Steve Romick is a very well-respected investment manager with First Pacific Adisors and manager of the FPA Crescent Fund (FPACX), and he gave a talk very much built on a “where to now” look at the broader economy, the huge problems with the government balance sheet, and the unsustainable nature of public financing.
The big picture presents real possibilities for inflation and for deflation, which present very different opportunities, so you need to prepare for both. He lacks conviction — keeping 30% cash because of the possibility of deflation, but if you believe inflation is the certain outcome you should be entirely in “risk assets.”
The trailing PE has been rising, the market has been fueled by PE expansion — the market now trades at 22.8X trailing 10-year average PE ratio. So what would we rather own than cash? His mutual fund has a large cash position (30%), but what to buy?
Large cap tech stocks are out of favor — his three are Oracle, Microsoft and Cisco. Seeing bad news, disappointment, and a negative media view. The pricing means they’re still attractive (his average cost is lower), and there is earnings growth so the valuations are unjustifiably low. They’re still growing faster than the market, revenue has grown twice as fast as the market over the past five years and earnings have grown more slowly than that (huge cash piles have been a big anchor for their return on capital).
The challenges these companies face are real — alternatives, need to grow through acquisition, secular decline, cloud-based services, etc. These companies have had a quick move from being premium priced to being discount priced, and from being low dividend payers to paying more than the average.
Microsoft (MSFT) — huge cloud business, sticky corporate business, still spending $10 billion a year on R&D, he thinks it’s still attractive and if it gets to a PE of 12 in 2016 that will provide returns of 11-15% annually until then. Very strong returns on a conservative assumption, little risk. Jeff Hubben of ValueAct did a good presentation about them, we’re told, and most people think the company has had substantial problems with capital allocation and management from the top, so there are some catalysts for improvement from better management … but it’s still cheap enough to account for that.