MI301: Deep Value: Timeless Strategies, New Insights w/ Bill Nygren and Robert Bierig
MI301: DEEP VALUE: TIMELESS STRATEGIES, NEW INSIGHTS
W/ BILL NYGREN AND ROBERT BIERIG
24 October 2023
Kyle Grieve chats with Bill Nygren and Robert Bierig about the formation of Harris Associates, their value-based investing strategy, their unique way they have their analysts and portfolio managers come to a consensus on a stock, a deep dive on an exciting underpriced business they’ve recently added in IQVIA, a look at some undervalued industries, the importance of re-evaluating your stocks regularly when information changes, and a whole lot more!
Bill Nygren has 42 years of investing experience and has been a part of Harris Associates since 1983. He is an astute value investor who is a wealth of knowledge. Robert Bierig has 24 years of investing experience and joined Harris Associates in 2012. He’s a portfolio manager of multiple funds for Oakmark.
IN THIS EPISODE, YOU’LL LEARN:
Why calculations of intrinsic value must be adjusted regularly to ensure a degree of accuracy.
How to look at growth stocks through a value perspective with examples of Adobe and Uber.
Why focusing on long-term returns helps align them with their partners.
The importance of per share growth when looking at growth metrics.
How a value-based approach has shaped their investing philosophy.
A deep dive into one of their newest portfolio additions, IQVIA.
Which industries Bill is seeing value in right now.
And much, much more!
Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.
[00:00:03] Bill Nygren: I think there’s a misperception out there that cheap means it’s not growing rapidly. And while that’s often true, it’s certainly not always the case. And I would cite an example that’s in our portfolio today. First Citizens Financial, the bank that bought SBB from the FDIC. It has grown its book value and earnings and sales so rapidly that in Morningstar’s ranking system it fits squarely in with growth companies, yet it sells at eight times earnings and at tangible book value.
[00:00:41] Kyle Grieve: In this episode, I chat with legendary value investor Bill Nygren and Robert Bierig about the formation of Harris Associates. Their value based investing strategy, their unique way they have their analyst and portfolio managers come to a consensus on a stock, a deep dive on an exciting underpriced business they’ve recently added in IQVIA, a look at some undervalued industries their researching, The importance of re evaluating your stocks regularly when information changes, and a whole lot more.
[00:01:07] Kyle Grieve: I first learned about Bill Nygren during his excellent interview with Michael J. Mobeson. I was very impressed with his value based approach and some of the unique ways his fund was run. It was a truly eye opening listen that provided me with a lot of interesting investing topics to think about. His wealth of knowledge and experience from 42 years in the field is very apparent when you hear him discuss investing.
[00:01:26] Kyle Grieve: Robert Buehrig has 24 years of experience in the investment world. He’s a portfolio manager for two of Oakmark’s funds and did a wonderful job of breaking down IQVIA to any investors looking for exposure to the data side of healthcare. Any value investor who is in search of new ideas should give this episode a listen.
[00:01:42] Kyle Grieve: as they give their valuable opinions on where they’re seeing the most value in today’s markets. Now, without further delay, let’s get right into this week’s episode with Bill Nygren and Robert Bierig.
[00:01:53] Intro: You’re listening to Millennial Investing by The Investor’s Podcast Network, where your hosts, Robert Leonard, Patrick Donley, and Kyle Grieve interview successful entrepreneurs, business leaders, and investors to help educate and inspire the millennial generation.
[00:02:17] Kyle Grieve: Welcome to the Millennial Investing Podcast. I’m your host, Kyle Grieve, and today we bring Bill Nygren and Robert Bierig onto the show. Bill, Bobby, welcome to the podcast.
[00:02:27] Bill Nygren: Thank you, Kyle. It’s a treat for us to be here today.
[00:02:31] Kyle Grieve: So I’ve been a big fan of you guys for the last few years. And I know listeners are going to learn a ton from you today about the two of you from how you invest at Oakmark, as well as going over an exciting new addition into your portfolio in the stock, the business IQVIA.
[00:02:44] Kyle Grieve: Bill, I wanted to kick things off with a question for you. Can you tell us a little bit more about the history of the fund? What differentiates it from competitors and how you’ve utilized a value based approach so successfully?
[00:02:56] Bill Nygren: Sure. When I joined Harris Associates 40 years ago, it was primarily a private wealth management business, and it had a very deeply held belief in long term value investing.
[00:03:11] Bill Nygren: And as my generation started to grow up in the firm, we wanted to have a way not only that we could invest our own money, But we could bring friends and acquaintances into Harris Associates before they had a 5 million minimum that you needed to be in a high net worth account. And we looked at the mutual fund industry and thought there were five important ways that we could differentiate
[00:03:38] Bill Nygren: relative to the competitive set. First, we thought we could build a strong brand where the name Oakmark would mean something. Most of the firms try and do so many things under one brand that we felt it diluted the value of the brand. But we wanted the Oakmark brand to be synonymous with value investing.
[00:04:00] Bill Nygren: And not only in the Oakmark fund, but any additional fund that we would offer. It would be a value investing framework that determined what stocks went into it. Secondly, we wanted our communications with shareholders to be educational. I think a lot of our industry communicates directly with their shareholders, only the twice a year that’s required by law, and that tends to be limited to which are the stocks that help performance and which hurt.
