In addition to his roles as chairman and chief investment officer of the $692 billion asset management firm T. Rowe Price, Brian Rogers (Trades, Portfolio) manages the T. Rowe Price Equity Income Fund (PRFDX), an income and value-oriented strategy. Read more about him here.
Brian recently took investing questions from GuruFocus readers. Below are his answers.
Question 1: How did you get into investing? Who influenced you the most?
My first job in the late 70s was at Bankers Trust in New York, where I was trained as a financial and credit analyst. Later, at Harvard Business School, three professors – Bill Fruhan, Norman Bartczak, and Jay Light – influenced my thinking when it came to the investment field. Another important influence was David Dreman (Trades, Portfolio), who wrote several books on contrarian investing 30+ plus years ago. The concept exposed by Graham & Dodd of buying assets at 50 cents on the dollar made a lot of sense. In my early days at T. Rowe Price one of the investors I watched most closely was the legendary Windsor Fund manager, John Neff.
Question 2: If you were managing small amounts of money, what are the things you would look at? What is your valuation approach and what do you consider when forecasting earnings? What would you recommend that the investor do in order to hedge their portfolio and buy insurance at a reasonable cost and in a relatively simple way?
The challenges of investing small amounts of money are essentially the same as those investing larger amounts of money. Your liquidity needs are less demanding but the challenge of making the correct investment decisions is the same. I encourage investors to focus on transaction costs and to think about tax consequences. My basic approach is to invest in companies with good records when they are out of favor. I employ a number of valuation techniques to identify valuation anomalies, and I am always interested in companies whose earnings, cash, and dividend streams are selling at attractive levels relative to their histories. I am a contrarian and think that Warren Buffet’s advice -- “be greedy when others are fearful; be fearful when others are greedy” -- is something for all investors to keep in mind. In terms of hedging portfolio exposure, I would say it is very difficult to make consistently correct market calls. Consequently, my focus has always been on investing in good companies at attractive prices. If a stock’s valuation is compelling, in and of itself, that’s a hedge. There are ways to reduce portfolio volatility. Some investors engage in covered call writing, which can reduce volatility and boost income. You can also buy puts to limit downside risk, although this can be expensive. I think the best approach for the individual investor is to focus on diversification as a way to reduce risk.
Question 3: If you were managing a stand-alone hedge fund, would you manage the market exposure of the portfolio according to the general level of the market (according to the Schiller P/E, for example) or according to how many individual ideas you were able to find? Could you share your current opinion about the macro picture for the next five to 10 years and how you incorporate it or not into the construction of your portfolio?
Assessing market conditions and the appropriate level of market exposure is the investor’s ultimate challenge. I compare expected returns on different asset classes and try to make a seasoned judgment about where relative values lie. For example, in today’s world the expected return on fixed income securities is somewhere in the 3% range. Expected returns on cash are south of 1%. Expected returns on equities are likely to be in the 6-9% range. Each investor has to decide whether it makes sense to assume the risks of equity investing in an effort to earn higher returns.
I would point out that after the strong market advance over the last five years, there are fewer bargains in the market. While the overall market is reasonably valued, investors should steer clear of the more exuberant market sectors such as bio-tech and social media, where behavior, in my opinion, is similar to what we saw in 1999 and 2000. In terms of the macro outlook for the next five to 10 years, inevitably we will have good periods, a mild correction or two, and probably one bear market. In the meantime, valuations are generally reasonable, global central banks are in an accommodative mode, and moderate global economic growth is likely.
Question 4: How much cash do you take in your fund? Is the cash position stable or do you tend to build up cash while the market becomes expensive? Also, how is your current personal private asset allocation (percent cash and cash equivalents, percent bonds, percent equity, percent alternative)?
The cash position in my fund is currently about 7%, which is up from 3-4% a year ago. It seems to me that there are fewer compelling opportunities today. Price earnings ratios are somewhat higher and our investment analysts have fewer buy rated recommendations. In my opinion there are more stocks to sell than there are to buy today. In terms of my personal asset allocation, I do not practice what I preach when it comes to the benefits of diversification, as 80% of my net worth is in T. Rowe Price stock. Ten percent is in our cash and fixed income funds and ten percent is invested in several T. Rowe Price equity funds, including the Equity Income Fund.
Question 5: AT&T (T) appears to be much cheaper than cable stock competitors. Do you think this is warranted? How will the spin-off GE (GE) is doing improve its P/E multiple? Any target? What is a fair value P/B over the next few years for large cap banks like Wells Fargo (WFC), Bank of America (BAC), or U.S. Bancorp (USB)? You are not a concentrated investor. Do you think investors who are very concentrated with 10 to 20 stocks are fooling themselves into thinking they can ever know all the risks of a stock?
