INVESTOR'S

GUIDE 2016

PART2

TOOLS

Going against the grain, these fund managers have outperformed their
peers with big bets on relatively few stocks. A look into these investors'
strategies and the companies they favor could pay off for you as well.
By
CAROLYN
BIGDA

+
Photographs by

MIKE
McGREGOR

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MONEY.COM

FEAR OF FAILURE drives many mutual fund managers to spread their

bets widely. Actively managed U.S. stock funds hold an average of 152
different companies, reports Morningstar. World funds, 225.
The stewards of the funds on the following pages are different. They
invest in 50 companies or fewer, following their best ideas with
conviction-and to great success. Each fund's five-year return has beaten
those of more than half the funds investing in similar stocks. For the
three funds that are at least a decade old, the same is true of their 10-year
returns. Follow the managers' advice and you may prosper too.
t

I JANUA RY / FE B RUAR Y

2 016

THE PICKS
PFIZER (PFE)
$32.25 P/ ERATIO: 13.6

MAKING ASERIOUS COMMITMENT

TO STRONG MANAGEMENT

II EXPENSES: 0.62% II MINIMUM: $500

II 5-YEAR ANNUALIZED RETURN: 12.6%
1110-YEAR: 7.0%
GROWTH OF $10.000 FOR FUNO ANO PEER GROUP

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HOMESTEAD FUNDS was founded in 1990

to manage retirement savings for
employees at some 900 rural electric
cooperatives. In that spirit of collaboration, Homestead Value's managersMark Ashton, at the helm since 1999;
Prabha Carpenter, who joined the fund

100

MONEY.COM

in 2002; and Gregory Halter, who

started in 2014-see themselves as
long-term partners of the companies in which they invest.
The trio stick to stocks of!arge
firms selling at a discount to the
value of the underlying businesses.
They also screen for earnings
growth rates in the high single
digits or better, ample cash flow,
and top brass who they believe
use resources wisely. "It's hard to
find exceptional companies," says
Carpenter, "so once you do, you
take a reasonable position."
One area the Homestead team
likes is pharmaceuticals, which
make up five of the fund's 49 current holdings. Big drug companies,
says Carpenter, are rolling out new
medicines but are not as expensive
as their biotech peers. The managers' instincts have often been correct. Homestead Value ranks in the
top 20% of its category for one-,
three-, five-, and 10-year returns.

JANUARY / F EBRU A RY 2016

In recent years big

pharmaceutical firms
have been hurt by patent
expirations of popular
prescription drugs. But
Carpenter says Pfizer is
replenishing its portfolio
with smart acquisitions,
like its intended merger
with global pharma
company Allergan.
Pfizer could face political
fallout for its plans to
move to Ireland for a
lower tax rate. But if the
merger goes through,
the company will have
more than 100 medica
tions in mid- to latestage
development. Pfizer's
forward price/earnings
ratio is just 13.6, vs. the
average 16.5 for large
drug companies. And the
stock has an attractive
dividend yield of 3.5%.

BANK OF AMERICA (BAC)

$17.00 P/E RATIO: 10.9
Bank of America has
been digging itself out
from under the housing
market mess-and
making progress. In the
third quarter of 2014 the
bank set aside $16 billion
for litigation expenses
related to the financial
crisis. One year later
the bank needed less
than $1 billion to cover
such costs. Meanwhile,
demand for its products

is growing. From July to

September, mortgages
and homeequityloan
originations expanded
13% from the year
before, to $16.8 billion.
And non interest income
rose 2%, to $11.2 billion.
The stock trades at just
one times Bank of
America~ tangible book
value (assets that would
remain if the bank had to
liquidate). Says Carpen
ter, "That's a very
reasonable valuation."

HONEYWEll
INTERNATIONAL (HON)
$102.00 P/E RATIO: 15.7
For earnings growth and
good valuations, Carpen
ter says she and her
co-managers "love the
industrials; especially
Honeywell, which makes
everything from home
security systems to
airline parts. CEO David
Cote says he wants
Honeywell to be the
Apple of.industrials, and
in 2014 the company
launched an initiative to
make products. like the
Lyric smart thermostat.
attractive and.easy to
use. The efforts are
paying off: Analysts
expect Honeywell's 2016
earnings to hit $6.51 a
share, up 6.7%. At the
same time, the stock
trades below the S&P
500's PIE of 17.4.

NOTES: Stock prices. PIE ratios (all of which are forward looking). returns. and yields are as
of Dec. 9. 2015. Growth of $10.000 is as of Nov. 30. 2015. SOURCES: Morningstar. Thomson Reuters

,J, I

PICKS FROM THE PROS

FOCUSING ON EARNINGS GROWTH

AMONG UNLOVED STOCKS
BILL NYGREN AND DAVID HERRO

GROWTH OF $10,000 FOR FUND ANO PEER GROUP

OAKMARKGLOBALSELECT (OAKWX)

II EXPENSES: 1.13% II MINIMUM: $1,000 II 5-YEAR ANNUALIZED RETURN: 10.4% 1110-YEAR: N.A.

