cash, though the company is growing slowly. Management is paying down debt and buying back stock, which is doing right by shareholders. From Standard & Poor's FundAdvisor