By Robert Barker
Growth-stock mutual funds that focus on big companies have been among the worst places to put your money over the past couple of years. On average, they were down more than 23% in 2001 and so far this year are off 2.7%, according to Morningstar. One of the notable exceptions is the Jensen Portfolio (JENSX ), a $300 million no-load fund that has beaten the annual average return of the Standard & Poor's 500-stock index by better than five percentage points over the past five years (see BW Online, 1/15/02, "Jensen Fund: The Importance of Being Picky"). The fund this year has gained 3.3% through Mar. 31, vs. 0.3% for the S&P 500.
To try to learn how Jensen's management team is prevailing, I reached two of its members by phone this week in their Portland (Ore.) office. Edited excerpts of my chat with Jensen's Bob Millen and Robert Zagunis follow:
Q: I spent some time at your Web site, and one of the things you mention there is that you have a particular way of analyzing a company's intrinsic value. How does your method differ from anyone else's?
Bob Millen:The fundamental definition of the value of any financial asset is the present value of its future cash flows. I think everybody does it that way. I think where we differ, however, is that we take a very long-term view, and we estimate cash flows out 10 years. I think a lot of other mutual-fund companies or a lot of other analysts will estimate the value of a company out a year or two, set a target price that they would like to reach, and then sell it and move onto the next one.
That's just not our approach. We find a company we like, we like to buy it at a big discount to its true value, and then we like to hold it for a long, long period of time.
Q: What kind of discount do you look for? The folks at Southeastern Asset Management, which runs the Longleaf Funds (LLPFX ), usually won't buy without at least a 40% discount to their estimate of intrinsic value. What discount do you look for?
Millen:We're in that range as well.
Q: How many stocks do you have in the portfolio?
Millen:We have 26 right now.
Q: I see the top 10 include MBNA (KRB ), Jones Apparel (JNY ), State Street (STT ), Equifax (EFX ), Pfizer (PFE ), Emerson (EMR ), Stryker (SYK ), General Electric (GE ), Clorox (CLX ), and Omnicom (OMC ). Is MBNA still your largest holding?
Millen:The two that kind of jockey back and forth as our largest -- and they're both right around 7.5% -- are MBNA and Jones Apparel.
Q: Speaking of Jones, what is it about the company that you feel gives it an enduring competitive advantage? Plenty of apparel makers are out there.
Robert Zagunis:Part of it is, well, management certainly has a lot to do with it -- and in fact has a lot to do with all these companies. But I think Jones's ability to have presence in a lot of different sectors of the apparel industry is one. Two, management definitely aligns itself with what we're interested in, and that's free cash flow.
Millen: I think the company does market some fairly strong brand names across most of the economic spectrum of the retail industry. So I think it gets some competitive advantage from that as well.
Q: What about Stryker (SYK ) and its competitive edge?
Millen:We really like Stryker. It's one of our top-five holdings. It bought Howmedica about three years ago. And here's an interesting story. Up until that time, it had virtually no debt on the balance sheet. The company incurred $1.4 billion in debt for that company, and in three years paid it down to under $700 million.
So it's a tremendous cash-flow machine. And it's the largest provider of orthopedic implants in the country. That alone gives it a competitive advantage.
Q: The news on IBM (IBM ) this week must have caught your eye. Is IBM within the small universe of companies you do close research on? And what do you make of IBM's earnings warning?
Zagunis:Interestingly, IBM was on our list many, many years ago.
Q: Back in 1992-93, when it was $40-something a share?
Zagunis:Exactly. And it dropped off our list because of not meeting the high standard of business performance that we require of our companies, and it basically was the beginning of the crumbling of its position in the PC market. So IBM has not been part of our list for probably 8 to 10 years.
Millen: One other comment on IBM: From what I've read, one of the things that [CEO Lou] Gerstner has done is had a nice string of increasing earnings, but that has come largely from cost reductions, accounting techniques, tax changes, and buying back stock. We like the idea of buying back stock, we also like companies to grow their top line, but IBM has not really grown its top line very much in the last five or six years.
Q: Do you keep an estimate of what the portfolio's discount to intrinsic value is?
Zagunis:We do, and you're going to ask us what it is, I bet.
Q: That's the next question.
Millen:We debated that issue the other day, whether we ought to even tell that to people. Are we delivering the jewels here, or not? If I can answer it this way, all the purchasing that we do is at less than 60 cents on the dollar. So I would have to tell you that the average for the portfolio is less than that amount today.
Q: The average stock price in the portfolio is less than 60% of what you estimate the stocks' intrinsic values to be?
Zagunis:The weighted average. We have some that are above 60 cents on the dollar, but we're buying companies today, some of which are 35 cents on the dollar. And if the companies continue to perform and the market pushes their price up, if they get to full value, 100% of intrinsic value, we'll start looking at them in terms of replacing them. But it's important to us to have that compression in the portfolio and consequently the safety for our shareholders.
Millen: As you might imagine, our model for calculating intrinsic value is a dynamic one. It literally changes daily, with the inputs that we put in, the hurdle rate we use for discounting, the changes in projections for cash flow, etc. As a company continues to do well, its price may rise, but its intrinsic value may rise too.
Q: Who among mutual-fund investors should not be buying the Jensen Portfolio?
Millen:Someone who trades every day. This is a portfolio for long-term, serious investors. Even though it isn't very volatile and is low on the risk spectrum...you should look at it as a serious, long-term investment.
Q: And how do you define long-term?
Millen:We say a minimum of five [years], but ours is longer than that. Ours is 10-plus.
Q: Have you guys got your own money in the fund?
Barker covers personal finance in his Barker Portfolio column for BusinessWeek. His barker.online column appears every Friday, only on BusinessWeek Online
Edited by Robert Barker