5 Lessons From the Top 10 Gurus

GuruFocus.com

- By Robert Abbott

In recent weeks I have profiled the eight gurus with the best average annual returns over the past 10 years, as shown on the GuruFocus Scoreboard. The investing philosophy of another other guru, Seth Klarman, had been provided recently by GuruFocus writer Rupert Hargreaves, while I had profiled Donald Yacktman in late 2016.


As the process unfolded, some themes started to appear, although not always immediately obvious. This article explores those themes, following brief overviews of each of the gurus. I am not prepared to say these explorations are definitive, but would hope they stimulate further thought and discussion.

The investing gurus with the best 10-year returns can be accessed on the GuruFocus Scoreboard by clicking on "10-Year (%)" (may require two clicks). The names that appear have the best 10-year records among all investing gurus followed by GuruFocus, and they appear in descending order. They are:

  • David Tepper (Trades, Portfolio): 20.1% (percentages are average annual return over 10 years)

  • Prem Watsa (Trades, Portfolio): 13.1%

  • Bill Ackman (Trades, Portfolio): 12.8%

  • Seth Klarman (Trades, Portfolio): 12.8%

  • Chuck Akre (Trades, Portfolio): 11.2%

  • Vanguard Health Care Fund (Trades, Portfolio): 10.2%

  • Yacktman Focused Fund (Trades, Portfolio): 9.8%

  • Jerome Dodson (Trades, Portfolio): 9.7%

  • Frank Sands (Trades, Portfolio): 9.6%

  • Eaton Vance Worldwide Health Sciences Fund (Trades, Portfolio): 9.5%



David Tepper

In the case of top-ranked Tepper, that quality may not be apparent to other investors--yet. He and his team take pride in finding promising names first. They can take on these seemingly risky plays because of their deep research and, of course, their belief in the efficacy of that research.

Tepper, the founder of Appaloosa Management, likes to pick up distressed companies when their prices are down and then ride their recovery. For example, in the fourth quarter of calendar year 2016, Tepper bought slightly more than 21,000 shares of Arch Coal Inc. (ARCH); although the political climate for coal has warmed considerably, the broader societal can be expected to continue chilling.

The two biggest sectors in his portfolio are technology and health care.

Prem Watsa

Watsa of Fairfax Financial Holdings (FFH.TO) has four criteria that help him identify promising stocks: Compounded, current market value should increase by 15% per year over the long term; long-term book value is growing, whatever the quarterly earnings; they are soundly financed; and management offers complete disclosure every year.

Watsa found a virtual mentor in the writings of Benjamin Graham, who pioneered the idea of value stocks. Like Warren Buffett (Trades, Portfolio), he has significant insurance holdings and he invests the float (premiums paid in advance by policyholders, but not yet paid out in claims) to build out his portfolio.

The two biggest sectors in Watsa's portfolio are technology and real estate.

Bill Ackman

The founder of Pershing Square Capital Management also likes distressed stocks, or at least stocks that are not performing as well as they should. But unlike most other investors, he does not always like to wait for a turnaround or new management; instead, he buys a sizeable position, gets himself or his associates elected to the board and makes (or attempts to make) changes that unlock shareholder value.

Ackman also looks for opportunities in market overreactions, "We rely on concentrated research to identify great businesses that are trading at highly discounted valuations because investors have overreacted." One such case is Chipotle Mexican Grill (CMG), which investors sold off vigorously when health concerns surfaced; Ackman says the underlying value remains, despite current investor sentiment.

Ackman's biggest sectoral holdings are consumer cyclical and consumer defensive.

Seth Klarman

Klarman, of The Baupost Group, has been described as an avid follower of Graham and Buffett, prompting The Economist magazine to dub him "The Oracle of Boston."

Not unexpectedly, then, an article at Investopedia argues that "Klarman often looks for value in underappreciated stocks and puts his assets into areas in which other investors would not consider."

A review of his largest holdings shows no Alphabet (GOOGL) (GOOG), Amazon (AMZN) or Apple (AAPL). Based on sectors, however, his profile matches that of many other gurus; technology and health care.

Chuck Akre

Akre, of Akre Capital Management, has a clearly articulated definition of quality companies: they compound value at above-average rates. This guru wants companies that not only deliver outstanding earnings, but also insists they reinvest those earnings and free cash flow in above-average opportunities.

Three elements factor into selections at Akre's firm: companies that know how to increase their intrinsic value, shareholder-friendly management and the ability to reinvest profits for above-average returns.

Unlike most of his peers, Akre favors the financial and communications sectors; the former makes up more than 40% of his portfolio.

The Vanguard Health Care Fund

Jean M. Hynes runs this fund, after taking over from its founder and long-time manager Edward P. Owens in 2013.

She has three criteria for the companies she considers: they must have high-quality balance sheets, strong management and a pipeline of potential products that will bring in above-average growth in both revenue and earnings.

Needless to say, the fund invests in only one sector, health, but under that umbrella buys stocks in five subsectors such as pharmaceuticals, health services and medical products.

Donald Yacktman

The Yacktman Focused Fund (Trades, Portfolio) pops up in the number six spot on the list of gurus with the best 10-year returns. The man who has been behind the fund is Donald Yacktman ( Trades , Portfolio ) , who semi-retired in May 2016 and handed over most fund responsibilities to his son Stephen (Donald is said to now have an advisory role).

