REPRINTED FROM DECEMBER 21, 2020 Identifying Intrinsic Value Key to Stock Selection MICHAEL NICOLAS has been a co-manager of the Oakmark Fund since 2020. He is also an investment analyst at Harris Associates and a VP of the Oakmark Funds. He started at Harris Associates in 2013 after serving as a managing director at Lakeview Investment Group. Prior to that, he was a senior analyst at Stratford Advisory Group. Mr. Nicolas earned a B.B.A. from the University of Wisconsin-Madison (2002). SECTOR — GENERAL INVESTING in this role, you must stay informed on almost every investment candidate TWST: Could you please introduce the Oakmark Fund that on our approved list of securities. This list is comprised of stocks that have you co-manage? And tell us about your continuing work at Harris gone through our investment process and have been approved for purchase Associates and the dual roles of being a portfolio manager and an by our Stock Selection Group members. I’m fortunate to be surrounded and investment analyst? supported by an incredibly talented research team. Mr. Nicolas: Harris Associates, the adviser to the Oakmark TWST: What is your team’s investment philosophy and mutual fund family, is a Chicago-based investment management firm guiding strategy? How has it evolved over the recent past, and over with approximately $100 billion in assets under management. The the course of your career? significant majority of our firm’s assets are invested in the public equity Mr. Nicolas: At Oakmark, we adhere to a proven, bottom-up markets, both domestically and overseas, but we also manage balanced investment process. We look to identify individual companies trading for portfolios as well as a standalone bond fund. The fund that I co-manage meaningful discounts to our estimate of intrinsic value, and where we alongside Bill Nygren and Kevin Grant is the Oakmark Fund. expect per-share value to grow over time. Furthermore, we want to make The Oakmark Fund specifically focuses on bigger domestic sure that the management teams that run our companies are properly companies and is typically comprised of 50 individual stocks. Our aligned with us, and that they think and act like owners of the business. portfolio often looks very different than broader market indices and tends We spend an awful lot of time studying the track records and the to be more focused than other diversified mutual funds. We’re proud of capital allocation history of the management teams we’re considering the fact that had you invested in the Oakmark Fund at its inception in investing with, which is critically important given our willingness and ability 1991, you would have made more than 25 times your original investment, to own a company for a long time. In terms of my own evolution relative to which compares to the 16 times you would have received by passively earlier in my career, I’ve gained a much greater appreciation for how investing in the S&P 500 index. important management quality can be in affecting investment outcomes. You mentioned the dual roles of being a portfolio manager and TWST: Tell us about your investment process and how that an investment analyst. This is common at Harris Associates. Many of our might be reflected in your current sector allocations? Has it changed portfolio managers also serve as investment analysts. A typical analyst at over this past year in view of COVID? Harris will be responsible for closely following roughly 10 individual Mr. Nicolas: We define value differently than many of our companies and will usually present three or four new investment ideas per peers. By that I mean we don’t believe value and growth are opposing year to our investment committee. forces as so many market strategists seem to suggest. Rather, we consider As a portfolio manager, I have the added responsibility of growth as one of many inputs that we incorporate into our calculation of assisting Bill and Kevin with portfolio construction. In order to be effective intrinsic value. MONEY MANAGER INTERVIEW MONEY MANAGER INTERVIEW ——————— IDENTIFYING INTRINSIC VALUE KEY TO STOCK SELECTION For us, a value investment is simply a business that trades That being said, we regularly incorporate devil’s advocate below our estimate of intrinsic value, which we calculate by making a reviews into our process, whereby one of our analysts will be tasked with number of predictions regarding a company’s future growth rate, profit presenting the bear case on a position within our Fund. The purpose of margins and capital requirements, among others. We perform a discounted these devil’s advocate reviews is to ensure that we’ve properly surfaced cash flow analysis, whereby we project all the future cash flow of a and sized the most important risks in any given idea. In a sense, our business and discount it back to the present using a discount rate that’s devil’s advocate reviews are internally written short reports on our based on the risk levels of a given business. existing long positions. But even when we appraise the value of a company to be far in We’ll debate the merit of these reviews during our weekly excess of its current stock price and see what we think is a clear path to investment committee meetings. As you might imagine, this can be an per-share value growth, we won’t uncomfortable and challenging buy the stock unless we have process for those involved, but conviction that the management Highlights one that we believe bolsters our team in charge of the business will risk mitigation efforts. The only think and act like an owner. The Michael Nicolas discusses the Oakmark Fund, which focuses way this process works is to have stocks that meet these criteria on bigger domestic companies. Mr. Nicolas explains that analysts who operate as generalists become candidates for ownership using a bottom-up investment process, fund managers and are capable of analyzing a in the Oakmark Fund. identify companies trading for meaningful discounts to their variety of different industries and I mentioned that the way estimate of intrinsic value and where they expect per-share business models. we define value is different than value to grow over time. The quality of a company’s TWST: How often do many of our peers. We don’t require management is also an important consideration. Sell targets you reposition your fund; that a current or prospective portfolio are typically set around 90% to 95% of their estimate of value. is, add or sell different company to trade for a low multiple Rather than considering value and growth to be opposing holdings? of the earnings or book value they dynamics, Mr. Nicolas views growth as one of many factors Mr. Nicolas: It really publish in their audited financial to incorporate into a calculation of intrinsic value. He seeks depends on the opportunity set statements. Our CIO–U.S. Equities, companies that are well capitalized with ample liquidity so and the relative attractiveness of Bill Nygren, has written at length that they’re positioned to take advantage of the rebound in our current holdings that are in about the flaws of solely relying on economic activity as the coronavirus subsides. Rather than the portfolio. On average, our generally accepted accounting speculate on short-term stock price movements, Mr. Nicolas portfolio turnover tends to be principles — or GAAP — to advises Millennials to allocate a significant percentage of their about 25% to 30% per year. determine how profitable or funds to the equity markets with a buy-and-hold mentality. TWST: And what is valuable a company is. At Given increased life expectancies, he believes Baby Boomers your sell discipline? Oakmark, we often go to should have a healthy allocation to equities as well. When a new idea is painstaking lengths to recast a Companies discussed: Alphabet (NASDAQ:GOOG); Comcast presented, the analyst company’s financial statements in Corporation (NASDAQ:CMCSA); CBRE Group (NYSE:CBRE); recommending the company order to reflect what we believe its Keurig Dr Pepper (NASDAQ:KDP); Wells Fargo & Co. will set an estimate of its fair true economic earnings power to (NYSE:WFC); JPMorgan Chase & Co. (NYSE:JPM); Visa value. From there, we’ll always be, which can sometimes look (NYSE:V) and Bank of New York Mellon Corp. (NYSE:BK). set buy and sell targets, with the quite different than how GAAP latter typically set around 90% would define it. to 95% of our estimate of value. For these reasons, you’ll see a mix of what I would call traditional As our estimates of value change over time, so, too, will our buy and value names in our portfolio, like many of our financial holdings, and non- sell targets. Additionally, we are constantly evaluating what we traditional value names, like Alphabet (NASDAQ:GOOG), which I can currently own against our internal opportunity set, which is our discuss later in more detail if you’d like. approved list of investable companies. “I believe that shorting is a difficult way to make a living, given that markets go up over long periods of time and the risk/reward is inherently unfavorable, as you have limited upside potential and an unlimited downside risk.” We’ve incorporated some other unique attributes into our process During certain periods, such as the violent downturn we witnessed that are worth noting. Oakmark is a long-only fund, which means that we earlier this year, we found ourselves in the unusual position of selling stocks that don’t actively bet against or short companies in our portfolio.