MI301: Deep Value: Timeless Strategies, New Insights w/ Bill Nygren and Robert Bierig

28:58As an example, maybe the drug was originally tested for cardiology, but what if it might also help with weight loss? You could use real-world evidence to evaluate that question. And what's unique about IQVIA is that it can use its data to find patients that fit all the parameters retrospectively and figure out whether the drug works as expected without having to go ahead and do another trial. So you mentioned earlier that IQVIA has access to data that goes back like 50 plus years. With this data, do they own all of it? Is it easily accessible by competitors? I'd love to know more about that. Yeah, this is a really important question.

29:41What's unique about the IMS data is really two things. One, it's global. And two, it has full depth and breadth. It's more detailed than anything else that's out there. ICON, which is the second largest CRO, also has data through Symfony, but that's mainly limited to U.S. pharma data. It doesn't help you recruit in Europe, China, Africa. And IQVIA's data, it consists of prescription records, pharmacy records. It's linked to historical data sets. It comes from many disparate sources. Like the secret sauce here isn't really the raw data per se. It's about the cleaning, the curating, and the linking that's done to pull together a picture on more than a billion non-identified patient lives.

30:33And like I said earlier, IQVIA has this data going back more than 50 years. Just talking about that data, obviously that's one of their competitive advantages, but do they have any other major competitive advantages over peers that you'd like to share? I think it's really kind of what they do with the data. I mean, the peers, if you want to talk like ICON and PPD are good companies. They're very strong operationally. But what differentiates IQVIA is its ability to find patients and find sites using the data really quickly. And ICON and PPD can't compete with IQVIA when it comes to that. And so just looking at their revenue, do they have any concentration risks between any of their customers or is it pretty well diversified?

31:20It's pretty well diversified. This is a really big business and it's a global business. So IQVIO right now is trading about 22 % below its 2022 highs. I assume this drop in share price was probably a driving force on what got you interested in the business in the first place. Can you tell me why the market has punished the share price so badly and why you think sentiment will change? Well, I think there are two main controversies to highlight. First, there are fears about the emerging biopharma funding environment. Second, there's a slowdown in the economically sensitive part of the technology and analytics, that task segment.

31:56I'd be happy to talk about each of those briefly if that would be helpful. Absolutely. So on the EBP funding issue, there was a big decline in 2022 after a couple of boom years. Funding got as high as$130 billion in 2020 and$120 billion in 2021, but it fell to$60 billion in 2022. Now, that sounds scary, but it's really not weak on an absolute basis. It's just back to where it was before the boom, which is a pretty normal level with more than enough money to fund good science. Also, IQVIA isn't feeling a hole today because much of the money that was raised during the boom went toward early stage, more speculative stuff that was never going to make it through to later stage phase two or three trials, which is where IQVIA plays.

32:50And then on the slowdown that happened and that's going on in TAS, consulting, which is sensitive to the economy, is causing modest pressure on growth. The organic growth in the TAS segment is running at around 6 % this year, whereas the typical growth rate is usually seven to nine. If you pull out consulting, the rest of the segment is growing at eight and it grew 9 % last year. So all things considered, we view this performance as solid considering the macro environment. We see this flow down there as more of a blip, but it's enough to scare away some healthcare investors who put a very high premium on stability.

33:30So a lot of pharmacy businesses were seeming to ride some pretty heavy COVID tailwinds, but IQV is continuing to see really good organic growth rates in both segments that you've already outlined. Do you see organic growth rates in that 9 % to 12 % range that you mentioned being sustainable over the next few years? IQV is COVID revenues should be around$400 million this year. COVID-related revenues got as high as almost$2 billion at the peak in 2021. But we value the company off of its normal earnings power and what its revenue should look like a couple of years out in 2025. And by then, we expect that COVID revenues will have trailed off to zero by then.

34:14So how are you guys navigating the Federal Trade Commission's attempt to block IQVIA's acquisition of Propel Media? Propel Media would be a nice addition for the company. It would help their digital marketing capabilities, but it's a really small percentage of the total value of the company. So it wouldn't have a material impact on our value if they were not able to go forward with that transaction. So let's discuss a little bit more about evaluation. In your second quarter commentary, you mentioned that you believe IQVIA is currently trading around 15 times normalized earnings. What do you feel is a reasonable normalized earnings multiple?

