Tuesday, September 02, 2008
10 Questions For John Dorfman
Kirk: Over a year ago you decided to devote full time attention to your firm, Thunderstorm Capital, and were getting ready to launch a new mutual fund. How are things going for you now?
Dorfman: I’m thrilled about the mutual fund. We launched the fund, which is modestly called Dorfman Value Fund, on December 31, 2007. As of June 30, we were actually up fractionally for the year – which in a nasty year such as 2008 pleased me very much. As of this moment, through the close on August 28, we are down -3.8% while the Standard & Poor’s 500 Index is down -10.2%.
For many years, I’ve dreamed about running a mutual fund. I have nothing against making rich people richer, but I’ve always wanted to have an investment product for the ordinary person. In addition, I’ve always liked the idea of competing in an open, fair public forum against other mutual fund managers, many of whom I respect. I love the idea that we are all judged quantitatively by the same rules, and that the results are public knowledge in newspapers and on the web. It appeals to my competitive instincts.
The fund’s stock symbol is DORFX and people can download the prospectus and other information from our website or they can phone 1-888-6-DORFMAN.
Kirk: Looking over the returns within your peer group, it hasn't been easy to be a value focused investor. Why do you think that is?
Dorfman: It hasn’t been easy to be an investor, period. Whether you are growth or value, this year has been a struggle. The growth and value indices are not too far apart.
Kirk: In the past Q&A, you said that you have three favorite screens - the Robot Portfolio, Bunny Portfolio, and Casualty List. How have they been working for you lately?
Dorfman: I’m pleased with how they’ve worked, but bear in mind that we don’t use them as a black box. We use these screens, and others, simply as a source of ideas. We don’t buy a stock just because its name lights up on a computer-driven algorithm, we also want to feel that we understand the business, and have some faith in management, and have some insight into the competitive landscape. But these screens have been a fertile source of ideas for us over the years.
The Robot screen contains low P/E outliers. It calls our attention to some of the very cheapest stocks in the market, in the bottom percentile of price/earnings ratios. It screens out stocks that have excessive debt. From this screen we recently bought Om Group (OMG), the largest U.S. dealer in cobalt. It also deals in metal powers. The stock is selling for less than book value and less than six times earnings. We also bought some Cal-Maine Foods (CALM). It produces and sells eggs. Now that some of the crazier diet fads seem to be receding, I figure that eggs can rebound a little bit as part of a well-rounded diet for most Americans. The stock sells for 6 times earnings.
The Bunny screen, or Growth at a Low Price, looks for stocks with a five-year historical earnings growth rate of 25% or better, and a current price/earnings ratio of 12 or less. Among those, the screen selects the five with the highest growth rates and the five with the lowest P/E. OM Group has made an appearance on this screen too.
The Casualty List is simply a list I used to write about each quarter containing stocks that are down a lot, and that I think have rebound potential. One stock that we’ve bought this year is Ceradyne (CRDN), which makes bullet-resistant armor and advanced technical ceramics. It was down more than 30% in the first quarter.
Kirk: Are there any stocks on these screens that you're particularly interested in right now?
Dorfman: There are a few we’re looking at. From the Bunny screen we are intrigued by Western Digital (WDC) & ConocoPhillips (COP). My friend and mentor David Dreman owns a lot of ConocoPhillips (COP). By the way, Goldman Sachs (GS), which we own in the fund, just missed the cut on the latest Bunny screen. I want to learn about Insight Enterprises (NSIT), a technology company that shows up on the Robot screen right now.
Kirk: Looking over the most recent SEC filings for your fund, I see some familiar stocks like Berkshire Hathaway, Bear Stearns, Autoliv, Apache, Goldman Sachs, Kinetic Concepts, Nam Tai, Rofin Sinar, Schnitzer Steel, etc. Can you talk about some stocks that you've sold recently?
Dorfman: We trimmed two of our energy holdings, Apache (APA) and Devon Energy (DVN), at mid-year, to keep them from being too large a percentage of the fund. Also, they had accelerated very fast in the first half of the year. Apache, for example, rose more than 29% in the first half. Since then it has fallen nearly 18%. Now that we’ve had an energy correction in July and August, I think it’s a good time for people to buy again.
By the same token, we did some mid-year trimming in two of our metals stocks, Schnitzer Steel (SCHN) and Commercial Metals (CMC). Again, that proved propitious. And again, in July and August we wished we had sold more. But you can’t be too fine or too cute with these things.
Recently I sold my holding in MB Financial (MBFI), a Chicago bank. It’s price/earnings ratio has crept up to 17, and there has been a little selling by insiders. In addition, the stock hasn’t been acting well. It’s down about 19% in the past 12 months. I still own other banks in the fund – Cullen/Frost Bankers and Banco Latinoamericano.
Kirk: I know your strategy is to focus on low-expectation stocks. In you opinion, looking ahead with a one year time frame, where should long-term value investors be focusing their attention as far as sectors go?
Dorfman: I think there are big bargains now in the financial sector and the pharmaceutical sector. Many pharmaceutical stocks have declined five years in a row. These are companies that make innovative products that save people’s lives. And yet they sell for multiples comparable to those of the tobacco stocks.
Kirk: A year ago you said, and I quote "Right now, for example, some of my screens are chock-a-block with homebuilder names. My judgment, though, is that the situation for home prices is going to get worse before it gets better." That was a terrific call at the time. Where do you think value traps current exist that we should watch out for on our value screens? (financials, homebuilders, commodities, techs?)
Thank you, regarding my call on the homebuilders. As for value traps now, I think it is still too soon to buy many consumer stocks. Most consumers’ balance sheets are weak now. And they can no longer tap into their home easily as a source of cash. So, by and large, I prefer industrial and materials and pharmaceutical stocks now to consumer stocks.
Kirk: As a value investor who uses p/e ratios, price-to-sales, and price to book, one of the questions I'm often asked is how to figure out the fair value for a particular stock. What are some tips and/or rules of thumb you have that would help those who attempt to undertake valuation analysis on their own?
Dorfman: Everyone needs to work out a method that feels right to him or her, and that works with his or her temperament. For my part, I generally look for stocks that sell for less than 15 times earnings, less than 2 times book value and less than 2 times sales.
Kirk: In your weekly Bloomberg column you frequently shared stock screens you'd find helpful. Have you been working anything new lately along these lines and/or have any interesting observations to share based on what you're seeing now?
Dorfman: I’m using the same screens as in past years, with a few tweaks. But screening is only one of many ways to find interesting stocks. I love to buy good companies on bad news. And I like to ask companies who, among their competitors, they respect.
Kirk: Many investors, including most on Wall Street, didn't see the credit crisis until it was too late. In your opinion, are there any long-term lessons individual investors should learn from this disaster? Are there any long-term ramifications that you think we should be aware of?
Dorfman: I was among those who didn’t see the damage coming, notably the collapse of Bear Stearns. I had a 2% position in Bear Stearns in the fund just before it went over the cliff. I think one lesson, always worth learning again, is to be very careful about leverage. I rarely buy a stock whose debt is greater than stockholders’ equity. That eliminates about one third of U.S. stocks right off the bat. Usually I prefer companies whose debt is less than 50% of equity, which puts them in the strongest one third of the universe.
Also, it’s important to have cross-checks, or as I call them “sincerity barometers,” to evaluate whether management’s true view of a company’s prospects is as rosy as public statements suggest. Insider purchases and sales are very useful as a test of managers’ conviction. Dividend policy is another good indicator. A company generally won’t raise the dividend unless it thinks earnings progress is sustainable. It doesn’t want to hear the howls from shareholders if the dividend later has to be cut.