[00:04:28] Bill Nygren: We wanted to take advantage of the opportunity to connect with our shareholders quarterly. And to try to educate because we believe to be a successful investor in equities, you need to be a longterm investor and that requires understanding how your fund managers think, not just looking at the results.
[00:04:49] Bill Nygren: So we write quarterly our materials available on oakmark. com and it tends to be some of the more insightful commentary that you see in the fund industry today. The third thing is we felt the advantage we could bring to the table was our stock selection skill. And we noticed that across the fund industry, managers really diluted their stock selection ability by having a hundred or more names in their portfolios.
[00:05:18] Bill Nygren: I think that approach only makes sense if you’re trying to really hug an index. And make sure you don’t underperform by much. But when you think stock selection is your skill, the fewer names you have in the portfolio, the more that skill influences the results. So our most diversified product, the Oakmark Fund, has roughly half the names in it of an average mutual fund today.
[00:05:43] Bill Nygren: Fourth, we wanted to maximize total returns on an after tax basis over a long time horizon. Most of the fund industry at that point in time would look at either return through capital appreciation or return through income and prioritize one over the other. And very few funds paid attention to after tax returns.
[00:06:04] Bill Nygren: We thought we could have an edge by being indifferent between growth that came from capital appreciation or dividend income, and to minimize the take of taxes to maximize after tax returns. And then last, we wanted to align the incentives.
[00:06:26] Bill Nygren: We thought it was interesting that across most of the fund industry, the investment by the management teams was very small. We started Oakmark because that’s how we wanted to invest our own money. And we’re proud of the fact today that for our portfolio managers on these funds, their personal investments in the funds that they manage are the largest investments that they have.
[00:06:49] Bill Nygren: So we thought if you combine those five differences, it would give us enough of a point of differentiation that a small one office firm in Chicago could compete effectively with the giants in the industry.
[00:07:02] Kyle Grieve: Just browsing at your portfolio, I see you guys own a really good mix of both traditional value stocks and growth businesses.
[00:07:10] Kyle Grieve: Do you use specific growth hurdles such as, per share revenues, profits, free cash flows, et cetera, when determining whether a business fits into your criteria?
[00:07:21] Bill Nygren: We would say that everything we own is a value stock, and some of them happen to grow more than average. And all of those metrics you mentioned are metrics that we will use occasionally, but we’re using those to try to get to an estimate of the rate of per share value growth.
[00:07:40] Bill Nygren: And what we are looking for, in addition to buying companies at a big discount, what we think their intrinsic value is, we want the combination of per share value growth and dividend yield to at least match what we expect from the market. And in that way, we can then have the patience that you need to be a successful value investor.
[00:08:02] Bill Nygren: Because the more time that goes by, the larger the valuation gap is.
[00:08:07] Kyle Grieve: Yeah, that makes sense. So you mentioned that you consider yourselves pure value investors, which I can’t disagree with, but what would you say is the difference between a growth stock and a value stock? Do you think there is a difference at all?
[00:08:23] Bill Nygren: We could spend the whole hour on this question and I’ll try not to make it take that long. I think there’s a misperception out there that cheap means it’s not growing rapidly. And while that’s often true, it’s certainly not always the case. And, I would cite an example that’s in our portfolio today, First Citizens Financial, the bank that bought SVB from the FDIC.
[00:08:47] Bill Nygren: It has grown its book value and earnings and sales so rapidly that in Morningstar’s ranking system, it fits squarely in with growth companies, yet it sells at eight times earnings and at tangible book value. Yes, it’s a growing business, but we definitely consider that to be a valued stock. I think the biggest difference between growth and value investors is how far into the future they’re willing to look.
[00:09:15] Bill Nygren: A growth investor is often trying to make an estimate of how the next decade or two will be different than the present is. And we, like most value investors, think our crystal ball gets cloudy much faster than that. So we don’t ever want to invest in a company where you need to have it sell at more than a market multiple seven years from now to justify the price that you’re paying today.
[00:09:40] Bill Nygren: That does rule out a lot of the really high P multiple stocks, but as you said, our portfolio, despite that constraint does have a lot of good growth companies in it.
[00:09:51] Kyle Grieve: On your site, you say that you want businesses with executives who think and act like owners. Could you elaborate a little bit more on that?
[00:10:00] Bill Nygren: Sure. I think one of the problems or potential problems you have as a public equity investor is the agency issue. That the executives managing the companies aren’t the owners of it. We, the shareholders, hire those executives to run the business in our best interests. And there can be differences between how a professional manager maximizes their personal economics and what’s best for the outside shareholders.
[00:10:29] Bill Nygren: And, you can cite examples of companies that have gotten bigger by making overpriced acquisitions, for example, makes the manager’s job bigger and probably pays better because of that, but it destroys per share value for the shareholders. So we want to make sure that the managements we’re investing in.
[00:10:50] Bill Nygren: Maximize their personal economics by doing the right thing for the outside shareholders. So when we look at the metrics that determine their performance compensation, generally we want to make sure there’s a denominator. So it’s not just growth, it’s growth per share. It’s not just earnings getting bigger, it’s earnings per share.
[00:11:10] Bill Nygren: Because we think human nature is people do a pretty good job of maximizing their personal economics. And we want to make sure we’re along for that ride as outside shareholders.
[00:11:21] Kyle Grieve: So you said you’ve, you like to buy businesses that are trading about 50 to 60 percent of their intrinsic value and then sell once it gets to say 90 to 100 percent of intrinsic value.
