Fairpointe Capital’s focused equity strategy, which has only 31 holdings in a portfolio that mainly includes private accounts, has doubled the returns of the S&P 500 Index this year.
The portfolio was up 19.9% for 2016 (through November), compared with 9.8% for the S&P 500
SPX, -0.21%
Among the best-performing holdings this year are Kennametal Inc.
KMT, -0.29%
a Pittsburgh-based maker of industrial machinery that has soared 75%; Quanta Services Inc.
PWR, +1.42%
a Houston-based provider of engineering services for the electric-power, oil and gas infrastructure industries that has increased 73%; and Apache Corp.
APA, +0.17%
a Houston-based oil and natural gas exploration and production company that’s up 52%.
We spoke with Bob Burnstine, president of Fairpointe Capital LLC of Chicago, who is also a fund manager running the firm’s focused equity strategy. He named four stocks, below, that he believes are good values to buy today, despite high valuations in the U.S. stock market.
Fairpointe has about $5 billion in assets under management, with roughly $65 million managed in its focused equity strategy, which was launched in August 2011. The firm serves as the manager for the AMG Managers Fairpointe Focused Equity Fund
AFPTX, -0.19%
which follows precisely the same strategy.
“By owning 30 stocks, people are investing in us for our research capabilities, and we are not going to look anything like a benchmark [index].”
Bob Burnstine, president of Fairpointe Capital LLC
The AMG fund — previously called the Aston/Fairpointe Focused Equity Fund — was established in December 2014, so it doesn’t have much of a track record. But Fairpointe provided total return information for the strategy, through Nov. 30, as verified by Ashland Partners:
Total return – 2016
Total return – trailing 12 months
Avg. 3-year annual return
Avg. 5-year annual return
Fairpointe Focused Equity Strategy, net of fees
19.9%
12.5%
6.8%
15.6%
Russell 1000 Index
RUI, -0.24%
10.0%
8.0%
8.9%
14.5%
S&P 500
SPX, -0.21%
9.8%
8.1%
9.1%
14.5%
Source: Fairpointe Capital LLC
In an interview on Dec. 27, Burnstine called 2015 a “tough year” for his strategy, and said a handful of major tech players were “sort of falsely leading the market to be flat.” Those included Amazon.com
AMZN, -1.09%
Netflix Inc.
NFLX, -1.15%
Facebook Inc.
FB, -1.04%
and Alphabet Inc.
GOOG, -1.03%
which holds Google.
Four stocks recommended by Burnstine
The Fairpointe Focused Equity strategy usually holds between 30 and 35 stocks.
“We want each stock to have the ability to impact performance,” Burnstine said. “We believe that by owning 30 stocks, people are investing in us for our research capabilities, and we are not going to look anything like a benchmark [index].”
Burnstine said a time frame of three to five years is the strategy’s “greatest advantage.” The fund has relatively low turnover of typically six to eight stock “going in and out of the portfolio” each year, he said, while also explaining that the portfolio will be rebalanced as stocks get closer to his target sale prices.
Burnstine focuses on stocks that are priced below where he thinks they should be, based on enterprise value, which encompasses his estimate of a company’s earnings power over the next three to five years.
Rather than focusing on the stocks that have been the year’s hottest in the portfolio, Burnstine mentioned four that he believes are still excellent buys today:
Hewlett Packard Enterprise
Hewlett Packard Enterprise Co.
HPE, -0.43%
was created in October 2015 when the “old” Hewlett was split into this company and HP Inc.
HPQ, +0.17%
As you can see in the table below, which lists all of the stocks held in the portfolio as of Nov. 30, Burnstine’s position in HPE is far bigger than the one in HPQ.
Shares of Hewlett Packard Enterprise closed at $23.74 on Dec. 27, and Burnstine believes the stock “is worth $30” over the next 12 to 18 months.
“What [CEO] Meg Whitman has done is tremendous for the company,” he said, because she has “slowly been peeling it apart and unlocking value in the entity.” Following the spinoff of HP Inc., which retained the old HP’s PC and printer businesses, HP Enterprise agreed in May to spin off its enterprise business and merge it with Computer Sciences Corp.
CSC, -0.33%
and agreed in September to spin off its software business and merge it with Micro Focus International PLC.
Following the spin-offs, HP Enterprise will be left with its enterprise servers, storage equipment, networking equipment and technology services units.
“HPE is undervalued because there are still people who do not give Whitman credit for what has been done. When you look at it on a price-to-earnings or cash-flow basis, or enterprise-value-to-revenue, the stock is still trading cheaper to peers and cheaper than the market,” Burnstine said.
Wal-Mart
Take a look at this two-year chart for Wal-Mart Stores Inc.’s
WMT, -0.13%
stock:
“At the beginning of 2015, Wal-Mart was a $90 stock and then it went to $60. It lost a third of its value. Those are big dollars,” Burnstine said.
What drew the fund manager to the stock was not only its decline, but management’s change of direction. “They are investing in their stores and investing in their people. They are also investing in their online initiatives,” which include the acquisition of Jet.com in September.
