GoodHaven Capital's letter to investors for the quarter ended September 30, 2024.
“It's not what you look at that matters, it's what you see.” – Henry David Thoreau
To Our Clients:
We had what we consider an exceptional quarter in the period ending September 30, 2024. Our separate account composite was up approximately 12.7% net of fees versus the S&P 500’s rise of 5.9%. Year to date (through 9/30/24), the same composite is up approximately 27.6% net of fees versus the S&P 500’s rise of 22.1%.
Our results for the separate account composite since the start of GoodHaven 2.0 (12/31/19) through 09/30/24 are a cumulative increase (net of fees) of 116.1% versus the S&P 500’s increase of 92.4%. While we wonder if there is a perfect “category” for our unique portfolio we note that, according to Morningstar, our public fund, managed alongside your account, ranked (at 09/30/24) in the top 13%, 1% and 3% of our category for the trailing one, three, and five-year periods respectively.
While we are happy with our recent results, as conveyed by the above numbers, there are a few other portfolio statistics that leave us even more pleased. The below table, which you’ve seen before, shows the portfolio valuation and growth characteristics of our public fund - managed alongside our accounts. We have accomplished what we have with a portfolio that is trading at a much lower valuation than the S&P 500 and also has a better recent growth profile. As you know, we do not utilize any portfolio leverage and the majority of accounts are not fully invested. How one achieves returns matters for us, as well as the returns themselves. Such statistics also convey our long-term optimism for our future returns despite pockets of overall market excess.
While the above statistics leave us feeling, in our view, good about both the long-term downside risk and upside potential of our holdings - we again take this moment of recent strong results to remind you that your portfolio is managed striving for long-term outperformance. We will underperform the market averages from time to time. Also, despite our best efforts and alignment as material fellow clients, we will make an occasional unsuccessful investment. Having said that, we are pleased (but never satisfied) with our recent results.
The domestic macro backdrop continues to be one of modest economic growth, materially lower recent inflation, recently reduced short-term interest rates and continuing unhealthy levels of Federal debt outstanding. We recall the long list of “experts” who not long ago vehemently predicted the impossibility of reducing inflation without creating a serious recession. It’s not that we predicted differently. It’s that we realize how difficult and counterproductive such predictions can be to long-term portfolio management. We think odds are pretty reasonable that higher corporate and personal tax rates are in the cards - no matter who wins the election.
As you know, we observe, respect, and monitor the macro. We then return to turning over rocks in search of new investments that fit our mandate, circle of competence, and can be purchased with what we believe is a margin of safety. We of course always closely observe current and likely future business trends for our existing holdings.
As we have conveyed before, plenty has been written in the financial press about the dominance of a small number of tech companies (now called the Magnificent Seven) on the results of the S&P 500, and how their price performance obscures the recent less robust performance of most of the index, much less other equity indices that are not dominated by these companies. We have long felt this is a topic worth paying some attention to, just not nearly as much attention as many think it warrants.
These extremes continue, though a bit differently lately, as our friend the noted financial journalist Allan Sloan recently thoughtfully articulated below on October 9, 2024:
“…even though we aren’t hearing quite as much about the Mag Seven as a collective group these days, they still have magnificent collective numbers.
Let me show you, using numbers that Wilshire Indexes sent me. The FT Wilshire 5000 Total Market Index, a market-cap weighted index of thousands of stocks, is intended to represent the entire stock market. I prefer the Wilshire to the more commonly used S&P 500 index for measuring the Magnificent Seven’s impact because the Wilshire, which tracks 3,334 U.S.-traded stocks, is a much broader indicator than the S&P, which tracks 503 stocks.
Because market caps of the Magnificent Seven companies are so large, they collectively represent 27% of the FT Wilshire 5000 Total Market Index. But they represent an even greater portion of the index’s 20.1% return so far in 2024. Through the end of last week, those stocks account for more than 40% of that return.
Sure, this year’s numbers for the Seven aren’t as magnificent as last year’s, when the Seven accounted for just over 50% of the Wilshire’s return, more than double their combined 24.4% weight in the index. But this year’s numbers are nothing to sneeze at.
The most interesting part of this year’s Mag Seven numbers is the huge role played by a single stock: NVIDIA Corp (NASDAQ:NVDA). Nvidia’s outsized contribution to the Wilshire’s return this year is yet another example of how Nvidia shares have been making tons of money not only for the investors who own it but also for those of us who own it indirectly through the S&P 500 and total stock market index funds.
The Wilshire rates stocks based on their market value changes, not on share price changes the way the Dow Jones Industrial Average (DJI) does. And Nvidia’s contribution to the Wilshire’s return this year is more than triple its Wilshire weight.”
We are open-minded and not dogmatic about sectors and companies to invest in. We need to have a margin of safety, and real confidence in what the company and industry will look like down the road. However, these distortions are important to be aware of. We have been able to materially outperform the S&P 500 at GoodHaven 2.0 without owning most of the index’s biggest recent winners. We are not emphatic about where we find ideas and we also won’t write pages of excuses when we periodically lag the index. We continue to show our results on your enclosed performance reports versus some additional indices which we think are relevant.