34:50And can you explain what adjustments that you made to their current earnings to come to that figure? At the time of our initial purchase, IQVIA was selling near a trough multiple, as you said, around 15 times our estimate of the normal earnings. This is well below the market multiple and well below where IQVIA has traded historically. Even though the company has prospects for sustainable growth at an above average rate, it usually trades at a premium to the market. When we think about the normal earning power, we look at what the business can earn a couple of years out, like I said a minute ago, and we add back amortization of intangibles.

35:29We factor in share repurchases between now and then. Management targets that 8 % to 10 % organic revenue growth, and we think the operating income growth should be at least that fast due to operating leverage. Life sciences companies and data and information services comparables that have similar growth characteristics and return profiles tend to sell for PE ratios in the mid-20s. And that seems reasonable to us for IQVIA. There's also a long history of private market transactions in the CRO area that would support an EBITDA multiple of over 20 times. We think that's about right for this business.

36:11Let's go over some of the growth drivers that they're going to have in the future. What do you see that they are currently pulling now or what can they pull out to help keep driving growth and organic growth at the rates they're going at now? Yeah. Well, the primary growth driver is the organic revenue. Management expects that eight to 10 growth in the core business. We also think there should be some operating leverage on top of that. And then in terms of buybacks, IQVIA has bought back nearly$620 million of the stock year to date. And this quarter, they increased the repurchase authorization by$2 billion to bring the total to about$2.7 billion.

36:50That's equivalent to 7 % of the market cap. And then finally, we think they'll be able to add a point or two to the growth rate through acquisitions. And I think one other thing is that management is comfortable running this business at more than four times net debt to EBITDA. They're at around three and a half times today. And I would point out that the levered buyback model tends to be an overlooked value driver at a lot of companies. We think it's an important thing to consider here, and it's really helped grow value at companies like AutoZone or HCA or Charter and several others. Let's take a quick break and hear from today's sponsors.

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40:46That's theinvestorspodcast.com slash tip-finance. All right, back to the show. So Bill, you've discussed spreads in terms of price to earnings ratios between value and growth in the S &P 500. You've also said that the spread currently is unusually high, which is allowing investors to make very high quality portfolio with investments that are a lot cheaper than usual. How do you see these spreads changing as the economy normalizes in the coming years? One of the ways we look at how attractive the value opportunity is in the market is we rank order the S &P 500 companies based on their PE multiples.

41:28And then we look at the 50th most expensive and the 50th cheapest. And today, the 50th most expensive S &P stock sells at about 60 times expected earnings. The 50th cheapest sells at about eight and a half times. So the multiple of the expensive stocks to the cheap stocks is about seven times. We've kept this data since 1990. And the average over the past 33 years has been the expensive stocks are about four times the cheap stocks. So if there are 50 stocks under 10 times earnings, there'd be 50 over 40 times earnings. And it's a pretty tight range around that four times number. Growth tends to get cheap when it's only three times as expensive as the cheap names, and it tends to be expensive at about five times.

42:23If you go back to the internet bubble around 2000, that ratio did get to nine times. Cheap stocks were about nine times earnings then, and expensive ones were over 80 times. And that was as high as we had ever seen it. And what followed was one of the best multi-year periods for value investing really ever. And then we saw that get elevated again in the late 2010s and then going into COVID. It spiked again, creating another really good value opportunity. Sitting at seven times like it is today, I would say this is in the 10 % of best opportunities for value investors. And the result of that for our portfolios has been the names we've been selling tended to be the growthier names.

43:18We bought them opportunistically, they performed well, but now their PE multiples are getting up pretty significantly above the S &P 500. And then that money is getting recycled into companies whose PE ratios are dramatically beneath the market. I think a lot of times you hear market commentators say, you know, the S &P is at 18 times or 20 times earnings. And then they'll use that as an excuse to say investors need to be unusually cautious and the opportunity set isn't as good as it normally is because over a longer period of time, the S &P has averaged more like 15 times earnings. We think that thinking about the spread gives another important piece of information because the history of buying stocks at single digit PEs and then patiently waiting for reversion to the mean has been very good for investors.

44:15So many businesses in the financial sector have had their stock prices heavily punished from just being associated with collapses in banks like Silicon Valley Bank and Signature Bank, et cetera. Can you tell me where you are seeing the most value in the financial sector and any other industries that you feel are currently heavily undervalued? Sure. And I'm sure, Kyle, you know that the banking industry has been under pressure pretty much since the great financial crisis 15 years ago and leads to people saying now Oakmark always loves financials. That has been true pretty much post-GFC, but that wasn't always the case.

