With Class and Old Fashioned Realism
John Hancock Classic Value Fund
Richard S. Pzena
Author: Jana Tchinkova
Last Update: , :
|With an in-house dedicated research team of 11 analysts and a proprietary computer modeling system, Richard Pzena and John Goetz have been managing this traditional value portfolio for nearly a decade now.
John Hancock Classic Value remained a consistent top-quintile performer over the past 5-year, 3-year, and 1-year periods. Pzena spoke to Ticker about their best quality picks and worst disappointments.
||John Hancock Classic Value Fund|
We only buy stocks when they are in the cheapest quintile. Fair value is the mid-point of our 500-stock universe. Once the stock price gets to the mid-point of the universe, itís an automatic sell, no exceptions.
We do intensive research on these companies to understand what their normal earnings power is. The good outcome, obviously, is the stock price goes up. You buy something at 7 times its normal earnings power and the mid-point today happens to be around 13.5 times. So, if the stock appreciates and trades at 13.5 times its normal earnings power then we sell it no matter how many Ďbuyí recommendations there are on Wall Street, no matter how comfortable we are with the business, no matter what the positive momentum is.
Now we may sell a security before it reaches the fair value point if we finish work on another company that we want to invest in and we donít have any money. We typically are fully invested, so we may be doing some new research and find something we really like, and want to buy it. So, if there is something within 10% or 15 % of the fair value point and we can buy something at half price, we will make that trade.
Q: In 2001 and 2002 the value categories were in the spotlight and many funds outperformed other categories. These two years were not your best years. What happened?
In 2000, right around the time the Nasdaq peaked, we were like kids in a candy store. We had the opportunity to buy really spectacular businesses that were industry leaders in their market with no real problems other than they werenít growing that rapidly and the market was only focused on companies that were growing very rapidly. You were able to buy those companies at 4 times their cash flow. It was once in a lifetime kind of opportunity.
Then, in 2001 and the first part of 2002 the opportunities werenít as great until we got to September 2002. Then the opportunities had re-materialized again because the market was very, very weak in that summer of 2002.
If look again at the trailing 12 months ending in September we had a 30% or 40% gain. Really, the only time you get these kinds of returns is when there is incredible stress in the marketplace. Those are not normal environments: 35% for 12 months is not normal and I wouldnít want anybody to believe you could get that kind of return long term or even short term.
Q: What have your best performing holdings have been and what was the story there?
Boeing is a great, world-class franchise. The stock fell down from the $70s to $26 this year. We started acquiring our position in the $20s. In a normal environment this company has about $5 of earnings potential. They are not earning that now but it is not normal to have almost no business on the commercial aircraft side. We are confident the commercial aircraft business will rebound and so will the stock.
Our second largest holding is Freddie Mac. Again, it is a really spectacular franchise but one that is undergoing lots of stress right now, because of the regulation by the government. There were also some accounting issues Ė they didnít report enough income. Normally you wouldnít perceive that as something so horrible but the market has treated it horribly. So, when they restated and increased their book value, it was viewed as a big problem.
Basically, accounting issues have been one of the best sources of investment ideas in the last 12 months. Probably our best performer over the last 12 months has been Computer Associates, which at one point was our largest holding and that stock a year ago was $8 a share. Now, it is $24 a share. It was $8 because of peopleís fear of accounting issues.
Computer Associates is very simple. They sell software, so they send the customer a disk and the customer sends them a check. That is the entire transaction. The way the accounting gets affected is basically the nuances of accounting for multi-year licenses that allow you to record as earning more than one year of earnings when you sell three years of license, letís say. But the cash flow is a cash flow. When they collect the checks and put them in the bank you can see that on their financials. So, there is no issue. You have to understand the relationship between cash and reported earnings and if you canít understand that relationship you should be scared. But if you can and the market gets a little panicky then you can exploit that opportunity.
Q: You can also partially invest in foreign issues. Do you have any such stocks in your portfolio at the moment?
We donít own any European or Asian companies right now. We do have XL Capital, a Bermuda-based re-insurer and Cooper Industries, which moved its headquarters to Bermuda. While they are Bermuda-based, we donít view them as really being non-US companies.
Q: Have you had disappointments with certain equities?
Of course. Right now Iíd pick Loews. Loews owns CNA Insurance and the Carolina Group. Itís a conglomerate that was selling for below the value of all its individual businesses. So, we bought it and some of the individual businesses. In particular, the insurance company CNA has continued to have problems and so while the stock had been significantly below book, the book value is deteriorating as they take extra reserves for some of their past insurance policies. We misestimated that, so that has been a disappointment. We still own it though, because we still think itís cheap.
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