Our biggest dollar detractor in the period was our long-time holding in Alphabet Inc (NASDAQ:GOOG). Alphabet was dealt a legal setback when a judge ruled it a monopoly in certain aspects of its core business. While we’d prefer that the recent legal cases had gone in the company’s favor, we’ve long contemplated (and articulated) that GOOG would have to deal with a hostile regulatory climate and potential legal/antitrust setbacks. Given GOOG’s recent strong operating results and growth, to a great extent it feels to us that “Mr. Market” has already materially penalized GOOG for such risks and uncertainties - and of course we are likely years away from any actual resolution. We also keep in mind what some of the “pieces” at GOOG might be worth if they were forced to separate some parts of the business. Having said that, we didn’t like the “remedies” from the DOJ discussing AI so much - GOOG needs to make sure “the customers aren’t the winners”, and there is clearly more competition for the core business. I doubt the GOOG’s culture will pivot to Apple Inc (NASDAQ:AAPL)’s capital allocation policies of the recent past of large share buybacks while throttling back much other spending, but it is interesting to consider. It’s also interesting to consider the positives and negatives of eliminating the Apple type exclusivity payments - if that was a remedy. In light of all of the above, we continue to think about where we might add to GOOG selectively considering the overall situation and modest stock price relative to earnings and the quality of the company - even with obvious headwinds.
Our next biggest dollar detractor in the period was a decline in our long-time holding Devon Energy Corp (NYSE:DVN). During the period Devon closed on its acquisition of Grayson Mill Energy - which seems attractive to us. At Devon’s recent share price, the stock is trading for less than 9x forward FCF and we feel plenty of upside exists, and we have selectively added to our holdings in the period.
Our biggest dollar gainer in the period was our long-time holding Builders FirstSource, Inc. (NYSE:BLDR) (which was last quarter’s biggest detractor). Builders is astutely managing through a period of lower single-family housing starts, weaker lumber prices and decline in housing affordability. Some portfolio decisions you “see” - buys or sells - and some you don’t “see” but are often as important. Our decision a few years ago to maintain our outsized housing industry exposure in the face of rising mortgage rates and affordability issues was counter-intuitive, but we think it has and will continue to serve us well over time. We applaud the coming well-deserved move of long-time Builders CFO Peter Jackson to the big chair.
Our next biggest dollar gainer was our long-time holding TerraVest Industries Inc (TSE:TVK). While some prefer an all-nighter in Las Vegas, I recently returned from an exhilarating trip to visit the TerraVest subsidiary Granby’s oil tank plant in Cowansville, Quebec. Charles Pellerin’s (Executive Chairman) capital allocation wisdom and TerraVest’s solid operating results have not gone unnoticed, with the shares having more than doubled for the year through 9/30/24. We still feel plenty of long-term upside remains.
Another material gainer in the period was Jefferies Financial Group Inc (NYSE:JEF). Not so long ago, Jefferies CEO Rich Handler articulated a vision to focus on gaining market share in investment banking, exit opportunistically its legacy merchant banking investments, and IF the share price remained attractive embark on a material share repurchase program. We were in the minority in our view that this could be done. Rich’s (and President Brian Friedman’s) 2023 letter excerpt and the statistics that follow sums up well the accomplishments:
“Returning capital to shareholders remains one of our overriding priorities. In 2023, we returned an aggregate of $986 million to common shareholders in the form of $816 million in dividends (inclusive of the Vitesse spinoff) and the repurchase of 5 million shares for a total of $169 million, or $34.66 per share repurchased. We have returned $6 billion in total capital to shareholders over the last six years, representing over 78% of tangible book value at January 1, 2018. 252 million fully diluted shares remain outstanding today versus 373 million six years ago.”
In addition, Jefferies continues to make significant market share gains in investment banking. JEF is currently in the top 10 in the North America M&A league tables (with deal $ volume more than doubling) YTD, compared to a #27 ranking just two years ago when industry deal volume was ~6% lower.
While the shares have traded up materially on this progress, we look forward to more long-term success.
Our only material sale in the period was to completely exit our successful holding in Goldman Sachs Group Inc (NYSE:GS).
While life contains many mysteries that defy easy explanation, one not so mysterious observation is that usually over time a company’s stock price follows its earnings per share, provided your starting point is a reasonable valuation. A very high or very low starting price can of course dampen or amplify such returns. While we are not saying it’s easy to deliver strong long-term gains, we do remind ourselves what is a critical driving force in achieving them.
One administrative note. Given how the world has evolved with the advancement of digital theft risk, I suggest that, where possible, folks viewing any financial account online set up some sort of “dual authentication” when logging in.
I thank all fellow clients for their confidence as GoodHaven 2.0 continues to unfold. Forward we go.
Stay healthy and safe,
Larry Pitkowsky
GoodHaven Capital Management
