Adviser Q&A: Global Blue Chip Bargains

 



Adviser Q&A
Global Blue Chip Bargains
John Christy, Forbes International Investment Report 04.18.07, 4:00 PM ET

Each month the Forbes International Investment Report includes a Q&A with a fund manager, analyst or another guest who we think has exceptional insight into global markets and investing. This month I spoke with David Herro, chief investment officer for international equities at Chicago-based Harris Associates. Harris manages nearly $70 billion in assets, including the Oakmark family of mutual funds. Herro's responsibilities at the firm include managing the Oakmark International Fund (OAKIX) and the Oakmark International Small Cap Fund ( OAKEX). Herro joined Harris in 1992 and has been involved in international investing for more than 20 years.

John Hill Christy: As a veteran international fund manager, you've been at this a long time. What's your advice to investors who are relatively new to global investing?

David Herro: First all, regardless of where you're investing, you have to look beyond short-term volatility when making decisions. So where does international fit? I think when you look at the size of the global economy and the opportunities available in overseas markets, people should have 25% of their equity assets in international stocks. Maybe more than that if global markets are cheap, maybe less when they're dear. But I'd say 25% is a good benchmark allocation given today's valuations. Having a larger universe to choose from greatly enhances your ability to find good values and take advantage of undervalued situations.

But we've had a few really good years now. Is it getting harder to find undervalued stocks?

Well, the imbalances we're seeing are on a company size and industry basis rather than a geographic basis. You've seen a huge wall of money move into small-cap stocks and cyclicals. Meanwhile, the stocks that have been ignored are companies that are involved in consumer products, pharmaceuticals, media and financial services.

What sort of opportunities are you finding in those sectors?

In the second half of the 1990s, the big blue-chip companies were systematically overpriced. Pharma stocks, and companies like Coca-Cola and Gillette, were trading at 30 or 40 times earnings. It was very hard to justify those valuations. But today, if we look at a company like GlaxoSmithKline, which is one of our largest holdings, it's trading at about 13 times earnings and pays a 3.5% dividend yield. And unlike some other pharmaceutical companies, it has a decent growth profile going forward, given the state of its pipeline. So one could argue that, if anything, Glaxo is better than it was four or five years ago, but it has been harshly de-rated.

The same could be said for consumer companies like Cadbury-Schweppes, Nestlé or Diageo. These have delivered good cash-flow growth and shareholder value over time, but have just been de-rated. The beauty of these stocks is that they're also very stable. Their earnings aren't going to fall off a cliff if there's some kind of shock to the global economy. I think they should be selling at premiums, not discounts to their current prices.

What do you think it will take for these stocks to break out of that de-rating process?

That's a very good question. I can't really tell you what the catalyst will be. But I will say that when there's an imbalance, the longer the imbalance persists, the more pressure there is for it to correct. Eventually the wall of money just slowly starts to move. Our view is that if we get the valuations right, there could be any number of catalysts. The important thing for us is to find the discrepancy between price and value.

What are some other names that you like?

In pharma we also like Novartis in Switzerland and Japan's Takeda Pharmaceutical. Takeda is one of the best-run companies in Japan in any industry. We also own some Sanofi-Aventis. In financial services, we're keen on the asset managers. It can be a volatile business in the short term, but it is very solid over the long run.

One of our largest holdings is UBS. It's not a pure play because it also does investment banking, but it's one of the largest asset managers in the world. UBS trades at 11 times earnings and pays a 2.5% dividend yield.

Are you doing much in emerging markets?

We did back in the wake of the Asian crisis [1997-98] when it was a very contrarian call. But I think today you're seeing the opposite. Everyone has been tripping over themselves to get into emerging markets, and there's a lot of euphoria. We're waiting for an opportunity to increase our exposure again, but we don't think it's justified at these prices. In China, for example, I think the best way to play the macroeconomic growth story is to make sure you're invested in companies that will be positively impacted by it. But we think corporate governance in China is still too opaque, and share prices are too expensive for us to be all that excited about buying Chinese companies.