[00:11:31] Kyle Grieve: As you mentioned previously, the speed that that happens determines your rate of return. What’s your desired speed on that or, or like you said, is it just purely to kind of outpace the S&P 500?
[00:11:43] Bill Nygren: The desired speed would be one day. It very rarely happens. We don’t have a target turnover ratio. We buy stocks, when they’re less than 60 cents on the dollar or so, then we sell them above 90 cents on the dollar.
[00:11:58] Bill Nygren: Obviously, the faster that happens, the better it is for our shareholders. We found that typically it takes about five years for the market’s view of value and our view to converge. And that’s why it’s so important. That we aren’t invested in value traps where the best days are behind them. They’re competitively disadvantaged and they might actually be worth less 5 years from now than it appears they’re worth today.
[00:12:24] Bill Nygren: That’s the criteria that we have that we want growth in per share value plus dividends to at least match the S&P is what allows us the luxury of taking a 5 to 7 year view on companies when we invest in them. And yes, of course, we want to do better than the S&P or any other equity index that you can think of, but we also don’t want to lose sight of we’re investing real money for real people to help them meet real world financial goals.
[00:12:54] Bill Nygren: So it’s not a game to us of trying to do a few basis points better than the S&P. We’re trying to grow people’s capital so that they can meet their financial needs for education, retirement, et cetera. And growth of capital in real terms is just as important as beating our competitors, beating the S&P, or any other index.
[00:13:19] Kyle Grieve: Let’s imagine that you do the modeling on one of these businesses and the price reaches your intrinsic value. How do you make adjustments to your intrinsic value as time goes along? Because, if you’re looking at really good businesses, obviously sometimes they get even better than you first imagined.
[00:13:37] Bill Nygren: Yeah, really important question because many of our long term holdings have risen way above what our initial estimate of intrinsic value was. So our analysts do maintenance work on every stock that’s in our portfolio and update their best guess of business value based on any new information that comes out.
[00:13:59] Bill Nygren: We want this process done formally, at least quarterly, but really it’s constant. That if a company, a similar company is acquired, That might help us refine our estimate of what multiple is appropriate for the earnings. If earnings come in a little better or worse than expected, we want to make sure we’re adjusting our long term estimates for any of those shortfalls or excesses that we believe are likely to be sustainable.
[00:14:26] Bill Nygren: If an analyst lets, I’ll just make up numbers, stocks at 60, the analyst thinks it’s worth 100, and if it got over 90, we’d sell it tomorrow. But a year from now, that hundred is probably 107, two years from now, 115, and by the time we’re out five or six years, it could be 50 percent higher than what our initial estimate of value was.
[00:14:50] Bill Nygren: But once the stock reaches our estimate of fundamental value, it’s sold. The only reason we might drag our feet would be to let a holding go long term, to… lower the tax bite, but we don’t become momentum investors just because something has worked out.
[00:15:07] Kyle Grieve: So Bill, on your conversation on value investing with legends, you mentioned a very interesting framework that exists between your analysts and fund managers.
[00:15:17] Kyle Grieve: In order for a stock to qualify for entry into the portfolio, it must be green lit by senior management team before it can make it into the portfolio. Can you discuss a little bit more about how you came about this approach and why it works so well for you guys?
[00:15:31] Bill Nygren: Sure. And I think most people are really surprised to find out I’ve been doing this for 40 years.
[00:15:36] Bill Nygren: I have never been able to put a stock into the portfolio just because I think it’s attractive. This is a policy that was in place 40 years ago when I joined Harris Associates, even before we had the Oakmark Fund. As I mentioned, we were primarily a private wealth management business, and that meant most of the professionals here who were responsible for those portfolios were more client contact, client relation managers, as opposed to spending all their time thinking about investments.
[00:16:10] Bill Nygren: So to kind of put guardrails on those, those managers, any stock idea that they wanted to put in the portfolio had to be presented in front of all our investment professionals. heavily debated, basically trying to shoot holes in the idea, trying to identify as many of our mistakes as we could before we lost real money on them.
[00:16:32] Bill Nygren: And as our business shifted from private wealth management to more of the mutual fund business, even though we had investors now in charge of, of the portfolios, this process has been so successful for us. We’d found the analyst suggestions tended to be better than the S&P 500, and then those that we voted acceptable for portfolios were better than the analyst suggestions.
[00:16:59] Bill Nygren: So each step of the process was adding value, and we knew that by having to debate in front of all the investment professionals you work with, it imposed a certain rigor on the analyst. You don’t just walk into the room and say, Hey, I heard a neat idea on C N B C this morning. You understand the business the competitive dynamics, why it’s more attractive than alternative investments.
[00:17:24] Bill Nygren: And we think that rigor is something that’s important. And even though everyone involved on the funds today is an investment professional by trade, as opposed to a client portfolio manager, we still think this process adds value. It allows our analysts to think more like portfolio managers. And we think that’s also important.
[00:17:48] Bill Nygren: As we think about building the next generation, I’ve often said that the secret sauce for us at Oakmark is our depth of talent, and one of the reasons our depth is strong as it is, is because of this process that every analyst goes through on not only their own ideas. But then it’s their job to try and poke holes in their peers ideas and it has worked very well for us for multiple generations.
