Sarbit almost fully invested

From a peak in 2007, U.S. equity markets have collapsed, bounced back, and gone sideways. All in all, for long-term investors, U.S. stocks at best made no contribution to investor portfolios over the past decade. At worse, they subtracted from portfolio values.

So is now a good time to buy? There are lots of reasons not too. There’s fear. There’s disappointment. And there’s the fact that, over the past 30 years, U.S. bonds have actually provided a better return than U.S. stocks.

Never one to go with the prevailing winds, Larry Sarbit, manager of IA Clarington’s Sarbit U.S. Equity Fund, thinks this time it’s different.

“It’s been a strange period of time,” he says from his Winnipeg base. “The one thing about our business is that it’s never boring. It’s like a different game every day.”

The game today is different from those who have followed Sarbit in the past, where he frequently beat his U.S. fund manager peers not through superior stock selection—he couldn’t find very many stocks that he liked—but by holding cash. When he was at AIC, he reached as high as 90% cash, and even last year, he was 36% cash, according to Morningstar Canada.

“In general we have bargains,” he now says. “It’s a different world in a lot of ways. But from my standpoint the most important thing about it is that you can buy stocks at much better prices, much cheaper prices than you could four years ago and that’s the exciting part of what we do.”

As a result, he suggests he may be running out of money to invest—something that hasn’t happened since the mid-1990s. But, he insists his discipline hasn’t changed.

“We just look for individual businesses that fit what we’re looking for. We don’t care where they are. We don’t care what they do particularly, as long they have the characteristics I’ve always looked for, which is a sustainable, competitive advantage.”

They’re good businesses he says, but investors aren’t buying. They’re frightened. “If people are happy, you pay a full price. I don’t see a lot of happiness out there, but we’re seeing lots of ideas. I’m almost 90% invested, which contrasts with where we were four years ago and certainly where we were 10 years ago.”

As for the investment ideas, he explains that he wants to be sure that “the business is going to be there pretty much in the same form three or five years from now, with a huge barrier to entry, with weak competitors—even better, no competitors—and which doesn’t require a lot of capital input and at the end of the day just keeps spewing out more and more cash to the shareholders.”

That makes for an eclectic portfolio, devoid of any major themes. Holdings include retail pharmacies, amusement parks and fashion brand owners.

Investor fear works for him, he thinks, but against their own interests: “As you know, markets went nowhere—they have gone nowhere for 10 years or longer. Is it any wonder that people don’t want to own stocks? But as usual investors have their eyes firmly fixed on the rear-view mirror. That’s not how you make money in this business. You have to look at the way things are, not at the way things were.”

He thinks those fears have already been discounted in market prices. “Everybody knows about 2007 and 2008. Everybody knows about the problems that exist today. We don’t have to spend any time on any of that because there’s just no point. It’s been beaten to death,” he argues. “Knowing about Greece and Italy, or Europe in general, or the economic problems of America, is not going to make you any money.”

Still, he admits he’d make a lousy macro-economist. He doesn’t know where the bottom is, or when to buy. Instead, citing Warren Buffett, he says he would prefer to be approximately right rather than exactly wrong.

Within his holdings, despite the economic gloom and doom, “companies are reporting not terrible earnings. If you focus on the valuations instead of the underlying business value, you’ll see that.”

Value and valuation are important distinctions for Sarbit. Great businesses can be bid up well above their underlying value. “We don’t own Johnson & Johnson, but I was looking at a chart and the stock has gone virtually nowhere in 10 years. But the earnings have kept going up. It’s just that the stock got so overvalued 10 years ago—I wrote about this 10 years ago—so how are you going to make money if you pay 40 times earnings for a company? It’s just nonsense.”

Investors have a tendency, he says, to base to their behaviour on what worked in the past. “People’s expectations 10 years ago were so outrageous,” he recalls, that “because they were looking in the rear-view mirror over the last 18 years or thereabouts and saying wow, we’ve compounded at 18% a year, the markets have compounded at 18% a year, and so you draw a straight line between the dots,” adding that “if you have a straight-line mentality you’re going to be disappointed at some point.”

Indeed, disappointment frequently has the effect of overlooking opportunities, he argues, because they are not visible from the rear-view mirror.

“What did people want 10 years ago? They wanted U.S., they wanted foreign, they wanted global; they didn’t want Canada, they didn’t want bonds, they didn’t want all the things that have performed over the last decade. Here we are today, with Canadians today owning virtually no American stocks.”

To be sure, investors have not been rewarded for owning U.S. stocks, he observes.

“You can say that they’ve had patience for 10 years, and they’ve run out of patience, but just when everyone has run out of patience, that’s when you need to be focusing on this.”

He then relates the famous anecdote about the man who never wins the lottery. “If you don’t have a ticket, you can’t be upset that you didn’t win,” he concludes.