INVESTMENT FLASH

On The Call With Wally Forbes
Capitalize On Pessimism: Buy Berkshire And Nestle While Others Are Shunning The Market
by Wallace Forbes, 5.24.12, 12:49 PM EST
Forbes.com

Henry Mercer III is president of Mercer Capital Advisers.

Henry Mercer III: The stock market got off to a terrific start this year, but it has struggled lately. Investors have once again become distracted by a number of macro risks, such as Europe’s financial and political mess and a decelerating Chinese economy.

The U.S. economy also remains stuck in a slow growth mode, and the approaching presidential election may make for a volatile summer. All this uncertainty is causing investors to avoid stocks, even though value is attractive. We are actually bullish about the stock market’s long-term prospects. Our optimism has been produced by the combination of attractive value and widespread investor pessimism.

Wally Forbes: It’s encouraging that you’re looking at this as an opportunity, rather than as a thunder cloud that’s going to stay.

Mercer: We want to take advantage of the gloom. A great example of the gloomy sentiment is a recent front page New York Times article which was headlined, “Stock Trading is Still Falling After 2008 Crisis”. The article cited how investors have been turning away from the stock market.

Equity funds continue to be hit with week after week of redemptions. Pension funds and endowments have been cutting back their equity allocations and putting money into bonds despite the miniscule yields there. To us, the pessimism surrounding stocks is very bullish from a contrarian perspective. Successful investing requires a sense of history and the awareness that the most profitable returns are generated from out of favor assets. And stocks are out of favor. We’re like a broken record on this subject.

We believe that the shares of the highest quality companies – companies operating dominant businesses that have withstood the test of time – provide excellent long term value. Today they can be purchased with a margin of safety, and the longer you hold them, the better the results are likely to be.

Forbes: Sounds good to me. That was also brought up by Graham and Dodd. Fundamental investing was the approach.

Mercer: It’s funny that you mention Graham and Dodd because we don’t believe that value investing is dead. One of our current favorites happens to be Warren Buffett‘s Berkshire Hathaway. It’s odd but despite Buffett’s exalted status as the world’s greatest investor, Berkshire Hathaway (NYSE:BRK) as a company is somewhat misunderstood – which has kept investors away in recent history.

The shares are trading at only 1.2 times book value. Yet Buffett has stated recently that the company will buy back shares for 1.1 times book. So there’s a floor under the stock price which, to us, enhances the margin of safety. Investors have been concerned about Buffett’s advancing age and his recent health scare. But he remains a brilliant allocator of capital. His tax crusade is a bit puzzling and has us joking around here that he must be spiking his Cherry Cokes. But there’s great value to the company.

Forbes: So Berkshire is one that you think is a good value and, as you say, it has a floor by way of his buyback announcements?

Mercer: It’s a wonderful collection of businesses that he’s put together over the years. And it’s really positioned, in many ways, to run itself. There are certain factors that will come into play when Buffett’s no longer here. His role will be separated into multiple jobs. You’ll have an operating CEO. You’ll have people running the investment portfolio.

But I think what may, in an ironic way, enhance the performance of the operating businesses is that Buffett has been rather hands-off. A very good operating CEO overseeing these businesses may really be able to drive more value out of them, longer term, than Buffet may have been able to. We just think that it’s misunderstood in the short term. It’s a wonderful value for patient people.

Forbes: Do you see any others that you think are particularly attractive at this point?

Mercer: We’re sticking with our high quality theme and what we like to call the “best of the best” companies. Another one that we like currently, and have liked for a while now, is Johnson and Johnson (NYSE:JNJ). It has a 3.8% dividend yield, a historically low P/E and actually just increased its dividend, which it’s done year after year.

For us, there’s an opportunity in J&J to take advantage of its recent difficulties. The company has had a sterling reputation for integrity that has been tarnished in recent years by a number of product recalls, for example. And they’ve exited from the stent business.

But CEO William Weldon has retired. We’re hopeful that the new CEO Alex Gorsky will place a major priority on restoring JJ&J’s reputation. We think it’s very important that they stick to the company’s famous credo and not hide behind it. But in the meantime, it’s still a powerhouse business with a durable, competitive position. We just feel the recent problems are allowing us to buy.

Forbes: Great. Any others?

Mercer: On our best of the best list there are a couple others that we like currently. Nestle (ADR:NSRGY), the Swiss-headquartered consumer products giant. It has a wonderful portfolio of businesses, approximately 30 brands that generate in excess of $1 billion in sales annually, plus a 3.1% dividend yield. It just announced that it’s purchasing Pfizer‘s infant nutrition business. And we just feel, again, that it’s a powerhouse company that is reasonably priced, with a wonderful history and consistent business record. Patient people should be rewarded.

We’ve also been purchasing Intel shares recently. Intel (Nasdaq:INTC) is the world’s leading manufacturer of integrated circuits – a very well known business that also has a 3% dividend yield. But it’s positioning itself to be a bigger player in chips for mobile devices. It also is becoming a manufacturer for hire, with a division that it calls Intel Custom Foundry Services. So it’s another giant with a bright future ahead. We want to take advantage of the current pessimism surrounding equities to be a long term investor.

Forbes: All of those companies sound like great opportunities.

Mercer: As Buffett says, “Be greedy when others are fearful.” We’re taking advantage of the current uncertainty to invest for the long term.

Forbes: Sounds great. Thank you very much, Henry.

Mercer: It’s fun to do. Thank you, Wally.

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