Some fund managers trade in and out of stocks frequently, making their disclosed holdings old news by the time they're released to the public. However, others tend to buy and hold and shop for long-term business quality, making their 13F filings a good hunting ground for stocks that buy-and-hold-oriented managers are buying now.
These funds and firms include SQ Advisors (led by Lou Simpson), Triple Frond Partners, and Brave Warrior Advisors, which tend to invest only their very best ideas, and concentrate their portfolios in a handful of stocks.
1. Your credit's good
Just as individuals have credit scores, companies do, too. Moody's is one of the leaders in the business. It generates about two-thirds of its revenue (about 84% of its operating income) from fees it earns by rating the debt of public and private companies.
The other third of its revenue, and about a sixth of its operating income, comes from Moody's Analytics, a line that develops and sells research, data, and software to financial institutions and risk managers. Notably, most of its sales (74%) are on subscription, resulting in generally predictable recurring revenue. Its products are also very sticky -- it reports a sky-high retention rate of 96% for its subscription products. In other words, its average customer life is about 25 years.
The true beauty of the business relies on its simplicity. As a business built on services and software, Moody's has to spend very little to grow its business. In the past 12 months, it generated about $1.2 billion in operating cash flow and spent only $84 million on capital expenditures, thus freeing the company to deploy cash to buy back stock and pay dividends. Not many companies can double revenue while repurchasing a third of their shares in a 10-year period. Moody's did.
2. Betting on brokerages
Though few large funds use brokerages like Charles Schwab, they're happy to make bold bets on a bright future for the brokerage business. Brokerages generally make money in two ways, from fees and commissions earned from customer transactions, and interest income earned by lending and investing customer balances. Charles Schwab generates the bulk of its revenue from sticky sources -- asset management and admin fees and interest revenue earned on brokerage and bank balances.
The bull thesis for Schwab largely rests on an increase in short-term interest rates, which would lift asset management fees and interest income. At the end of 2015, the company forecast that a 1% increase in short-term rates would add 8.2% of high-margin interest income to its top line.
Increasing rates would also allow it to remove fee waivers on many of its currently low-yielding funds. Schwab waived $672 million of fees for its clients in 2015. If reversed, this would flow right into pre-tax profits for the discount brokerage, growing net revenue from its asset management and administration fees by 25% overnight.
Charles Schwab is a fairly unique bet on rising rates. The Federal Reserve's rate decisions affect the brokerage more so than other financial firms because it earns on the short end of the interest rate curve. But lest you think it's all about rates, it isn't. Rising interest rates are simply the icing on top.
Schwab posted its best year since the financial crisis in 2015, earning $1.45 billion on net revenue of $6.4 billion. Those are the kind of margins investors love to see, and since most of its costs are fixed, a large share of each incremental revenue dollar goes into shareholder's pockets.
3. Banking on Buffett
There are perhaps few safer investments for fund managers than making a bet on Warren Buffett, perhaps the greatest investor the world will ever see. A number of funds increased their stakes in Berkshire Hathaway last quarter.
Though Berkshire Hathaway has simply grown too large to generate the market-thumping results of the past 50 years, it isn't exactly priced for the same performance. Berkshire Hathaway shares trade for just 1.35 times book value, having started the year trading as low as 1.2 times book value. It won't get much cheaper than that, given Buffett's intention to buy back stock when it trades for less than 1.2 times book.
Buffett's company didn't exactly have a stellar 2015. Lower gas prices hurt its car insurer, Geico, as its customers took to their cars and got in more accidents. Similarly, depressed commodity prices led to lower operating profits for BNSF, America's biggest railroad. And Buffett didn't get much help from the stock market, as two of his largest holdings, American Express and IBM, tumbled through 2015.
But to say that last year's performance is indicative of the future would be a big mistake, in my view. Investors should only be so lucky that a weak year gives them the opportunity to buy a stock at the same price the world's very best investor says is a bargain.