Commentary

Concentrated Strategy

December 31, 2021

THE MARKET ENVIRONMENT

U.S. stock market indexes finished higher for the quarter as gains in October and December offset a retreat in November when news of the Omicron variant began to surface. Strong corporate earnings and generally mild symptoms reported from patients with the new variant supported the rally in U.S. equities.

Inflation remained a focus point for investors, policymakers and financial media. It accelerated to 6.8% year-over-year growth in November, following a rise to 6.2% year-over-year growth in October. Supply chain constraints, labor shortages, surging demand outpacing supply, and high material and commodity prices all contributed to the increases in prices. The U.S. Federal Reserve left the federal funds rate unchanged at its December meeting while accelerating the pace of its asset purchase tapering. At the current rate, asset purchases are now on track to cease by the middle of March 2022. In addition, the Federal Open Market Committee continued its recent trend of appearing increasingly hawkish, with the dot plot revealing the median of members’ expectations at three 25 basis point rate hikes in 2022, three in 2023 and two in 2024.

Meanwhile, President Biden’s $1 trillion bipartisan infrastructure bill passed in the House of Representatives in November and was signed into law shortly thereafter. The deal provides funding for various projects, including roads, bridges, railways, broadband access, clean water and electric grid maintenance. On the other hand, although the roughly $2 trillion Build Back Better Act passed in the House of Representatives in November, it ultimately stalled in the Senate with a formal vote expected in January. The bill includes funding for various programs, such as universal pre-K, Medicare expansion, renewable energy credits and affordable housing.

With seemingly constant uncertainty in politics, economics and market sentiment, we focus on finding undervalued and well-managed companies that will benefit from economic tailwinds while proving capable of weathering difficult environments. We believe this approach best services our goal of growing and protecting our investors’ capital over the long term.

THE PORTFOLIO

Top Performers:
Alphabet’s third-quarter earnings release resulted in the company’s share price moving higher throughout the quarter. Reported revenue growth amounted to 41% and operating margins (ex-other bets) expanded 670 basis points. In addition, search and YouTube advertising revenue both grew over 40%. Management bought back $12.6 billion worth of stock in the third quarter, which puts the company on pace to meet our expectations for the full-year period. Although Alphabet’s share price declined on news that YouTube TV subscribers lost access to Disney-owned entertainment options, the issue resolved itself shortly thereafter. We believe Alphabet remains an attractive holding with upside potential despite its recent share price appreciation.

Revenue growth of 87% year-over-year and adjusted earnings per share growth of 65% year-over-year highlighted a third-quarter earnings report that helped propel shares of Charles Schwab higher in the fourth quarter. The company continues to see expansion in brokerage accounts. The third quarter of 2021 marked the fourth straight quarter with at least one million new brokerage accounts opened, and new accounts year-to-date totaled six million. The company generated core net new assets of $139 billion in the quarter, bringing the total for the year to $396 billion with an annualized organic growth rate of 8%. We appreciate that Schwab consistently emphasizes extending its share of financial assets and has been creatively entering new markets over time to achieve this goal. In addition, we believe the company’s wide-moat business model and competitive advantages position it for continued growth in assets and earnings.

In late October, Lear entered into an agreement to purchase Kongsberg Automotive’s interior comfort systems business for EUR 175 million. In November, Lear delivered decent third-quarter earnings results, despite a tough operating environment, as earnings per share ($0.53 ex-items vs. $0.47) and revenue ($4.27 billion vs. $4.22 billion) bested consensus estimates. In addition, sales outgrew light vehicle production by 9%, though management lowered fiscal-year sales and adjusted earnings guidance. Later, Lear increased its quarterly dividend by over 50% to $0.77. We met with management in November and learned that the team is actively considering strategic alternatives to create shareholder value in light of the stock’s significant underperformance over the past few years. Options include spinning off or selling the e-systems business for the right price, which adds to our confidence in management’s commitment to bolstering shareholder value.

Bottom Performers:
Charter Communications’ share price retreated throughout the quarter. Investors proved disappointed with the deceleration in the company’s broadband business as exhibited in Charter’s third-quarter earnings results. Importantly, we appreciate the company’s history of transparency in the past when competitive intensity in the market increased and do not believe the slowdown in internet net additions is attributable to a reduced win rate. In addition, Charter’s adjusted earnings increased nearly 14%, and mobile net additions were solid, in our view. The company repurchased 8.1% of its share base in the year-to-date period, and our investment thesis remains intact.

Citigroup’s third-quarter earnings report largely met market expectations and the company reiterated its full-year revenue and expense guidance. Later, Citigroup announced it expects to recognize about $1.2-$1.5 billion of cash charges over the course of 2021 and 2022 as a result of employee separation payments associated with the company’s exit of its South Korean consumer business. CFO Mark Mason noted that the economics of winding down operations in South Korea are “much more attractive than continuing to run the business” given the heavily regulated market with high labor costs and price controls. In December, Citigroup presented at a conference where it reiterated its full-year revenue and expense guidance. Trading guidance fell short of investors’ outlook, while fee revenue figures across the balance of the business exceeded analysts’ estimates. The company also announced a pause in share repurchases, which we found disappointing, though we do understand the company’s unwillingness to temporarily dip below its targeted CET1 ratio. In our view, Citigroup’s underperformance is attributable to the market’s unwillingness to look through near-term pressures, and we believe the company trades at a discount to our perception of its intrinsic value.

In our view, GoHealth’s third-quarter earnings results were strong relative to its peers, though the market proved disappointed with the report. Revenue grew 33% and bested expectations, but adjusted earnings fell short of analysts’ estimates as the company exceeded its prior agent hiring target. Despite the earnings miss, management reaffirmed previous full-year adjusted earnings guidance as the company expects to leverage the third quarter’s increased hiring and agent training investments during the fourth-quarter annual enrollment period for Medicare. Management believes that the investments made in 2021 will set the company up well for success with lower investment in 2022 and beyond.

During the quarter, we initiated positions in Mastercard, Visa and Wendy’s. We eliminated Automatic Data Processing and Workday 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 12/31/21.

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.