High-Quality Stocks on Sale

Every investment has its season. During the 2008 meltdown, Treasury bonds offered the only safe harbor. Last year, gold was a big winner.

Today’s most attractive opportunities lie, in my view, in high-quality, blue-chip stocks. I’m talking about companies that have demonstrated steady earnings and sales growth, boast competitive advantages over rivals, hang tough during economic slowdowns, and have little or no need to borrow money and often pay a dividend.

Here’s the surprise: On average, the stocks of these best-in-breed companies are trading at about the same multiples to earnings, sales and assets as lower-quality, riskier fare. That’s why I believe that blue chips, out of virtually all the stock categories, offer the most potential to improve your personal bottom line.

But don’t take my word for it. Listen to Donald Yacktman, who has been managing money for 42 years. Yacktman, co-manager of Yacktman Fund (symbol YACKX) and Yacktman Focused (YAFFX), doesn’t always load his two funds with blue chips such as Coca-Cola (KO), PepsiCo (PEP) and Pfizer (PFE). But those are the kind of stocks he prefers, and he now has almost all the $3 billion he manages in blue chips.

“For what you’re getting, high-quality stocks are clearly cheaper than the rest of the market,” says Yacktman, who shares management duties with his son Stephen and Jason Subotky. “Why would you buy the equivalent of a single-A bond when you can buy triple-A quality for the same price?”

Both Yacktman funds have delivered superb results. Over the past ten years through February 26, Yacktman Fund returned an annualized 14%. That compares with an annualized loss of 1% for Standard & Poor’s 500-stock index. Focused has performed equally well -- but with the slightly greater volatility you’d expect from a more-concentrated fund.

The funds don’t always focus on blue chips. During the 2008 debacle, they scooped up shares of troubled companies, such as Bank of America (BAC) and Barclays (BCS), and did well with them. But such stocks have become pricey, in Don Yacktman’s view.

Keep it simple

To hear Yacktman tell it, investing isn’t all that difficult. Start by looking for high-quality businesses. Next, consider price. “So much of investing is how much you pay,” he says.

Yacktman, who’s based in Austin, Tex., favors market leaders. “If you have a 40% share of the market,” he says, “you’ll likely make four times as much as a competitor that has a 20% market share because so many costs are fixed. Producing more widgets doesn’t cost that much extra.”

When he likes a stock, Yacktman isn’t afraid to back up the truck. Currently, PepsiCo and News Corp. (NWSA) each make up 9% of Yacktman Fund; Coca-Cola accounts for 7%, and Pfizer, 5%. His top ten holdings make up 56% of the fund. “Why put a lot of money in your 50th-best idea?” Yacktman asks.

Some of his top holdings are longtime laggards. Coke, for instance, traded in the high $80s in 1998. “Today it’s in the mid 50s, and almost every year since its peak it has recorded higher earnings and dividends,” Yacktman says.

Yacktman is a patient investor: “So much of the market is driven by short-term momentum. When we analyze a stock, we like to think in terms of the next ten years.” He generally holds stocks four or five years.

Yacktman Fund has more than 10% of its assets in cash. That, he says, is not a call on the stock market or the economy, but rather stems from his inability to find many compelling stocks trading at cheap prices.

Yacktman Fund is the better choice of the two funds largely because it has a lower expense ratio (0.95% per year, compared with 1.25% for Focused). Investors looking for other funds that are bullish on high-quality stocks should consider Primecap Odyssey Growth (POGRX) and Fidelity Contrafund (FCNTX).

March 1, 2010

—Steven T. Goldberg