[00:18:16] Kyle Grieve: So let’s jump into our company deep dive into IQVIA. Bobby, to start us off, can you give the audience a brief overview of the business and its industry as well?
[00:18:28] Robert Bierig: Sure. It’s a pleasure to be with you, Kyle. I’m happy to do that. IQVIA is the largest contract research organization, and it’s a leader in related healthcare technology.
[00:18:39] Robert Bierig: Contract research organizations are known as CROs. So what they do is manage the key elements of clinical trials for pharma and biotech companies. You can think of it as an outsourcing model for services like study design, patient recruitment, data collection, and regulatory compliance. All of these things are related to clinical trials.
[00:19:01] Robert Bierig: And then on the healthcare technology side, IQVIA provides real world evidence and software. analytics and consulting, and prescription data to biopharma companies. We can go into more detail on these businesses later in our conversation, but at the big picture level, what’s important is that we think IQVIA is positioned on the right side of trends in healthcare.
[00:19:24] Robert Bierig: It’s a good example of a company that meets our investment criteria today because it sells at a significant discount to what we think it’s worth. It’s growing per share value. In fact, it’s doing so at an above average rate. And it’s run by a good management team with a track record of both strong operational performance and capital outage.
[00:19:46] Kyle Grieve: So IQVIA was formed from a merger between Quintiles and IMS Health back in 2016 in an all stock transaction. Can you discuss this merger in a little more detail for the audience?
[00:19:59] Robert Bierig: Yes. As you mentioned, IQVIA was, was formed through this combination that happened around seven years ago. The deal closed in October of 2016.
[00:20:09] Robert Bierig: It was structured as an all stock merger. IMS shareholders owned 51% of the company quintile shareholders owned 49% of the company. And Ari Bousbib, who’s the CEO of IQVIA today had joined IMS Health as CEO back in 2010. When Ari came to IMS, he saw that it was really a data business. The company has prescription and pharmacy records on over a billion patients all over the world going back more than 50 years.
[00:20:39] Robert Bierig: So this data is considered like the gold standard in the healthcare industry. And what I already saw back then is that IMS had good market share, but they weren’t growing much beyond just taking price. He looked around at companies like McKinsey, Accenture. and Viva. And he realized that these companies were building their own businesses using IMS data.
[00:21:04] Robert Bierig: So Ari saw an opportunity to broaden what IMS was doing by investing in technology and saw that they could create a much larger addressable market opportunity.
[00:21:15] Robert Bierig: He could leverage this core data to grow in analytics and consulting and he could do higher value work for pharma clients. Ultimately, the combination with Quintiles was really a natural extension of RE’s strategy.
[00:21:30] Robert Bierig: The logic of the merger was that you could run IMS data through
[00:21:34] Robert Bierig: Quintiles CRO pipes to accelerate growth and gain share.
[00:21:40] Kyle Grieve: So can you tell me a little bit more about the CEO, Ari Bousbib? What was his previous work history? You mentioned that he was with one side of the merged companies, and how do you think he’s done so far with IQVIA?
[00:21:51] Robert Bierig: Previously, Ari had spent 14 years at United Technologies. He ran their commercial companies, which included Otis Elevator, Carrier, and their fire and security business. He’s a former partner. at Booz Allen. So he’s done a good job throughout his career. I think he’s done an excellent job with IQVIA. Before he came in, Quintiles was the largest CRO, but it really wasn’t reaching its full potential.
[00:22:21] Robert Bierig: I think Ari said back then that Quintiles was the Rolls Royce of CROs. It had a large existing book of business, but it didn’t do enough selling. And I already saw this opportunity to add salespeople, focus more on the emerging biopharma companies that drive a lot of the growth in the industry and eliminate this kind of middle management overhead, bringing Twin Tiles and IMS together.
[00:22:47] Robert Bierig: What they did was they improved trial design. They provided more efficient site identification and they accelerated patient enrollment. And that’s translated to the fastest bookings growth and the highest book to bill ratios in the industry. So if you step back, IQB has gone from around 9 billion in pro forma revenue at the time of the merger to a little over 15 billion today.
[00:23:12] Robert Bierig: And the adjusted earnings per share has gone from less than 4 to more than 10. Management has also bought back around 25 percent of the, of the share base since that merger. And the last thing I’ll say on Ari is that he thinks and acts like an owner because he is an owner. Bill mentioned earlier in the conversation that we like to see people that have significant skin in the game.
[00:23:34] Robert Bierig: Ari owns 250 million plus of the stock outright, and he has another 1 million options.
[00:23:43] Kyle Grieve: Are there any other notable executives that investors should familiarize themselves with if they were interested in learning more about iQVIA?
[00:23:50] Robert Bierig: I think the CFO, Ron Bruleman, is someone else to become familiar with.
[00:23:55] Robert Bierig: He, Ron has been with RE for many years. He became the CFO of IQVIA in 2020, but before that had been CFO at IMS prior to the deal and then was an advisor to RE. He actually started out working with RE at United Technologies, so they’ve known each other for a long time.
[00:24:14] Kyle Grieve: So let’s jump into some of the details of IQVIA’s two major segments. Which of these two segments excites you the most and why?
[00:24:22] Robert Bierig: I think both of the major segments are exciting. The R& D solutions segment accounts for a little more than half of total profits. That’s the CRO business, which management sees growing at around 9 to 12 percent organically. The market there is only around 50 percent outsourced today and it should get to 70 to 80 percent eventually.