44:54Typically, financial stocks traded at, say, two-thirds the S &P multiple. We think they're better businesses today, less risky because they have more capital, and they're trading at eight, nine times earnings when the S &P is close to 20. So their discount to the market multiple is much larger than it has been historically. And we think the fundamentals would justify that discount narrowing from the historical numbers because of the risk reduction. And I think one of the most important things across the financial space, these companies used to like amplify their own cyclicality by chasing revenue goals.

45:34And you'd hear all the major bank CEOs talk about how they expected to grow faster than the industry. Well, as the economy would start to top out, they'd all be trying to grow faster than the industry. That meant lending standards had to decline. But what you see today is every major bank CEO talks about growth in terms of per share value. And they're just as excited about putting capital to work, reducing the size of the company, the number of outstanding shares as they are in trying to grow the scale of the business. And both, we're equally excited about either form of growth. So we like the large banks.

46:17We think they have important competitive advantages against smaller peers. Things like fraud prevention, regulatory compliance, mobilization, all of those cost only a little bit more if you're a much bigger bank than they do for a smaller bank. So in terms of that cost relative to the assets that you have, there are tremendous economies of scale. And that's why the big banks have been gaining share because they're able to offer their customers a better value proposition. So we like most of the large banks. We like a lot of the insurance companies, a name like AIG that's been in our portfolio for a long time.

46:59Again, it has the great financial crisis taint to it. It sells at a big discount to book value. It's rapidly closing the performance gap between AIG and the other large insurers, yet still sells at a low PE multiple. In addition to financials, we think the oil and gas industry is very cheap. Most of the US E &P companies trade at single digit PEs based on current price for oil. And like the banking industry, this is an industry that's also gotten comfortable with returning capital to shareholders. In the past, these companies would tend to take every dollar they could get their hands on and try and explore to find new oil.

47:43But as the industry has grown up and matured, they've come to recognize or they've come to accept the responsibility of maximizing per share value to shareholders. And you're seeing them put capital to work, buying back stock, paying dividends that in a lot of cases now are above average for the S &P 500. And we also think the energy industry has kind of an ESG taint associated with it. And we expect as ESG investors become maybe a bit more nuanced in how they think about environmental effect, that the U.S. companies will fare very well with them because they are so much more carbon efficient than the rest of the world is.

48:30There are people who are patting themselves on the back when regulations went into effect that would reduce U.S. production of oil, but then that just meant we were buying oil from Venezuela and per barrel they're producing 50 % more carbon than we are. So it helps the U.S. hit their goals, But in terms of the world goals, it's a big negative. We also saw with the Ukraine war the advantage of being energy self-sufficient. And there is a tremendous social good to having some energy independence. So the executives at the oil companies are telling us they're starting to get more thoughtful questions from the ESG community, as opposed to them just saying, no, we don't ever want to own any energy companies.

49:17So we think there'll be increasing investor demand for these companies. And if we're wrong and there isn't, the tremendous cash flow will largely be coming back to shareholders. Another area that we find attractive is traditional media. You find a lot of people referring to the cable TV industry. We'd refer to it as internet service providers. The current battle we're seeing between Disney and Charter, I think, highlights that what used to be cable industry is now making almost all their money from providing internet access. and that internet access is going to be necessary for work from home, for video streaming.

50:01We think those companies, single digit PE multiples, are deserving of infrastructure type multiples that would be significantly higher, in some cases higher than the S &P 500. And then last, I mentioned consumer durables. There's been a tendency of investors to highly prioritize risk reduction in their portfolios, given kind of what we've been through the past couple of years of highly volatile markets. It's resulted in consumer non-durables like food stocks, in many cases, selling at premiums to the S &P 500. We have a hard time arguing that those are better than average businesses, but the consumer durables, things like auto and auto-related businesses typically sell in the mid-single-digit range.

50:52I think investors are thinking they are going to be disrupted by EV technology. And we think in a lot of cases, the parts companies are going to do well, regardless of how rapidly EV takes over from ICE. And that a lot of the OEM companies, like General Motors, are among the leaders in transitioning their fleet from ICE to GEV. Again, single digit PEs, reasonable growth in business value, and a lot of capital coming back to shareholders as they're generating more capital than they can invest. I think one other thing is investors are kind of fearful of an economic decline. Got the Fed trying to reduce inflation and concern that'll induce a recession.

