Part V: My Favorite Mistake, and 5 Stocks for the Next 10 Years
TMF: Spanning your career, is there any one company that stands out in your mind that you still kick yourself today over not purchasing, where everything made sense to you, but for whatever reason, you didn't go with it? Warren Buffett talked about how he didn't buy Wal-Mart (NYSE: WMT ) in mass quantities five years ago.
Nygren: Warren's my hero, so let me use the same stock. I think it was the CFA-1 exam essay question, probably June of '82: Which company would you rather purchase, Kmart or Wal-Mart? And it went through all the fundamental statistics for both companies. Being a budding value investor, knowing myself at that time well enough to know that value investing was what made sense to me, I thought it was the easiest question I'd seen on the exam. Explaining why the stock that sold below book value at a low P/E with a higher yield was better than a company that was in the same business but was very expensive on a valuation basis. Like I said, it was a no-brainer.
Fortunately, they don't come back with 20 years of hindsight and take the CFA designation away from you because you completely missed the boat on that and did not understand that, despite it's small size, Wal-Mart's culture of focusing on expenses was giving them a competitive advantage that was going to allow them over time to put their biggest competitor out of business. And market by market, they made Kmart face the decision of do we cut prices enough so that we don't make money or do we let Wal-Mart slowly take market share.
I think that lesson that structural advantages exist, they last for a long time, and they can make you very wrong in intra-industry comparisons is something that I still frequently think about. When we were talking about First Data (NYSE: FDC ) , when we were first investing in that, I remember our analyst went through why First Data looked cheap relative to its comparables. And as its comparables, he had listed all the smaller companies in the same business segments as First Data was in. Western Union is in the money transfer business. They're in credit card merchant processing and then credit card-like back-office processing.
And the whole argument at the time he was recommending the stock was it was undervalued by enough that we should be buying it and talked about the great competitive advantages First Data had in each of these businesses. And then in the comp sheet, he was showing First Data was cheap vs. these others, but the comp was vs. companies that they were slowly putting out of business. I remember the discussions we were having about it, of is this really the right comp list, because it's going to make First Data look expensive with a relatively small move in the stock price.
But qualitatively, you're talking about why First Data is a much better business than all of these comparables, yet you're not reflecting that in your numbers. It's the kind of discussion we often have of maybe the comp set shouldn't be the companies that your target company is slowly putting out of business. Maybe it should be companies in other industries that have a similar competitive advantage. I think that's how you could have realized Wal-Mart was cheap, even though it had a higher P/E than the other retailers. It's how you could realize First Data was cheap, even with a P/E that was similar to other credit card processors and money transfer firms. Anheuser-Busch does not look especially cheap vs. other brewers. On the other hand, Anheuser Busch is gaining market share every year, so it's probably not the right comparison.
For a value investor, having the right comparable group is so important to demonstrating whether the company you're looking at is cheap or expensive. And I think it's often trickier than just looking at the other companies that sell the same product that they do. And that Wal-Mart/Kmart example is so important to me, not just because I got it dead wrong and shy in magnitude when you have one company go up a hundred-fold and the other one go bankrupt. It's not just the magnitude of that mistake, but it's how that same lesson translates to so many investment situations today.
TMF: Let's just say you have evolved quite a bit since you sat down to take that CFA test in '82.
Nygren: That's correct.
TMF: It would probably be a dream come true for you: A major league baseball team calls you tomorrow, and they want you to sign on as a player, but they need your commitment for 10 years and you're going to have to give up the investment biz. Before you start playing, you put your money in five stocks, not to be touched for 10 years. Which stocks are they going to be?
Nygren: If they've seen me play softball this season, that's not happening. Buy five stocks for 10 years and why. When you talk about a 10-year time horizon, the characteristics of the business begin to overwhelm the gap between business value today vs. price today. So I would want to focus on companies where I believe there was a competitive advantage, either through cost structure or brand -- that there is some reason to think that I have more confidence in their earnings outlook than the average business.