[00:24:44] Robert Bierig: which creates a multi decade tailwind for above average growth. That segment gets most of the attention from the sell side because the analysts who cover IQVIA tend to be CRO specialists. But for that reason, it’s the other segment, which is the technology and analytics solutions business that’s called TASC.
[00:25:04] Robert Bierig: That probably isn’t as well understood as it should be. And it accounts for a little less than half the total profits. Management thinks that it can grow 7 9 percent organically. Now the TAS segment consists of several different pieces,
[00:25:18] Robert Bierig: but the part that’s most worth highlighting is the real world evidence portion, which is around 25 percent of the segment.
[00:25:26] Robert Bierig: This business is growing at a mid teens rate or higher, so it’s an important driver of overall growth. You can think of real world evidence as a phase 4 clinical trial. So when you do a typical clinical trial in phases 1 to 3, it’s mostly about determining the safety of a drug. When you get into phase 4, it’s about finding out the effectiveness and other use cases of the drug in different indications.
[00:25:54] Robert Bierig: As an example, maybe the drug was originally tested for cardiology, but what if it might also help with weight loss? You could use
[00:26:03] Robert Bierig: real world evidence to evaluate that question. And what’s unique about IQVIA is that it can use its data to find patients that fit all the parameters retrospectively and figure out whether the drug works as expected without having to go ahead and do another trial.
[00:26:22] Kyle Grieve: So you mentioned earlier that IQVIA has access to data that goes back like 50, 50 plus years with this data. Do they own all of it? Is it easily accessible by competitors? I’d love to know more about that.
[00:26:35] Robert Bierig: Yeah, this is a really important question. What’s unique about the IMS data is really two things. One, it’s global and two, it has full depth and breadth.
[00:26:45] Robert Bierig: It’s more detailed than anything else that’s out there. ICON, which is the second largest CRO, also has data through Symfony, but that’s mainly limited to U. S. pharma data. It doesn’t help you recruit in Europe, China, Africa, and IQVIA’s data, it consists
[00:27:05] Robert Bierig: of prescription records, pharmacy records. It’s linked to historical data sets.
[00:27:11] Robert Bierig: It comes from many disparate sources. Like the secret sauce here isn’t really the raw data per se. It’s about the cleaning, the curating, and the linking that’s done to pull together a picture on more than a billion non identified patient lives. And like I said earlier, IQVIA has this data going back more than 50 years.
[00:27:34] Kyle Grieve: Just talking about that data, obviously that’s one of their competitive advantages, but do they have any other major competitive advantages over peers that you’d like to share?
[00:27:43] Robert Bierig: I think it’s really kind of what they do with the data. I mean, the peers, if you want to talk like ICON and PPD are good companies.
[00:27:51] Robert Bierig: They’re very strong operationally. But what differentiates IQVIA is its ability to find patients and find sites using the data really quickly. And ICON and PPD can’t compete with IQVIA when it comes to that.
[00:28:07] Kyle Grieve: And so just looking at their revenue, do they have any concentration risks between any of their customers or is it pretty well diversified?
[00:28:16] Robert Bierig: It’s pretty well diversified. This is a really big business and it’s a global business.
[00:28:21] Kyle Grieve: So IQVIA right now is trading about 22 percent below its 2022 highs. I assume this drop in share price was probably a driving force on what got you interested in the business in the first place. Can you tell me why the market has punished the share price so badly and why you think sentiment will change?
[00:28:36] Robert Bierig: I think there are two main controversies to highlight. First, there are fears about the emerging biopharma funding environment. Second, there’s a slowdown in the economically sensitive part of the technology and analytics, that task segment. I’d be happy to talk about each of those briefly if that would be helpful.
[00:28:56] Robert Bierig: Absolutely. So on the E B P funding issue, there was a big decline in 2022 after a couple of boom years. Funding got as high as 130 billion in 2020 and 120 billion in 2021, but it fell to $60 billion in 2022. Now, that sounds scary, but it’s really not weak on an absolute basis. It’s just back to where it was before the boom. which is a pretty normal level with more than enough money to fund good science. Also, IQVIA isn’t feeling a whole today because much of the money that was raised during the boom went toward early stage, more, more speculative stuff that was never going to make it through to later stage phase two or three trials, which is where IQVIA plays.
[00:29:46] Robert Bierig: And then on the, on the slowdown that happened in that’s going on in TAS, Consulting, which is sensitive to the economy. is causing modest pressure on growth. The organic growth in the TAS segment is running at around 6 percent this year, whereas the typical growth rate is usually 7 to 9. If you pull out consulting, the rest of the segment is growing at 8, and it grew 9 percent last year.
[00:30:10] Robert Bierig: All things considered, We view this performance as solid considering the, the macro environment. We see the slowdown there as, as more of a blip, but it’s enough to scare away some healthcare investors who put a very high premium on stability.
[00:30:26] Kyle Grieve: So a lot of pharmacy businesses were seeming to ride some pretty heavy COVID tailwinds, but IQVIA is continuing to see really good organic growth rates in both segments that you’ve already outlined.
[00:30:35] Kyle Grieve: Do you see organic growth rates and kind of that nine to 12 percent range that you mentioned being sustainable over the next few years?
