Bob Rodriguez – FPA Capital Q3 Letter

In the fund`s last letter, Bob Rodriguez made it clear he is cautious with stock markets valuation – over 20x  P/E (ttm) and 15x P/E (12m fwd), which compares to 1996-1998 and 2004-2007 – and the economy perspectives. There were a couple highlights in the letter:

  • How he thinks of cash: 

“We think of cash as an asset that has no duration, but provides an embedded call option  that can be exercised when quality assets are cheap on sale.”

  • Comment on career risk: 

“It is often a lonely endeavor to be a true contrarian absolute value manager. Most people feel secure in the knowledge that others like them are nearby, doing similar activities, and generally moving in the same direction. Most people do not want to be alone or feel awkward because they are the only ones dancing on the dance floor.”

  • What he looks for in companies:

“Our pipeline of companies with long histories of profitability, strong industry positions, pristine balance sheets, and solid management team (…)”

  • His view on stretched valuations and value screened paramenters:

“It is hard to intelligently deploy capital when most people are stretching for yields. We can see the reaching for return effect in our “core value screen” which looks for companies selling below 15x earnings, 7x cash flows, 2.2x book value and 1x sales, and have debt to capital of less than 40%. This screen is qualifying less than one hundred names currently, which is in the bottom third historically.”

  • Macro thoughts:

“The U6 unemployment rate, which includes part time employees who would prefer ful time jobs, is almost double the 2007 level of 8.0%, and has increased in the last six months from 14.5% to 14.7%. Total nonfarm employment is still 4.5 million below the 2008 level. As a result, the civilian employment-to-population ratio has dropped from over 63% in 2008 to 58.5%. This is almost five-point drop is the real hit to employment level, and it is substantial.” 

“The real median income for U.S. households measured in 2011 dollars has declined by nine percent since 2000 (when it hit $54,932) to $50,054 per household.”

“In our eyes, further quantitative easing is neither logical nor well thought out, since the upside does not offset the risks.”

“White concludes that the current ultra easy policy is neither likely to be effectively transmitted to the real economy, nor to lead private sector spending to respond and reduce unemployment.”

Bottom line: macro backdrop is worrisome, with unemployment at high levels, household real income falling over a ten year period and lack of investments. S&P margins should drop going forward which should give an opportunity to value investors deploy capital wisely. Cash is king (almost 1/3 of NAV is in cash). He keeps looking for high quality companies with discount to their intrinsic value and acknowledges the rally was of low quality companies.

Full letter can be found here.

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