Michael Kops: Hello, I’m Michael Kops, Vice President at Heartland Advisors. I’m here with Will Nasgovitz, portfolio manager for the Heartland Value Fund.
Will, the euphoria in the market seems pretty intense. Since the election, Bitcoin jumped more than 34%. Alphabet and Apple are up double digits, and Tesla has soared over 60% since November. What do you make of this?
Will Nasgovitz: Hi Mike, thanks for having me, and thanks to all who are listening in.
It seems unstainable. And therein lies the opportunity for long-term, contrarian investors like us. By almost every measure, large-cap growth stocks are over-valued, over-owned, and come with overly lofty expectations. More than a quarter of U.S. companies, based on market capitalization, are trading at more than 10X enterprise value to sales, a level not seen since the dotcom bubble. Investor confidence is even higher than it was prior to the tech wreck in 2000.
Mike: What types of dislocations are being created as a result?
Will: One interesting area of disconnect is the Materials sector. Normally, this group moves in the same direction as Industrials, as they supply the inputs used in manufacturing. In our portfolio, Materials stocks were down 11.73% in the quarter even as our Industrials rose 13.8%.
Mike: How are you taking advantage of this discrepancy?
Will: Sealed Air (SEE), a global packager, caught our attention. After thorough research, we determined Sealed Air was mispriced by Wall Street, selling substantially below its intrinsic worth and less than half the market’s PE ratio.
Mike: For the quarter, the Heartland Value Fund was up 1.97%, while the Russell 2000® Value Index fell 1.06%. And you outperformed the benchmark over the past 1, 3, and 5 years. What do you attribute that to?
Will: Stock selection explained virtually all of our outperformance in the fourth quarter, as has been the case over the past 1, 3, and 5 years. Our selection effect was particularly strong in the Industrials, Communications, and Utilities sectors, though we underperformed in Real Estate, Technology, and Materials.
Mike: What’s something that’s setting the stock selection process apart?
Will: Our commitment to the 10 Principles of Value Investing™, along with establishing four price targets for each holding, two good and two bad. This allows us to consider how investors might value each company under different economic and market scenarios. This gives us a framework for assessing stocks should circumstances change.
Mike: Is there an example of how your four price-target approach has helped you with a specific holding?
Will: That’s a great question Mike. The four price targets help us remain patient, even under challenging circumstances. Delek (DK), an energy company whose refineries produce petroleum products for the transportation industry, is a good example.
When we moved the stock from our watchlist to the portfolio, we set a max downside loss price target of $16 a share. Since April, the stock has been cut nearly in half, amid weakening diesel demand and tighter refining margins. While we aren’t happy the stock has slid to around $17, it was an extreme valuation level that we anticipated might occur.
This allowed us to remain patient. There are signs of a recovery for trucking on the horizon, which could start to materialize in the spring or summer of 2025. Management has also been creating its own tailwind, as it is focusing on unlocking the sum of the parts of the combined company. We still believe the sum of the parts of Delek is worth substantially more than the current share price of $17.
Mike: Are there other examples that demonstrate your patience?
Will: Our patience leads us to businesses like Patterson Companies (PDCO).
Patterson is really two companies: a supply and equipment distributor for dental practices as well as for veterinary clinics. Investors have been assigning little value to the animal health portion of the business. While that segment isn’t as profitable as the company’s dental unit, it still generates over $4 billion in sales.
PDCO remaining sales are in dental distribution, which competes directly against Henry Schein. Based on enterprise value to sales, however, Patterson trades at roughly half of Henry Schein’s valuation.
In our view, Patterson shares were grossly undervalued, so we held on even as the stock lost more than a quarter of its value from January through the end of November. We were ultimately rewarded when the company was acquired in mid-December by a private equity health investment firm for $31.35 a share, representing a 36% premium.
Mike: This type of patience isn’t being embraced by most investors, is it?
Will: That’s not what most investors are focusing on today. Instead, speculation is rampant. Momentum is in.
Mike: But you don’t think that will persist forever.
Will: No. At the very least, companies with earnings yields approaching 8% or more — based on their low PE ratios — should receive increased attention in the years ahead. It’s our responsibility to anticipate those shifts and position our investors’ assets prudently to take advantage of favorable risk vs. reward opportunities.
Mike: Thanks for your time Will.