When asked how he defines a high-quality company, Yacktman told a GuruFocus interviewer, "I would make it a function of high return on asset businesses. In other words, the businesses that have the sustainability to earn high returns on assets, I think they are the high quality businesses. And if you were to take your piece of paper and use two axis, one would be fixed assets, the other economic sensitivity, you could plot any company on there."

Technology and consumer defensives are the biggest holdings in the Yacktman funds.

Jerome Dodson

Dodson, the founder, chairman and CEO of Parnassus Investments, is often singled out because of his belief that good companies, i.e., companies that are environmentally and socially committed to proper governance, deliver better than average returns. Think of these characteristics as an extra screen Dodson uses in selecting companies.

Beyond that screen, he searches for strong businesses that provide what he calls "increasingly relevant" products or services. These businesses also must have sustainable competitive advantages (economic moats), stakeholder-responsive management teams and ethical business practices. And, one more thing--he wants to buy those companies at prices that ensure he receives the right, risk-adjusted internal rate of return.

His main go-to sectors are health and technology.

Frank Sands

This father and son duo (Frank Sr. and Frank Jr.) of Sands Capital Management has a growth orientation. They believe high quality starts with earnings power, which in turn drives a company's valuation.

Within that context, they have six criteria for evaluating stocks, including sustainable, above-average earnings growth, a leading position in a growth sector, a clear view on creating value for shareholders, financial strength and fair valuation.

Sectors are technology and consumer cyclicals.

Eaton Vance Worldwide Health Sciences Fund

This fund focuses, as its name suggests, on the health sector. But, there is also a strong influence of technology; it is called a health sciences, not health care, fund.

Managers Jason Kritzer and Samantha Pandolfi focus on companies making scientific advances in the health field. More specifically, they want at least half of target companies' sales, earnings or assets to come from the application of scientific advances related to health care.

They also have a bias toward growth, by seeking out big companies that have the potential to increase their market share and smaller companies with ambitious research and development projects. Presumably, such R & D projects have the potential to power scientific advances at an early stage.

Five lessons

Shop for technology and health care

In my initial scan of the top 10 gurus, I was struck by how many held large positions in technology or health care (and health care often involves a healthy dose of technology). Checking further, I discovered that eight out of 10 gurus had one or the other of these as their leading sectoral holding:

Guru sector preferences
Guru sector preferences

Technology and health care do make intuitive sense in this situation; they often embed some form of proprietary knowledge and that may constitute an economic moat. The moat, in turn, provides pricing and margin power, which lead to stronger earnings and free cash flow.

The gurus also have heavy weightings in these two sectors, 30% to 40% of a portfolio is not unusual.

For individual investors who want to emulate the gurus, shopping for technology and health care will be essential. Be warned, though, that these sectors can take back as well as give. Investors with a heavy weighting of them should hedge some of that risk with stops, trailing stops or put options.

Skip dividends

Surprisingly, to me at least, was the absence of dividends as an issue for the top 10 gurus; after all, compounding is a powerful tool over time. Watsa mentions dividends and compounding, but not in the context of picking stocks.

On further reflection, though, the absence of dividends makes intuitive sense. Dividend-paying stocks, at least those with notable dividend yields, are those of mature companies. They pay dividends because they no longer see internal growth that yields more than investors might reasonably earn elsewhere. Even from a total return perspective, a dividend-paying stock is not likely to excite these gurus.

Buy quality, not bargains

Several gurus, including Tepper and Ackman, like to pick up stocks at deeply discounted prices. But they are not buying what Buffett has called cigar butts; instead they look for companies with solid foundations for recovery. Ackman often goes a step further with his activist orientation, buying significant holdings in individual companies and then pushing management to make changes.

Klarman, a Graham disciple, also shops for bargains, but he searches for companies that have lost favor with the masses, investors with shorter time horizons.

Stick to the plan

At one time or another, all the gurus have had bad years, whether self-inflicted or external black swans. Yet, they have stuck by their chosen philosophies and strategies, believing their direction will be justified over time.

The two health care funds that made the list of top gurus had fewer choices because of their nameplates, but within that sector and industry, they have maintained consistency in their stock picking. The team at Vanguard keeps picking names from five subsectors, while the Eaton Vance team keeps picking stocks that should grow in value because of scientific advances.

Among the other gurus, Watsa stays within the Graham-Buffett orbit; Akre wants companies that cannot only grow, but can also reinvest their profits for above-average returns; Dodson maintains his focus on socially responsible, or ESG, stocks; and the father and son team at Sands Capital remains dedicated to owning a handful of growth stocks.

Be lucky

Despite all the skills, the singular focus and good management, bad stuff still happens and funds have bad years. Fallout from the last decade's financial crisis immediately comes to mind, but many other external events have also roiled markets over the years and will continue to do so in the future.

All the gurus reviewed here have lived through difficult times brought on by outside forces, forces over which they had no control.

By insisting on quality in every name they hold, however, they have kept their heads above water while the black swans swim past them. Individual investors might aspire to emulate them by building their own protection with quality stocks and remaining committed to their own philosophies and plans.

Disclosure: I do not own shares in any of the stocks listed in this article, nor do I expect to buy any in the next 72 hours.

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This article first appeared on GuruFocus.