[00:30:43] Robert Bierig: IQVIA’s Covid revenues should be around $400 million this year. Covid related revenues got as high as as close as almost $2 billion at the peak in 2021. But we value the company off of kind of its normal earnings power and where it should, what its revenue should look like a couple years out in 2025.
[00:31:04] Robert Bierig: And by then we expect that COVID revenues will have trailed off to zero by then.
[00:31:09] Kyle Grieve: So how are you guys navigating the Federal Trade Commission’s attempt to block IQVIA’s acquisition of Propel Media?
[00:31:16] Robert Bierig: Propel Media would be a nice addition for the company. It would help their digital marketing capabilities.
[00:31:22] Robert Bierig: But it’s a really small percentage of the total value of the company, so it wouldn’t have a material impact on our value if they were not able to go forward with that transaction.
[00:31:32] Kyle Grieve: So let’s discuss a little bit more about evaluation. In your second quarter commentary, you mentioned that you believe IQVIA is currently trading around 15 times normalized earnings.
[00:31:43] Kyle Grieve: What do you feel is the reasonable normalized earnings multiple and can you explain what adjustments that you made to their current earnings to come to that figure?
[00:31:51] Robert Bierig: At the time of our initial purchase, IQVIA was selling near a trough multiple, as you said, around 15 times our estimate of the normal earnings.
[00:32:00] Robert Bierig: This is well below the market multiple and well below where IQVIA has traded historically, even though the company has prospects for sustainable growth at an above average rate, it usually trades at a premium to the market. When we think about the normal earning power, we look at what the business can earn a couple of years out, like I said a minute ago, and we add back amortization of intangibles.
[00:32:24] Robert Bierig: We factor in share repurchases between now and then. Management targets that 8 10 percent organic revenue growth, and we think the operating income growth should be at least that fast due to operating leverage. Life sciences companies and data and information services comparables that have similar growth characteristics and return profiles tend to sell 20s.
[00:32:50] Robert Bierig: And that seems reasonable to us for IQVIA. There’s also a long history of private market transactions in the CRO area that would support an EBIT A multiple of over 20 times. We think that’s about right for this business.
[00:33:06] Kyle Grieve: Let’s go over some of the growth drivers that they’re going to have in the future.
[00:33:09] Kyle Grieve: What would you see that they are currently pulling now, or what can they pull out to help keep driving growth and organic growth at the rates they’re going out now?
[00:33:18] Robert Bierig: Yeah the primary growth driver is the organic revenue. Management expects that eight to 10 growth in the core business.
[00:33:24] Robert Bierig: We also think there should be some operating leverage on top of that. And then in terms of buybacks. IQVIA has bought back nearly 620 million of the stock year to date, and this quarter they increased the repurchase authorization by 2 billion to bring the total to about 2.7 billion. That’s equivalent to 7 percent of the market cap.
[00:33:47] Robert Bierig: And then finally, we think they’ll be able to add a point or two to the growth rate through acquisitions. And I think one other thing is that management is comfortable. running this business at more than four times net debt to EBITDA. They’re at around three and a half times today. And I would point out that the levered buyback model tends to be an overlooked value driver at a lot of companies.
[00:34:12] Robert Bierig: We think it’s an important thing to consider here and it’s really helped grow value at companies like AutoZone or HCA or Charter.
[00:34:22] Kyle Grieve: So Bill, you’ve discussed spreads in terms of price to earnings ratios between value and growth and the S&P 500. You’ve also said that the spread currently is unusually high, which is allowing investors to make very high quality portfolio with investments that are a lot cheaper than usual.
[00:34:40] Kyle Grieve: How do you see these spreads changing as the economy normalizes in the coming years?
[00:34:44] Bill Nygren: One of the ways we look at how attractive the value opportunity is in the market is we rank order the S&P 500 companies based on their P. E. multiples. And then we look at the 50th most expensive and the 50th cheapest.
[00:35:00] Bill Nygren: And today, the 50th most expensive S&P stock sells at about 60 times expected earnings. The 50th cheapest sells at about 8. 5 times. So the multiple of the expensive stocks to the cheap stocks is about seven times. We’ve kept this data since 1990 and the average over the past 33 years has been the expensive stocks are about four times the cheap stocks.
[00:35:31] Bill Nygren: So if the 50 stocks under 10 times earnings, there’d be 50 over 40 times earnings. And it’s a pretty tight range around that four times number. Growth tends to get cheap when it’s only three times as expensive as the cheap names, and it tends to be expensive at about five times. If you go back to the internet bubble around 2000, that ratio did get to nine times.
[00:35:58] Bill Nygren: Cheap stocks were about nine times earnings then, and expensive ones were over 80 times. And that was as high as we had ever seen it. The end. What followed was one of the best multi year periods for value investing really ever. And then we saw that get elevated again in the late 2010s and then going into COVID.
[00:36:21] Bill Nygren: It spiked again, creating another really good value opportunity. Sitting at seven times like it is today, I would say this is in the 10 percent of best opportunities. For value investors and the result of that for our portfolios has been the names we’ve been selling tended to be the growthier names. We bought them opportunistically, they performed well, but now their P multiples are getting a pretty significantly above the S&P 500.
[00:36:55] Bill Nygren: And then that money is getting recycled into companies whose P. E. ratios are dramatically beneath the market. I think a lot of times you hear market commentators say, the S&P is at 18 times or 20 times earnings. And then they’ll use that as an excuse to say investors need to be unusually cautious.