A couple of specific stock comments. AT&T has been a bit of a laggard. I view its 5.2% dividend yield as very safe, so you can look at AT&T as a fixed income proxy. It sells at 12 or 13 times earnings, which is a discount to the market but, of course, the company’s earnings growth is modest. AT&T is a good source of stable income and has a moderately growing dividend. In terms of General Electric, the planned spin-off of some of its financial services businesses will likely raise its price earnings ratio, since financial businesses usually sell at lower multiples than industrial businesses. GE was a good stock for us in 2013 but it has lagged in 2014. I think it sells at a reasonable valuation. Of the three banks you cite, the one with the most upside is probably Bank of America, which sells at below book value. Wells Fargo and U.S. Bancorp have been very strong performers and sell at premiums to book, so I would expect them to have less upside than Bank of America in the intermediate term. In terms of your question about portfolio concentration, I admire investors who hold 10-20 stocks because they have tremendous conviction. I manage the T. Rowe Price Equity Income Fund in a more diversified way. I think either approach makes sense if it works for the portfolio manager. Anyone who thinks they know all the risks of a stock is fooling himself or herself, and that applies to portfolios with ten stocks as well as portfolios with several hundred stocks.
Question 6: I own T. Rowe Price Group Inc. (TROW) shares, so keep up the good work! Can you provide some color on your sell discipline? How do you think about portfolio turnover and position sizing? Thanks.
In terms of sell discipline, I focus on companies whose prices have increased to the point where their relative P/E ratios are selling at higher-than-average levels and whose relative dividend yields have declined to the point where the company no longer looks inexpensive. In terms of portfolio turnover, I believe less is better. Lower turnover saves money. When I make an investment in a company I intend to hold it for a minimum of several years. In terms of position size, we have approximately 115 holdings in the portfolio today, with our core holdings representing between 1-3% of portfolio assets. Roughly 20 of our holdings are either positions we are beginning to accumulate or small positions we have not yet finished selling.
Question 7: When you are considering adding a stock to your portfolio, how do you balance between the stock’s performance and the dividend performance? How much weight do you give to dividend performance and what are some of the guidelines you use to make your final decision to buy or pass on a stock? Do you consider the high-yield dividend stocks at all?
When we make a new investment we are interested in both capital appreciation and an attractive and growing dividend stream. The total return from an equity investment, in simplest terms, approximates the dividend yield plus the company’s growth rate. Over the long term, the contribution of dividends to the total return of an investment is significant. Of our 115 portfolio holdings, about 110 pay dividends. In terms of the highest dividend yielding stocks, our experience has been that those companies with the highest yields often end up cutting their dividends, so we are naturally suspicious of the highest yielders.
Question 8: In the last months we saw quite a few ups and downs in the price of gold. Which miners would you prefer? And from which miners would you stay away?
With respect to gold stocks, the price of gold declined sharply in 2013 and gold stocks declined even more dramatically. In the Barron’s Roundtable interview I was part of earlier in 2014, I mentioned gold as an out-of-favor sector and Newmont Mining as one of my recommendations for the coming year. Newmont is attractive because relative to many gold companies, it is a relatively high-quality company. When you are contemplating investing in gold I would really pound home the message that you should diversify into a handful of companies. A basket of stocks such as Newmont, Goldcorp, Agnico Eagle Mines, and Barrick Gold could be worthy of a look. In terms of oilfield service companies, I have investments in Schlumberger and Diamond Offshore, which represent two very different types of investments in the oil services sector.
Question 9: What are a couple of good dividend-paying (and dividend-growing) companies that you would recommend buying now as a long-term investment (10 or more years)? If you could recommend one investing-related book or newsletter, what would it be?
Several of our holdings in T. Rowe Price Equity Income Fund meet your criteria and can be found on the S&P list of “Dividend Aristocrats,” which recognizes companies that have raised their dividends in each of the last 25 years. I’d mention Chevron (CVX), Clorox (CLX), and Stanley Works (SWK) as three companies that might fit the bill. On investment-related books and newsletters, I find the S&P Outlook to be helpful and, of course, I couldn’t live without Value Line. For interesting investment books, I really enjoyed Value Investing: From Graham to Buffet and Beyond by Columbia professor Bruce Greenwald. The Little Book of Value Investing by Christopher Brown is a short and interesting read.
Question 10: What are some areas of the market that you view as being inefficient (or, at least, less efficient) because of institutional restrictions (e.g., limited mandates, size, etc.) and might allow the diligent individual investor to outperform? If so, could you elaborate? What are your thoughts on portfolio concentration, given that this issue seems to divide many in the investment community?
While many argue that U.S. and developed markets are relatively efficient, I believe that investors overshoot on both the upside and the downside when it comes to how they value companies. Investors have a historical tendency to overpay for growth and certainty and to avoid stocks characterized by controversy and uncertainty. There are pockets of inefficiency which arise due to a range of behavioral patterns. I also believe that many investors have a very short-term time horizon and that, if you adopt a longer-term view, you are doing something very different from other investors and may benefit accordingly. There are many inefficiencies in markets outside the U.S., notably in emerging markets, and in certain sectors of the fixed income market, such as the high yield sector. The municipal bond market also can have inefficiencies that investors can capitalize on. Regarding portfolio concentration, I’ve seen great investors such as Mason Hawkins (Trades, Portfolio) and Staley Cates manage highly concentrated portfolios successfully and, of course, the legendary Peter Lynch managed a fund with hundreds of holdings. There is no right answer on the correct number of portfolio holdings. It’s what works best for the individual.
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