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FREE TO INVEST in thousands of

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companies worldwide, Global Select has remarkably few holdings

at any given time: about 20 stocks.
More impressively, Global Select
has beaten two-thirds or more of
its peers in seven of the past nine
years (it launched in 2006).
To make their selections,
managers Bill Nygren and David
Herro look for stocks selling at a
steep discount to the price they
believe a buyer expecting a reasonable return would pay for the
company. The managers
also screen for firms that
have a combined earnings growth rate and
dividend yield that's at
least equal to the market's average (about 7%
today) and management
teams focused on pershare growth.
The fund is currently
invested about 40% in
the U.S. and 60% abroad.
Low interest rates, slow
growth in emerging
markets, and the strong
dollar are overall headwinds. But looking out
over the next three to
five years, the managers
aren't worried. "We don't
think these trends should
persist," Nygren says.

will improve. In fact, analysts

estimate that profits will
jump 19.5% in 2016.

THE PICKS

AMERICAN INTERNATIONAL
GROUP (AIG)
$62.25 P/ ERATIO: 12.1

Since AIG's 2008 government

bailout, the global insurer
has shifted priorities. In place
of growth at any cost, AIG is
getting leaner. In October, for
example, it said it was pulling
back in Central America and

Japan. The trimming, says

Nygren, should improve the
company's return on equity
(a measure of profitability).
AIG's stock trades at an
inexpensive 80% of book
value (a company's net
worth). As the legacy of AIG's
bad business continues to
fade, Nygren says earnings

OAIMLER (DDAIY)
$84.25 P/E RATIO: 10.6

Volkswagen's emissions
scandal and slow growth in
emerging markets weighed
on stocks of auto companies
in 2015. But Nygren says that
Germany's Daimler is resilient.
Third-quarter sales of its
Mercedes-Benz cars rose 18%
from the year before, thariks
in part to strong U.S. demand.
And cost cutting helps: From
January through September,
earnings per share rose 13%
year over year.

TE CONNECTIVITY (TEL)
$84.25 P/E RATIO: 15.3

Nygren likes the oftoverlooked TE Connectivity,

which makes sensors and
connectors used in cars,
industrial products, and
communication systems. in
2015, TE sold a subsidiary for
$3 billion, earmarking almost
all of that for stock buybacks
to boost earnings per share.
And demand is rising. TE
forecasts 2016 automotive
sales up 3% to 5% (ignoring
exchange rates).

MONEY.COM

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1ill

INVESTOR'S
GUIDE 2016

PART2
TOOLS

FINDING BARGAINS IN ENERGY

STOCKS AND INDUSTRIALS
JOHN ROGERS AND TIMOTHY FIDLER

GROWTH OF $10.000 FORFUND AND PEER GROUP

ARIELAPPRECIATION(CAAPX)

II EXPENSES: 1.12% II MINIMUM: $1 ,000 115-YEARANNUALIZED RETURN: 11.3% 1110-YEAR: 7.7%

REBULAR READERS of MONEY

need no introduction to
Ariel Appreciation, a longtime member of the
MONEY 50, our list of top
mu t u a l a nd exchangetraded funds (see page 104).
John Rogers, in charge since
2002, and co-manager Timothy Fidler, who joined the
fund in 2009, invest in the
stocks of 25 to 45 midsize
companies. The fund's fiveyear return beats those of
more than 70% of its peers.
To execute their winning
formula, the managers buy
when shares trade at a 40%
discount to their estimate
of a firm's private market
value, or the price a business
would fetch if put up for sale.
And though the bull market hits its
seventh anniversary in March, the
two say they have no trouble finding bargains. "There is still a lot of
pessimism out there keeping stock
prices down,'' Rogers says.
Industrials and energy are two
sectors where the mood has been
particularly gloomy-and where
Rogers and Fidler are hunting.
"You hear talk of an earnings recession in industrials and the distress in energy," Fidler says. "But
within those sectors are names
worth owning."

102 1

MONEY.COM

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like drill bits and blades,

have fallen 51% since
December 2013. a result
of low commodity prices:
of the firm's sales. 44% are
to mining and energy firms.
Kennametal was run inefficiently, says Fidler. operating too many factories. But
under a new CEO, the
company is slimming down.
The managers value the
stock at $36-a conservative figure. says Rogers.
given the potential for
bigger profits. especially if
industrial spending picks up.