[00:37:17] Bill Nygren: And the opportunity set isn’t as good as it normally is. Because over a longer period of time, the S&P is averaged more like 15 times earnings. We think that thinking about the spread gives another important piece of information. Because the history of buying stocks at single digit PEs and then patiently waiting for reversion to the mean has been very good for investors.
[00:37:42] Kyle Grieve: So many businesses in the financial sector have had their stock prices heavily punished from just being associated with collapses and banks like Silicon Valley Bank and Signature Bank, et cetera. Can you tell me where you are seeing the most value in the financial sector and other any other industries that you feel are currently heavily undervalued?
[00:38:01] Bill Nygren: Sure. And I’m sure Kyle, that the banking industry has been under pressure pretty much since the great financial crisis. 15 years ago and leads to people saying now Oakmark always loves financials. That has been true pretty much post GFC, but that wasn’t always the case. Typically, financial stocks traded at, say, two thirds the S&P multiple.
[00:38:26] Bill Nygren: We think they’re better businesses today, less risky because they have more capital, and they’re trading at eight, nine times earnings when the 20. Their discount to the market multiple is much larger than it has been historically. And we think the fundamentals would justify that discount narrow, narrowing from the historical numbers because of the risk reduction.
[00:38:49] Bill Nygren: And I think one of the most important things across the financial space, these companies used to amplify their own cyclicality by chasing revenue goals. And you’d hear all the major bank CEOs talk about how they expected to grow faster than the industry. As the economy would start to top out and they’d all be trying to grow faster than the industry, that meant lending standards had to decline.
[00:39:15] Bill Nygren: But what you see today is every major bank CEO talks about growth in terms of per share value. And they’re just as excited about putting capital to work, reducing the size of the company, the number of outstanding shares, as they are in trying to grow the scale of the business. And both, we’re equally excited about either form of growth.
[00:39:39] Bill Nygren: We like the large banks. We think they have important competitive advantages against smaller peers. Things like fraud prevention, regulatory compliance, mobilization, all of those cost only a little bit more if you’re a much bigger bank than they do for a smaller bank. So in terms of that cost relative to the assets that you have, there are tremendous economies of scale, and that’s why the big banks have been gaining share, because they’re able to offer their customers a better value proposition.
[00:40:13] Bill Nygren: So we like most of the large banks. We like a lot of the insurance companies. A name like AIG that’s been in our portfolio for a long time, again, has the great financial crisis taint to it. It sells at a big discount to book value. It’s rapidly closing the gap, performance gap between AIG and the other large insurers, yet still sells at a low PE multiple.
[00:40:39] Bill Nygren: In addition to financials we think the oil and gas industry is very cheap. Most of the U S E and P companies. Trade at single digit PEs. based on current price for oil and like the banking industry, this is an industry that’s also gotten comfortable with returning capital to shareholders. In the past, these companies would tend to take every dollar they could get their hands on and try and explore to find new oil.
[00:41:07] Bill Nygren: But as the industry has grown up and matured, they’ve come to recognize or they’ve come to accept the responsibility of maximizing per share value to shareholders. And you’re seeing them put capital to work, buying back stock, paying dividends that in a lot of cases now are above average for the S&P 500.
[00:41:29] Bill Nygren: And we also think the energy industry has kind of an ESG taint associated with it. And we expect as ESG investors become maybe a bit more nuanced in how they think about. environmental effect that the U. S. companies will fare very well with them because they’re so much more carbon efficient than the rest of the world is.
[00:41:54] Bill Nygren: There are people who are patting themselves on the back when regulations went into effect that would reduce U. S. production of oil. But then that just meant we were buying oil from Venezuela and per barrel they’re, they’re producing 50 percent more carbon than we are. So it helps the U. S. hit their goals.
[00:42:11] Bill Nygren: But in terms of the world goals, it’s, it’s a big negative. And we also saw with the Ukraine war, the advantage of being energy self sufficient and there is a tremendous social good to having some energy independence. So the executives at the oil companies are telling us they’re starting to get more thoughtful questions from the ESG community, as opposed to them just saying, no, we don’t ever want to own any other energy companies.
[00:42:41] Bill Nygren: So we think there’ll be increasing investor demand for the, these companies, and if we’re wrong, and there isn’t the tremendous cash flow will largely be coming back to shareholders. Another area that we find attractive is traditional media. You find a lot of people referring to the cable TV industry.
[00:43:00] Bill Nygren: We’d refer to it as internet service providers. The current battle we’re seeing between Disney and Charter, I think, highlights that the, what used to be cable industry, is now making almost all their money from providing internet access. And that internet access is going to be necessary for free. For work from home, for video streaming we think those companies, single digit PE multiples are deserving of infrastructure type multiples that would be significantly higher in some cases higher than the S&P 500.
[00:43:37] Bill Nygren: And then last I would mention consumer durables. There’s been a tendency of investors. To highly prioritize risk reduction in their portfolios given kind of what we’ve been through the past couple of years of highly volatile, volatile markets. It’s resulted in consumer non durables like food stocks, in many cases, selling at premiums to the S&P 500.
[00:44:01] Bill Nygren: We have a hard time arguing that those are better than average businesses, but the consumer durables, things like auto and auto related businesses. Typically sell in the mid single digit range. I think investors are thinking they are going to be disrupted by EV technology. And we think in a lot of cases, the parts companies are going to do well, regardless of how rapidly EV takes over from ICE and that a lot of the OEM companies like a General Motors are among the leaders in transitioning their fleet from ICE to EV.