51:40But if it does, this is going to be a really unusual recession for the auto industry because our starting point now is about 20 % below normal annual car sales. And that's because of lingering supply chain issues that resulted from COVID. Those are the four areas broadly that we're overexposed to. Most forms of financials, most forms of energy, legacy media, and consumer durables. So you recently talked about how you utilize non-GAAP financial metrics to help you make better sense of evaluation in tech businesses. You mentioned using them to help you evaluate businesses like Adobe and Uber. Can you share a little bit more about how you go about making adjustments to some of these tech names to help you get a better grasp of the true economic value of them?

52:31Sure, I'd be happy to. The two names you mentioned, even though most people would call them growth businesses, we didn't have to do much changing to their financial statements to highlight the value at the times we bought them. In the case of Adobe, the stock had fallen a fair amount and then they announced the acquisition of Figma and their stock fell by more than the entire acquisition price of Figma. It got so low that on a year out basis, they were looking at a higher cash flow yield than the S &P 500 had. And we have always believed Adobe was an excellent above average business deserving of a premium multiple.

53:16So seeing that multiple go to a discount within a one to two year time period was pretty attractive to us. And in the case of Uber, at the time we purchased it, it had a double-digit cash flow yield, so greater than 10%. Now, there are a lot of companies we've invested in over the years that have required us to make some adjustments to gap numbers. And the reason is that gap accounting was really designed for an industrial world. And when an industrial company wanted to grow, they'd build a new plant. and because that plant would last for 30 years, instead of that expense going through the income statement, it would go on the balance sheet and then it would go through the income statement 1 30th each year as a depreciation expense.

54:06And the basic message of gap accounting is it has to be a tangible asset to go on the balance sheet. If you can't touch or feel it, then it should be expense. And if you think about the businesses today that are above average growers, a lot of the expenditures that make them above average are intangibles. They're to acquire a customer base or R &D spending, marketing spending. All of those go straight through the income statement, even though they have enduring benefits for the business. Customer acquisition costs, we owned a database company, Gartner. They would spend to get new customers and that customer would be with them on average seven years.

54:50When they decided the opportunity was there to accelerate their expenditures for new customers, it ended up reducing earnings rather than increasing them. Recharacterized that expense as a capital expenditure, went through amortizing that through the income statement over a seven-year time period. And instead of Gartner looking like it was selling at twice the market multiple, it made it look like it was selling at less than the market multiple. And there is no debate about Gartner being a better than average business. Most people were talking about, did it really deserve to be at 35 times earnings?

55:28But we thought that was a case where Gap Accounting just wasn't doing justice to a very high quality business. This is something we've done at Oakmark since our inception. Early days, it was on the cable TV industry, where they were spending tremendously on customer acquisition costs, or on a company like Amgen that had very high R &D. But it would be something that every couple of years, we'd find a company where we needed to adjust the financial statements. Today, there are probably half a dozen names in the portfolio, including our largest holding alphabet where the headline multiple looks like it's at a premium to the market.

56:10But after you make a few adjustments, you see that the basic search business is actually available at a discount. Well, Bill, Bobby, thank you so much for joining me today. Before we close out the episode, where can the audience connect with you and learn more about your fund? I think the best spot to learn about Oakmark is to go to our website. That's oakmark.com. And as I mentioned early on in this discussion, we put a lot of effort into trying to write quarterly reports that really explain how we think about investing. And an investor who wants to try and understand us can go to our website and read probably the past five years of quarterly reports that we've written.

56:55None of that gets changed. We don't pro forma it for mistakes that we made back then. And so you can see our comments real time about our successes and our failures, what we thought about the market, what it was causing us to do differently in our portfolios. And I think somebody who puts in the time to read those reports will come away with an understanding of how we invest that would give them the confidence to be a long-term oak market investor, which is what we think you need to be to make a success of a long-term value investing style. Excellent. Well, thank you guys very much. Thanks, Kyle.

57:33Thanks, Kyle. Okay, folks, that's it for today's episode. I hope you enjoyed the show and I'll see you back here very soon. Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by the Investors Podcast Network. Every Wednesday, we teach you about Bitcoin and every Saturday we study billionaires and the financial markets. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.