Burnstine says the timing of Wal-Mart’s $20 billion share-buyback program, announced in October 2015, was prescient. “I would not have liked it if they announced it at $90 a share, but since they announced it at $60, it’s awesome, because it shows management recognizes the value of the stock,” he said.
He emphasized that Wal-Mart was a three- to five-year play on the expected improvement in the appearance of the stores, as well as the greater investment in employees.
21st Century Fox
21st Century Fox Inc.
FOXA, -0.87%
was formed in June 2013 when the “old” News Corp. was split into Fox and the “new” News Corp.
NWSA, -1.59%
which holds the formerly combined company’s publishing businesses, including Dow Jones, which includes the Wall Street Journal and MarketWatch.
Burnstine holds both companies in the portfolio, but Fox is its second-largest holding, at 4.7% of assets, while the News Corp. position is much smaller.
Burnstine said Fox was trading at a discounted valuation to other media companies, and that he was impressed by the buildup of its regional sports network, and its offer to acquire the 60% of Sky PLC that it doesn’t already own.
Discovery Communications
According to Burnstine, Discovery Communications Inc.
DISCK, -0.85%
CEO David Zaslav’s strategy of focusing the company’s various content networks to specific audience demographics will pay off.
Such targeting helps Discovery’s networks stick out from the crowd for viewers who have over 100 stations to chose from, which can set up the company “to fight the next battle, including ‘over-the-top’ distribution,” which means distributing content directly to consumers, as Netflix
NFLX, -1.15%
does.
Burnstine is attracted by Discovery’s forward price-to-earnings ratio of 11.9, based on the consensus 2017 earnings estimate. This compares with a forward P/E of 17.1 for the S&P 500.
Fund holdings
Here are all 31 equity holdings of the Fairpointe Focused Equity Fund as of Nov. 30:
Company
Ticker
Industry
Share of portfolio
Total return – 2016, through Dec. 23
Total return – 5 years
Kennametal Inc.
KMT, -0.29%
Industrial Machinery
4.7%
75%
-2%
21st Century Fox Inc. Class A
FOXA, -0.87%
Media Conglomerates
4.7%
6%
90%
Carnival Corp.
CCL, +0.54%
Cruiselines
4.3%
0%
85%
Hewlett Packard Enterprise Co.
HPE, -0.43%
Computer Processing Hardware
4.3%
58%
N/A
FMC Corp.
FMC, -0.21%
Agricultural Chemicals
4.3%
48%
38%
Teradata Corp.
TDC, -0.07%
Information Technology Services
4.3%
3%
-45%
Northern Trust Corp.
NTRS, +0.61%
Regional Banks
4.2%
27%
149%
Discovery Communications Inc. Class C
DISCK, -0.85%
Media Conglomerates
4.2%
9%
48%
Legg Mason Inc.
LM, +0.70%
Investment Managers
4.0%
-19%
40%
Wal-Mart Stores Inc.
WMT, -0.13%
Discount Stores
3.9%
17%
33%
Baker-Hughes Inc.
BHI, +0.76%
Oilfield Services/ Equipment
3.7%
44%
41%
BP PLC ADR
BP, +0.52%
Integrated Oil
3.7%
28%
14%
Cree Inc.
CREE, -1.08%
Electronic Components
3.6%
4%
27%
Liberty Interactive Corp. QVC Group Series A
QVCA, -0.78%
Catalog/ Specialty Distribution
3.4%
-26%
63%
Quanta Services Inc.
PWR, +1.42%
Engineering and Construction
3.4%
73%
61%
Staples Inc.
SPLS, -0.87%
Specialty Stores
3.4%
3%
-21%
Varian Medical Systems Inc.
VAR, -0.14%
Medical Specialties
3.3%
13%
37%
Scholastic Corp.
SCHL, -0.72%
Publishing
3.3%
26%
69%
HP Inc.
HPQ, +0.17%
Computer Processing Hardware
3.1%
33%
49%
Fluor Corp.
FLR, +0.84%
Engineering and Construction
2.9%
16%
13%
New Corp. Class A
NWSA, -1.59%
Publishing
2.7%
-9%
N/A
VMware Inc. Class A
VMW, -0.35%
Information Technology Services
2.7%
42%
-6%
Hologic Inc.
HOLX, -0.16%
Medical Specialties
2.5%
4%
129%
AGCO Corp.
AGCO, +0.33%
Trucks/ Construction/ Farm Machinery
2.3%
30%
42%
Transocean Ltd.
RIG, +0.57%
Contract Drilling
2.3%
23%
-53%
Cisco Systems Inc.
CSCO, -0.56%
Computer Communications
2.2%
17%
91%
Unilever PLC ADR
UL, +0.53%
Household/ Personal Care
2.0%
-3%
43%
PepsiCo Inc.
PEP, -0.25%
Beverages: Non-alcoholic
1.8%
8%
83%
Apache Corp.
APA, +0.17%
Oil and Gas Production
1.2%
52%
-22%
Greif Class A
GEF, +0.27%
Containers/ Packaging
1.1%
79%
41%
Lions Gate Entertainment Corp.
LGF.A, -0.11%
Movies/ Entertainment
0.5%
-19%
227%
Sources: Fairpointe Capital LLC, FactSet
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