[00:44:40] Bill Nygren: Again, single digit PEs, reasonable growth in business value, and a lot of capital coming back to shareholders as they’re generating more capital than they can invest. I think one other thing is investors are kind of fearful of an economic decline, got the Fed trying to reduce inflation and concern that’ll induce a recession.
[00:45:02] Bill Nygren: But if it does, this is going to be a really unusual recession for the auto industry. Because we’re already, we’re, our starting point now is about 20 percent below normal annual car sales. And that’s because of lingering supply chain issues that resulted from COVID. Those are the four areas broadly that we’re overexposed to.
[00:45:24] Bill Nygren: Most forms of financials, most forms of energy, legacy media, and consumer durables.
[00:45:33] Kyle Grieve: So you recently talked about how you utilize non GAAP financial metrics to help you make better sense of evaluation and tech businesses. You mentioned using them to help you evaluate businesses like Adobe and Uber. Can you share a little bit more about how you go about making adjustments to some of these tech names to help you get a better grasp of the true economic value of them?
[00:45:53] Bill Nygren: Sure, I’d be happy to. The two names you mentioned, even though most people would call them growth businesses, We didn’t have to do much changing to their financial statements. To highlight the value at the times we bought them. In the case of Adobe, the stock had fallen a fair amount, and then they had announced the acquisition of Figma and their stock fell by more than the entire acquisition price of Figma.
[00:46:22] Bill Nygren: It got so low. that on a year out basis, they were looking at a higher cashflow yield than the S&P 500 app. And we have always believed Adobe was an excellent above average business deserving of a premium multiple. So seeing that multiple go to a discount within a one to two year time period was pretty attractive to us.
[00:46:46] Bill Nygren: And in the case of Uber, at the time we purchased it, it had a double digit cashflow yield. Greater than 10%. Now, there are a lot of companies we’ve invested in over the years that have required us to make some adjustments to GAAP numbers. And the reason is that GAAP accounting was really designed for an industrial world.
[00:47:08] Bill Nygren: And when an industrial company wanted to grow, they’d build a new plant. And because that plant would last for 30 years, instead of that expense going through the income statement, it would go on the balance sheet, and then it would go through the income statement one thirtieth each year as a depreciation expense.
[00:47:28] Bill Nygren: And the basic message of GAAP accounting is it has to be a tangible asset to go on the balance sheet. If you can’t touch or feel it, Then it should be expense. And if you think about the businesses today that are above average growers, a lot of the expenditures that make them above average are intangibles.
[00:47:48] Bill Nygren: They’re to acquire a customer base or r and d spending, marketing spending. All of those go straight through the income statement, even though they have enduring benefits for the business. Customer acquisition costs. When we owned a database company, Gartner, they would spend to get new customers and that customer would be with them on average seven years.
[00:48:12] Bill Nygren: When they decided the opportunity was there to accelerate their expenditures for new customers, it ended up reducing earnings rather than increasing them. Re characterized that expense as a capital expenditure, went through amortizing that through the income statement over a seven year time period. And instead of Gartner looking like it was selling at twice the market multiple, it made it look like it was selling at less than the market multiple.
[00:48:40] Bill Nygren: And there is no debate about Gartner being a better than average business. Most people were talking about, did it really deserve to be at 35 times earnings? But we thought that was a case where gap accounting just wasn’t doing justice to a very high quality business. This is something we’ve done at Oakmark since our inception, early days, it was on the cable TV industry where they were spending tremendously on customer acquisition costs or on a company like Amgen that had very high R& D, but it would be something that every couple of years we’d find a company where we needed to adjust the financial statements.
[00:49:20] Bill Nygren: Today, there are probably half a dozen names in the portfolio, including our largest holding alphabet, where the headline multiple looks like it’s at a premium to the market. But after you make a few adjustments, you see that like the basic search business is actually available at a discount.
[00:49:39] Kyle Grieve: Bill, Bobby, thank you so much for joining me today.
[00:49:42] Kyle Grieve: Before we close out the episode, where can the audience connect with you and learn more about your fund?
[00:49:48] Bill Nygren: I think the best spot to learn about Oakmark is to go to our website, that’s oakmark.com, and as I mentioned early on in this discussion, we’ve put a lot of effort into trying to write quarterly reports.
[00:50:03] Bill Nygren: that really explain how we think about investing and an investor who wants to try and understand us can go to our website and read probably the past five years of quarterly reports that we’ve written. None of that gets changed. We don’t perform it for mistakes that we made back then. So you can see our comments real time about our successes and our failures, what we thought about the market, what it was causing us to do differently in our portfolios.
[00:50:31] Bill Nygren: And I think somebody who puts in the time to read those reports will come away with an understanding of how we invest that would give them the confidence to be a long term Oakmark investor, which is what we think you need to be to make a success of a long term value investing style.
[00:50:51] Kyle Grieve: Excellent. Thank you guys very much.
[00:50:53] Bill Nygren: Thanks Kyle.
[00:50:54] Robert Bierig: Thanks Kyle.
[00:50:56] Kyle Grieve: Okay folks, that’s it for today’s episode. I hope you enjoyed the show and I’ll see you back here very soon.
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