Bill Nygren calls himself a value investor: He buys stocks selling at a deep discount to what he thinks the underlying businesses are worth.
So he isn’t surprised when shareholders in his $20 billion Oakmark Fund raise their eyebrows upon finding out that he owns high-flying technology names like Apple, Alphabet and Netflix. With a price-earnings ratio of 241, Netflix is no obvious bargain in a market that trades at a 22 multiple.
Nygren’s not alone. Many of the best-performing funds in Bloomberg’s large-cap value category over the past year got help from the so-called FAANGs — Facebook, Apple, Amazon.com, Netflix and Google parent Alphabet. The stocks all belong to the Russell 1000 Growth Index, but the fund managers say they haven’t changed their strategy or compromised their standards.
“On traditional measures like price-earnings these stocks can look expensive,” said Connor Browne, whose $982 million Thornburg Value Fund holds Alphabet, Facebook and Apple. “But if you back some things out, even a company as exciting as Facebook can look cheap.”
Many in the value camp eschew the FAANGs. Hedge fund manager David Einhorn has been shorting a “bubble basket” of growth stocks including Amazon and Netflix, with frustrating results. Bill Smead, who is steering clear of the stocks at his $1.3 billion Smead Value Fund, said value managers who own them are just “trying not to be put out of business by the momentum of this trade.”
Large-cap growth funds averaged returns of 25 percent over the past year, dwarfing the 11 percent gains made by their value counterparts, according to researcher Morningstar Inc.
History isn’t on the side of the FAANGs, according to Rob Arnott, a pioneer of smart-beta investing and the founder of Research Affiliates, which helps oversee about $214 billion in assets. His research shows that, typically, nine out of the 10 global stocks with the greatest capitalization — all the FAANGs except Netflix fit the bill — trail the market over the next decade.
“That is a daunting headwind for those who want to chase the growth names,” Arnott said.
Nygren isn’t worried. Since he took over Oakmark in March 2000, it has returned almost 11 percent a year, compared with 5.4 percent for the S&P 500 Index. The fund has beaten at least 97 percent of peers over the last one, three and five years.
“The problem is growth usually comes at a price the value investor isn’t willing to pay,” Nygren, 59, said in a telephone interview from his Chicago office.
The money manager also makes more classic value investments. Key holdings Citigroup and Bank of America boosted returns in 2017. Still, Nygren sees no reason a value investor can’t own fast-growing companies.
The trick can be figuring out what you are paying. Alphabet’s P-E ratio is misleading, Nygren said, because the tech giant has businesses that lose money, including the Waymo autonomous-driving unit, or may be marginally profitable, like video operation YouTube. Those divisions can crimp current earnings but carry significant value because of their potential.
“When you dig deeper you can easily conclude that the stock market is not pricing Alphabet as the excellent business we believe it is,” Nygren said.
His reason for owning Netflix is different. Nygren passed on the streaming company in 2011 because he saw its future as too uncertain. When one of his analysts recommended the stock in 2017, he remained skeptical. Nygren changed his mind after concluding that Netflix’s strategy of keeping subscription prices low at $11 a month hurts profitability but allows it to grow faster.
Browne at Santa Fe, N.M.-based Thornburg Investment Management has owned Netflix in the past but deems it too pricey now.
“We’d love it if they stumbled and gave us another chance to invest,” he said.
Even the definition of value is squishy. Most FAANG holders on Bloomberg’s value-fund leaderboard, including Oakmark, Thornburg and the $11.4 billion Davis New York Venture Fund, are classified as large-cap blend by Morningstar.
Nygren is aware that many question his approach, as he’s heard from investors and financial advisers over the years. People should force him to defend his picks, he said.
“We are value investors and only buy companies selling at a large discount,” Nygren said. “Owning these stocks is consistent with our philosophy and we are delighted to go through that exercise with our shareholders.”