KKR & CO. (KKR)

$15.75 P/ ERATIO: 6.1

THE PICKS
BRISTOW GROUP (BAS)
$26.50 P/ ERATIO: 10.1
You need to believe in an
oil-price rebound to invest
in energy firms these
days-but not so to buy this
stock, say Rogers and Fidler.
Bristow flies helicopters
for the global offshore oil
industry, taking workers
to and from rigs. Clients
have cut spending, but the
company gets 60% of its
contracts' value even if its
helicopters don't fly. And
Bristow is reducing its

reliance on the energy

market: It recently agreed to
provide civilian search-andrescue services for the U.K.
Analysts expect profits
to rise 33% in the fiscal
year ending March 2017.
but Fidler says Bristow is
already a deal: "The market
value of their helicopter
fleet alone is $50 per share."

KENNAMETAL (KMT)
$25.75 P/ ERATIO: 15.0
Shares in Kennametal, which
makes small industrial parts

As money flows into alternative investments, KKR.

a private equity firm with
$98.7 billion in assets. can
benefit. Investors worry that
it's getting harder for KKR
to find bargain companies
to buy, but Rogers counters
that it has diversified with
international and real estate
funds. It's also returning
cash to shareholders. Last
year, KKR (a master limited
partnership whose dividend
is called a distribution) said
it would pay $0.16 per share
quarterly starting at the end
of 2015, for a current annual
yield of 4.1%. Rogers says
the stock is worth $30.

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PICKS FROM THE PROS

THE PICKS
TJX COMPANIES (TJX)
$70.75 P/E RATIO: 19.6

TRACKING BIG TRENDS THAT

BENEFIT CONSUMERS
firms that are leaders in their markets and add value to customers'
BUFFALO LARGE CAP (BUFEX)
lives. "You have the wind at your
back when a product is a good deal
11 EXPENSES: 0.96% MINIMUM: $2,500
for a customer," she says. Jones
11 5-YEARANNUALIZED RETURN: 12.3%
also favors companies that can
1110-YEAR: 7.8%
generate impressive returns on
their investments and build their
GROWTH OF $10.000 FOR FUNO ANO PEER GROUP
business in North America, where
she believes economic expansion
l lll~1t:I'Jii!! ll is sound. And overarching everything are 26 long-term growth
trends that guide all investment
decisions at Buffalo Funds, from
changing demographics to health
care co~s. "By focusing on these
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'1 5
trends, .ve'll hopefully be invested
in companies that are less impacted
ELIZABETH JONES, who joined Bufby business cycles," Jones says.
falo Large Cap in 2007, buys stocks
So far the approach is workof large companies with strong
ing. Jones owns stocks of no more
growth potential, using a strategy
than 45 companies at a time, and
the fund's five-year return beats
that she has fine-tuned in recent
years. For one, Jones screens for
those of 53% of its peers.

ELIZABETH JONES

SEND COMMENTS ON THESE PROS' PICKS TO letters@moneymail.com.

IC3J

Online retailers threaten

the business of department stores. But Jones
says TJX, owner of
off-price retailers such
as T.J. Maxx and Marshalls, is well protected.
"People like to buy name
brands at a discount and
in real time," she argues.
Home products make
up as much as a quarter
of revenue, and TJX
has benefited from the
housing market recovery. Analysts forecast
profit growth of 10%
in 2016, compared with
mid-single-digit growth
at best for other department stores.

CHIPOTLE MEXICAN
GRILL (CMG)
$548.00 P/ ERATIO: 32.2
This chain's stock fell
hard in 2015, a result of
slower same-store sales
growth and an E. coli
outbreak. But Jones says
people still want to eat
healthy, and Chipotle,
which touts organic
ingredients and responsibly raised meats.
feeds that demand.
As for growth,
Chipotle could as much
as double its store count
in the U.S., says Bradley
Angermeier, a Buffalo
analyst. The impact of E.
coli on sales will go away

in ayear at the latest, he

thinks. Plus, the company is "just beginning
to dip its toe overseas;
he says. Its 22 restaurants outside-the U.S.
represent 1% of Chipotle's total locations.

AKORN (AKRX)
$35.75 P/E RATIO: 15.2
Last year this generic
drug maker revealed it
had overstated 2014
revenue and pretax
income by about
$35 million-a discrepancy linked to drugcompany acquisitions.
Akorn's stock is down
37% since then. Anew
chief financial officer
joined in October, but a
corrected 2014 report
won't arrive before
March. That makes the
stock a risk, but Jones
notes that Akorn has
not restated its cash
balance-a better indication, she says, that its
business is sound.
Akorn specializes
in producing generic
versions of hard-tomake drugs, and
prospects are good.
Last year. Akorn got the
. government okay to sell
11 new drugs, and the
company has another
78 products awaiting
approval. Analysts
expect earnings to
jump 21% in 2016.

MONEY.COM

1103