Commentary

Concentrated Strategy

March 31, 2022

THE MARKET ENVIRONMENT

U.S. markets finished lower for the quarter for the first time since the Covid-19 pandemic began. Russia’s invasion of Ukraine caused sharp increases in volatility across most major markets with the S&P 500 reaching a quarterly low of 4,170 before recovering to 4,530 at the end of March. Ultimately the S&P 500 retreated about 5% and the Nasdaq and Russell 2000 both retreated closer to 10% as investors rebalanced portfolios to reduce exposure to risky assets. The energy and utilities sectors benefitted from the volatility in energy prices, while most other sectors were pressured by the backdrop of geopolitical uncertainty, inflation and tightening monetary policy.

As previously forecasted, the Federal Reserve increased the fed funds rate by 25 basis points at its March meeting, the beginning of a phase of tightening monetary policy in efforts to combat the recent high inflation. Chairman Jerome Powell said the Fed could begin unwinding its balance sheet as soon as May when he also sees the possibility of a 50 basis point hike. Markets are currently pricing in around 200 basis points in cumulative rate hikes by the end of 2022.

Fixed income markets saw the 5- and 30-year Treasury spread invert followed by a brief inversion of the 2- and 10-year Treasurys as well. While history shows that this is a precursor to a recession, many investors believe there is less cause for concern due to the recent fiscal and monetary policy, the pandemic, and restabilizing of the global economy. The war in Ukraine persisted through the end of the quarter, though peace talks continued to be held. In addition, many countries are believed to be considering further sanctions against Russia due to the reports of war crimes being committed against the Ukrainian people.

For long-term investors such as ourselves, times of uncertainty and volatility offer us the opportunity to carefully readjust our portfolios and position sizing to take advantage of mispricing in the market. We believe that share prices often react more aggressively than the changes to underlying business fundamentals, which provides opportunity for disciplined managers. During the current backdrop, we are continuing to focus on our goal—the protection and appreciation of our investors’ capital over the long term.

THE PORTFOLIO

Top Performers:
CDK Global’s fiscal second-quarter earnings report revealed dealer sites increased by 3%, marking12 straight quarters of growth, while revenue per site increased 4%. Overall organic growth increased by 5%, and despite headwinds from a lower margin roadster deal, adjusted earnings grew faster than revenue. In addition, the company repurchased $108 million of shares during the quarter, or 2% of the outstanding float. Later, a Dealreporter article claimed CDK was exploring a sale, citing three sources. In our view, there are above-average odds of this, and we continue to believe CDK is an attractive holding.

Amazon’s share price advanced following the release of its fourth-quarter earnings report, which showed revenue growth of 9% year-over-year as well as 40% growth in Amazon Web Services versus the year-ago period. Moreover, the company’s guidance for the first quarter of 2022 of $3-6 billion of earnings proved to be a relief for investors given growing concerns around competition, inflation and a seasonally slow quarter. Amazon also guided for 6% revenue growth in the first quarter versus the year-ago period and announced a price increase for Prime. We appreciate that the company gained market share on a two-year basis while making a large investment in one-day shipping, and the first-quarter earnings guidance suggests the investment cycle has peaked. Later, Amazon announced a $10 billion share repurchase authorization and a 20-for-1 stock split, the former of which we find to be important as the company rarely repurchases stock.

American International Group reported fourth-quarter earnings results in February, highlighted by earnings per share of $4.38, adjusted earnings per share of $1.58 and ending core book value of $68.90, which grew 21% year-over-year. Gains from selling an affordable housing portfolio helped boost earnings per share and book value. The general insurance segment had a particularly impressive quarter, in our estimation, with general insurance premiums growing by 7% with a combined ratio of 92.4%. We appreciate the company’s strong financial position, exemplified by a net debt to capital ratio below its target level of 25%, capital within its general insurance and life units above target level, and liquidity of $10.7 billion which is over two and half times their target. In our view, these figures position the company well for its anticipated partial IPO of the life and retirement unit in the second quarter. Management also expects to repurchase a minimum of $4 billion worth of shares during 2022. Later in the quarter, the company announced its intention to rebrand the parent company for its life and retirement business as Corebridge Financial when it becomes public.

