The Two Holdings Harvard Should Increase
Harvard Management Co. has 120 securities in its publicly disclosed portfolio. Its top four holdings, representing 55% of the portfolio’s $2.3 billion value, are internationally oriented exchange-traded funds (ETFs) that focus on generating income in emerging markets, China, Brazil and South Korea, respectively.
Given Harvard’s clear preference for managing its risk through the diversity afforded by ETFs, I wanted to know which stocks the nation’s wealthiest university endowment was holding.
Seven equities comprise at least 1% of the portfolio as of its most recent filing. None are in the same industry, all except one has a multibillion-dollar market cap; most are megacaps valued at more than $40 billion. Three of the companies — BJ Services, Burlington Northern Santa Fe and Marvel Entertainment — have since been acquired.
Here are the companies Harvard owns, what the university is betting on, and my take on the investment’s prospects:
The largest stock holding is Barclays PLC (NYSE: BCS). This British bank has seen decent returns since Jan. 1, with a better than +27% gain, and a one-year return of more than +100%. Even so, the bank has lost nearly 50% of its value during the past five years as the global financial system weathered the Great Recession. Investors are still unwilling to pay much for bank assets, which isn’t so surprising when you look at the strength of the asset pool that required 8.0 billion pounds in loss provisions in 2009 and 5.4 billion pounds the year before. Investors are only willing to pay 88 pence on the pound for assets, which effectively values the bank’s underlying business at zero.
As Barclays and other banks earn their way out of the bad loans they made, their earnings will inevitably rise, as the cash they were allocating to problem loans will flow instead to the bottom line. It’s a waiting game. Harvard should keep at it. I’d hold this position.
Teva Pharmaceutical Industries (Nasdaq: TEVA) is an Israeli drug maker that specializes in generics. Sales, earnings and book value have grown every year since 2000. The shares currently command 27 times earnings, a discount to its historical average of about 40. Future profits should be significantly enhanced by a recent acquisition of a German drug maker and by a spate of expiring U.S. patents.
Owning Teva is a bet on cost-conscious consumers in the health-care sector, an economic segment that tends to grow faster than overall U.S. gross domestic product. As recent health-care legislation extends coverage to previously uninsured patients, drugs sales are likely to see an increase. The wager has been a good one so far. Teva has outpaced the S&P this year (Teva +11.4%, the S&P +7.0%) and the company has posted annualized returns of +14.3% for the past five years.
Harvard would do well to increase this position.
BJ Services (NYSE: BJS) is an oilfield services company, and owning it signifies a belief that drilling activity around the world will remain strong. As oil prices creep closer to the triple digits and each day seems to bring another announcement of a new crude discovery, that appears to be a good bet. The company was recently acquired by Baker Hughes (NYSE: BHI), which trades near its 52-week high at a robust 35 times earnings, a richer valuation than Google Inc. (Nasdaq: GOOG).
Baker Hughes is a storied company, and Wall Street likes the story. That’s why its valuation has risen to historic highs even despite lackluster 2009 results and ho-hum forecasts for 2010. The longer-term prospects look good, but the company offers a less-than-compelling entry point at these prices.
I see more potential value in offshore players like Transocean (NYSE: RIG), Noble Energy (NYSE: NE) and Diamond Offshore (NYSE: DO), especially as the Obama administration has opened up previously protected U.S. waters for exploration.
Harvard should have some individual-equity exposure to the petroleum sector, but Baker Hughes has limited upside. The offshore drillers are far more promising opportunities: Why buy a company at an inflated price hoping its earnings will rise to lower its earnings multiple when you can buy a company with similar growth prospects but a depressed valuation?
Harvard should close this position.
News Corp. (Nasdaq: NWS) Rupert Murdoch’s media empire has about $30 billion a year in annual revenue, but its run of robust profits came to an end in 2009 when it posted a $5.6 billion loss. Yet even those earlier profits haven’t done much for the stock, which has achieved an annualized gain of +0.7% in the past five years and an appalling -10.7% annualized loss during the past three years.
Though News Corp. produces news and entertainment, it is primarily in the high cyclical advertising business. Its recent track record has been rocky, with 2009 earnings coming in below 2008, and its future doesn’t look great, with 2010 earnings forecast to come in under 2009. So the fact that News Corp. is trading at 24 times trailing twelve-month earnings per share of $0.75 is curious. That’s higher than the S&P 500, which, as a whole, should be able to grow faster than a $40 billion media company. Its valuation also exceeds the company’s five-year average of 18.
Here’s the rub: If a company’s earnings are worth more than the broader market, its assets ought to be, too. After all, the premium to book value represents the market’s valuation of the business that’s going to create those future earnings. But that’s not the case. News Corp. trades at 1.9 times its net asset value, a discount to the broader market’s 2.2. So News Corp. either needs to somehow erode shareholder equity to lower its book value (unlikely), or it needs to seriously juice its earnings. An increase in earnings, however, is already priced in.
There’s no upside to News Corp. Harvard should close this position.
Pebblebrook Hotel Trust (NYSE: PEB) is an anomaly in Harvard’s portfolio. It’s a small real investment trust as opposed to a large international corporation. It went public in December 2009 and has so far only managed to post a small loss. The REIT received proceeds of nearly $400 million that it plans to “opportunistically” invest in the beaten-down hotel sector, which suffered a -16.7% decline in revenue per available room in 2009, one of the worst years for the industry.
Any wager on hotels is clearly a bet on a strong economic recovery where businesses aren’t afraid to spend money on travel and consumers become less discount-focused when booking rooms for vacations. This is an income play that has, of yet, produced no income. Better, more established yields are available.
The last two stocks that made the list are Marvel Entertainment, which was acquired by Disney (NYSE: DIS), and Burlington Northern Santa Fe, the railroad, which Warren Buffett’s Berkshire Hathaway (NYSE: BRK-B) bought. After approval by BNI shareholders — with 70% voting in favor of the $26.4 billion deal — Berkshire said 40% of Burlington shareholders wanted to be paid in cash and 43% wanted Berkshire stock.
Which leaves one final question on this exam.
Will the smartest university join forces with the world’s smartest investor?
To be sure, Harvard got it wrong the first time. The university turned Buffett down when he applied to its graduate business school in 1950. And if Harvard wants to see serious returns on its assets, then it might want to rethink its approach. After all, its investment managers achieved a stunning -27.3% loss on their portfolio in the fiscal year ended June 30, 2009, while Mr. Buffett, who, despite his Columbia MBA, ended 2009 with a +19.8% gain in Berkshire’s book value.
The long-term picture is even better with Buffett: He has delivered a +20.3% annualized return vs. Harvard’s +11.7% annualized growth, which roughly matches the market.
Here’s the crib sheet for the exam: You have to generate some returns in excess of market gain if you’re ever going to get ahead. Let’s check the numbers: Invest $100 million with Buffett and you’ll end up with $4 billion after 20 years. Invest with Harvard and you’ll arrive at a $914 million balance during the same time period, less than 25% of what Buffett earned.
Let’s hope Harvard got it right this time and took the shares instead of cash. We’ll find out in about a month, when the next filing is due. The cash would have earned nothing, but Berkshire has returned +22.1% year-to-date.