Why a high-value fund loves homebuilders, REITs, and oil stocks


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Cole Smead, left, and his father, Bill Smead, co-manage the Smead Value fund.

Photograph by Cassidy Araiza

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Millennials buy homes and have children later, demonstrating far different priorities and challenges than the baby boomers who raised them. But Smead Capital believes this generation has more in common with their parents than they want to admit.

“We have a vision of what the next five to 10 years will look like, and the dominant factor is what is happening as millennials continue to marry, start families and buy homes,” Bill said. Smead, 63, founder of the company. .

The father-of-five has seen this pattern play out with his own grown children and their friends, but to find out firsthand how this thesis is going, Smead can ask his second oldest, Cole, who sits directly to his left. In 2007, Cole helped his father launch their value-driven fund store, and in 2014 he joined his father and co-manager, Tony Scherrer, to manage the company’s flagship product, valued at $ 3.1 billion.


Smead value

funds (ticker: SMVLX).

The Smeads have their differences when it comes to vacation ideas (Bill thinks Cole’s travels are too exotic) and the greatest baseball players of all time (Bill says Willie Mays and Cole says Ken Griffey Jr.). But when it comes to investing, young Smead is very much in his father’s strategy to buy businesses that customers can’t live without, while investors don’t want anything to do with them. If the thought of buying a stock makes you uncomfortable, “you should probably buy,” says Cole, 37.

The fund, which typically holds 25 to 30 US stocks, tends to see more than its share of volatility. For investors who have held their own, however, the payoff has been 17% average annual returns over the past decade, better than 99% of the fund’s high-value peers, even after factoring in an expense ratio. high of 1.26%.

To remove emotion from investment decisions, the Smead team uses eight criteria, starting with five that are non-negotiable: companies must meet an economic need; have a distinct competitive advantage and a track record of profitability; generate free cash; and are traded at a significant discount to their intrinsic value. The team also takes into account the health of a company’s balance sheet, its history of shareholder-friendly decisions and strong insider ownership.

Homebuilders have been a staple of the fund since late 2013, when it became clear that demand for millennials would significantly outstrip supply. “The number of homes built in 2011 on an absolute basis was 40% lower than the worst calendar year in the previous 60 years,” said Bill Smead. He bought shares in


NVR

(NVR), the parent company of Ryan Homes, for $ 940 that year; the stock recently traded around $ 5,200. The fund added


Lennar

(LEN), recently valued at nearly $ 108, for $ 47 in 2016. At the end of February 2020, as the Covid-19 pandemic caused the early stages of a massive sell-off in the market, the Smead team picked up


DR Horton

(DHI) about $ 57 per share. It recently traded at around $ 93.

In addition to demand exceeding supply, says Bill Smead, large home builders have the advantage of scale, especially when dealing with supply chain issues, in what is otherwise a very large industry. fragmented. “DR Horton says he will build 10% of all homes in the United States this year,” said Elder Smead, who believes the industry is on the cusp of consolidating, which will pave the way for higher profits and multiples of actions.

Total return
1 year 5 years 10 years
SMVLX 55.9% 17.8% 17.2%
Russell 1000 Value Index 31.0 11.7 13.0
Top 10 holdings
Company / Teleprinter % of net assets
Continental Resources / CLR 8.5%
American Express / AXP 6.0
Target / TGT 5.8
Lennar / LEN 5.2
NVR / NVR 4.9
Simon Real Estate Group / SPG 4.7
Macerich / MAC 4.7
ConocoPhillips / COP 4.6
eBay / EBAY 4.6
JPMorgan Chase / JPM 4.5
Total: 53.5%

Note: Assets as of September 30. Returns until November 15th; the five and ten year returns are annualized.

Sources: Smead Capital Management; The morning star

Along with the increase in home purchases comes an increase in foot traffic in lifestyle centers offering restaurants, entertainment and retail.

“I feel bad for the hedge funds paying millions of dollars for research to fly helicopters over shopping mall parking lots as I walk home and talk to my wife,” says Bill Smead, who describes his wife as a prolific shopper and trendsetter. .

Millennials may be more prone to point and click for basic necessities, but investors have been too quick to write the obituary in malls, he says. This thesis prompted the fund to buy


Macerich

(MAC), which is considered one of the best mall operators in the industry, in July 2019 at around $ 33 a share. When the pandemic sent


Simon Real Estate Group

shares (SPG) tumbling in March 2020, the Smead team noted that CEO David Simon and other insiders were buying, so the fund bought shares in the largest retail real estate investment trust at $ 57 per action.

As demographics drive demand for housing and commercial real estate, rising inflation makes land, and particularly land rich in natural resources, all the more valuable. This is just one of the reasons Smeads like energy stocks, which represented 20% of the fund’s assets at the end of September.

After a long hiatus in energy stocks (the fund last held the sector in 2010), managers bought


Western Oil

(OXY) in 2019, but sold it at a loss in 2020, as concerns over its debt-funded acquisition of Anadarko and falling oil prices sent its shares into the teens. The fund used the harvest of tax losses to replace this position with


Chevron

(CVX) at $ 109 per share, then added


Continental resources

(CLR) in August 2020 at less than $ 19 per share, followed by


ConocoPhillips

(COP) in October 2020 at around $ 33. All three stocks have since won.

As the Smeads’ conviction about oil grew, they used Warren Buffett’s turn on a Mae West quote – “Too many good things can be wonderful” – and redeemed Occidental in July of this year, amid the 20s. Buying it back for a higher price was “one of the hardest things I’ve ever done,” says Bill Smead. Yet what played against the West in 2020 – its debt – could work in favor of investors. “In a few years, they might be able to buy back their bonds at a lower price and higher oil prices,” says Cole Smead.

Smeads, of course, are aware of the growing pressure to replace fossil fuels with clean energy. Cole Smead postulates that energy companies could eventually be leaders in carbon sequestration, but they say the energy transition will take much longer than current multiples suggest. “I was 10 years old when the US government banned tobacco ads from television,” says Bill Smead. “Guess what has been the best performing stock on the New York Stock Exchange over the next 40 years?


Philip morris
.

E-mail: [email protected]

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