Bottom Performers:
Investors proved disappointed by Meta Platform’s fourth-quarter earnings report and its share price fell over 20% following its release. Revenue guidance for the first quarter of 2022 of between 3%-11% was on the lower and wider range relative to the company’s history. Management pointed to new regulation in Europe and Apple iOS changes as a $10 billion headwind for personalized advertisements. However, it expects the investments the company is making in advertising technology and infrastructure to improve both targeting and attribution over time. The company also reported its first decline in daily active users for Facebook, which we believe is attributable to the size of the existing base and the amount of users pulled forward during the Covid-19 pandemic. Management emphasized its focus on generating revenue from its fastest growing content format, reels, a competitor to TikTok. The company believes the transition from stories to reels will be similar to the transition from feed to stories in 2018 and expressed encouragement from early results. Given the company’s success at these transformations in the past, we have confidence in Meta’s ability to continue to adapt. Despite the challenges, organic revenue grew 21% year-over-year to a new record, and the company repurchased $19 billion in shares during the fourth quarter. We appreciate management’s focus on many different revenue streams, some with upside opportunities, and the long-term thinking behind their capital allocation.

Although Netflix’s fourth-quarter subscriptions and earnings margin largely aligned with market estimates, the company’s guidance for 19-20% margins (or a 150 basis point contraction at the midpoint) and 2.5 million net additions in the first quarter proved disappointing to investors. However, we find that the strong dollar is serving as a margin headwind, and management noted that pricing and costs will be adjusted over the medium term. Absent the headwind, the margin is tracking in line with our expectations, and management reiterated its guidance for +300 basis point per year margin expansion over “any few year period.” Despite the disappointing guidance for subscriber growth, we continue to believe the valuation for the high-quality company remains attractive, offering a compelling reason to own.

Concern for increased competition pressured the share prices of companies in the cable industry in the first quarter, including Charter Communications. However, we appreciated that the company’s fourth-quarter adjusted earnings improved 7.7% and the mobile segment added a record 380,000 lines in the fourth quarter. Investors responded favorably to management’s upbeat tone in describing improving trends in broadband net adds through most of November and December, prior to the onset of the Omicron variant, as well as guidance for subscription growth to continue to improve as 2022 progresses. Robust full-year adjusted earnings growth of 11.4% afforded Charter with the opportunity to repurchase $17.3 billion in stock for the year, and we believe the company remains undervalued relative to our perception of its normalized earnings power.

During the quarter, we initiated positions in Amazon and Willis Towers Watson. We eliminated Comcast and Post Holdings from the portfolio.

Past performance is no guarantee of future results.

The S&P 500 Total Return Index is a float-adjusted, capitalization-weighted index of 500 U.S. large-capitalization stocks representing all major industries. It is a widely recognized index of broad, U.S. equity market performance. Returns reflect the reinvestment of dividends. This index is unmanaged and investors cannot invest directly in this index.

The specific securities identified and described in this report do not represent all the securities purchased, sold, or recommended to advisory clients. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time one receives this report or that securities sold have not been repurchased. It should not be assumed that any of the securities, transactions, or holdings discussed herein were or will prove to be profitable. Holdings are representative of Harris Associates L.P.’s Concentrated Value Equity composite as of 03/31/22.

Certain comments herein are based on current expectations and are considered “forward-looking statements”. These forward looking statements reflect assumptions and analyses made by the portfolio managers and Harris Associates L.P. based on their experience and perception of historical trends, current conditions, expected future developments, and other factors they believe are relevant. Actual future results are subject to a number of investment and other risks and may prove to be different from expectations. Readers are cautioned not to place undue reliance on the forward-looking statements.

The information, data, analyses, and opinions presented herein (including current investment themes, the portfolio managers’ research and investment process, and portfolio characteristics) are for informational purposes only and represent the investments and views of the portfolio managers and Harris Associates L.P. as of the date written and are subject to change without notice. This content is not a recommendation of or an offer to buy or sell a security and is not warranted to be correct, complete or accurate.