With that in mind, I would take Yum! Brands (NYSE: YUM ) . Three very strong franchises. Great global opportunities. A management that gives extremely candid assessments of their performance. Anyone who has not read the Yum! Brands CEO letter to the shareholders in the annual report -- I commend that as an example of one of the best-written letters I've read from a CEO. I like how they invest their excess cash flow. It's a business where, I think, great change in the leaders is unlikely over the next decade. It's very likely 10 years from now that McDonald's (NYSE: MCD ) , Taco Bell, Pizza Hut, KFC, are all still very strong brands. Wish they had McDonald's. The last three are all theirs.
I would take First Data. I think the bulk of the value there is in the Western Union business. It has a competitive advantage because of the distribution network that it has and how many more locations a Western Union transfer is available. I think it's very likely over the next decade we will see a continuation in the growth of people working outside of the country where their family lives. And the demand for international wire transfers ought to grow much more rapidly than the average business.
Time Warner (NYSE: TWX ) . Love the strength of their media portfolio. They run good cable systems, which is a big piece of the value. But also on the cable programming side, with assets like HBO. I think Dick Parsons is a great CEO who is restoring a sense of pride, a focus on corporate goals rather than ego-driven goals that is very healthy for the organization. As I mentioned earlier, AOL is being priced as a cheap option and I think has a better chance of succeeding over a decade than most people give it credit for. That was three of my names.
I'd pick Washington Mutual (NYSE: WM ) . I think they have a great model for retail banking growth. I think over the next decade they will achieve their goal of becoming a dominant, nationwide retail bank to the middle class. You're starting at a very low price there, with a high dividend yield and growth in retail banking that's far above average. It's been obscured by mortgage banking, but as each year goes by, retail banking's importance vs. mortgage banking -- that gap is going to widen. And one more?
TMF: Or if you're comfortable putting your money in four, we can leave it there.
Nygren: Oh, give me a chance. I might as well pick a fifth name. Moody's (NYSE: MCO ) . I think Moody's is one of the greatest businesses we have ever analyzed. It has great cash flow. It's basically a duopoly. It participates in growth of worldwide need for debt, and we think that will continue to grow. The business has basically no reinvestment needs. It has a smart management team that is willing to use that cash flow to shrink the equity. So I think the combination of comfort in the industry growth, that their share will stay as strong as it is today, and the management's smart use of excess cash flow makes that a decade-long hold.
TMF: Now Moody's was spun off from D&B, right?
Nygren: That is correct.
TMF: Is that what had initially attracted you to D&B?
Nygren: Well, we were attracted to D&B around the time of the trivestiture, I think they called it when D&B split off from Cognizant and A. C. Nielson. So they split old D&B into three pieces. We thought D&B had great assets. New D&B on both sides of the business: the Moody's side and the credit reporting side. We had not been fans of prior D&B management and had felt that the trivestiture would free Dun & Bradstreet from the corporate management that we'd not been enamored with. We were early on it and needed one more management change to see the value of the assets come through. D&B became one of our only examples of becoming active in trying to see a corporate structure changed. Because we thought the stock was so cheap, it's one of the few times that we thought there was enough return in trying to change things, as opposed to selling it and buying something else that was cheap.
We ended up keeping both sides of it: the Dun & Bradstreet side and the Moody's side. Still have both holdings today. Very pleased with the job John Rutherford has done on the Moody's side. And Alan Loren -- the job that he did coming out of AmericanExpress and taking over the credit reporting side of the business. Both those guys have done a great job. Both those guys got great assets and they have done a great job of letting the value of those assets come through to the shareholders.
TMF: I've got one last question, and it's an important one. You're in the Chicago area, I'm in the Chicago area. Cubs or White Sox?
Nygren: The easiest one you've asked all day. I grew up a Twins fan, so cheering for the White Sox would be so difficult. My dad was a Cubs fan, so my National League team even before I moved to Chicago was always the Cubs. I am complete Cubby blue.
TMF: Thank you so much for talking to us today.
Nygren: You're very welcome.
To read more about Bill Nygren's views on investing and the market, see the interview series:
- Master Value Investor Tells All
- Is Time Warner Undervalued?
- Why This Value Guru Sleeps Well
- Nygren's Master List
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