Four Buy Ideas from Our Best Performing Manager

For those not familiar with the fund's inner workings, the Yacktman Fund is managed by the father and son duo of Donald and Stephen Yacktman, who have amassed an impressive track record of beating the market over the years. The fund's investment style is fundamentally built around time-tested value investing principles that focus on companies that are inexpensive, have a solid business model with good cash flow, and are run by top-notch, shareholder friendly managers. Donald Yacktman believes that a good business is one that exhibits the following characteristics: (1) market leading position in its principal product or service, (2) products that have staying power and (3) business that should create recurring revenue opportunities (meaning that their products are ones that are repurchased frequently).

Top 10 Holdings of Yacktman Fund on 09/30/09

Stock Price and Morningstar Rating data as of 11-05-09

When you look at the fund's top ten holdings, it should come as no surprise to see that the portfolio is heavily weighted towards Consumer Goods and Media stocks, which made up close to half of the overall equity portfolio at the end of the most recent quarter. It's also evident that the Yacktmans believe in running a concentrated portfolio, with their top ten holdings at the end of the third quarter accounting for close to two-thirds of their total stock holdings. And while the team has a long term investment horizon, they aren't averse to shuffling their portfolio when they identify new investments that offer better rates of return. In fact, over the last year, the Yacktman's have been quick to enter and exit positions when the market presented them with the right opportunities to do so. Ironically, though, many of the largest holdings today are the same ones that the father and son duo owned going into the downturn in 2007, only this time around they're trading at much more attractive valuations than they were just two years ago, with superior return prospects to what they were offering at that point in time.

Top Purchases by Yacktman Fund in 3Q09

Stock Price and Morningstar Rating data as of 11-05-09

The fund has also seen significant inflows from investors this year, which has allowed the managers to continue to put money to work in some of their more favorite names. Of the top ten purchases made by the Yacktmans during the third quarter, three names-- Comcast ,  Procter & Gamble , and  Pfizer --are trading at prices where our analysts still consider them to be buyable.  H&R Block stands out as well, because it was a significant new money purchase during the quarter (albeit one that the firm has owned in the past).

As you may recall, we tend to give a bit more weight to new money purchases, since we believe that they tend to represent an even stronger sign of conviction on the part of managers than increased stakes in existing positions, given the amount of time and effort that typically goes into the decision to invest in an entirely new name. The same holds for outright sales, which we feel is the highest level of conviction (aside from a new money purchase) that a manager can demonstrate within his or her portfolio.

Besides H&R Block, the Yacktman Fund also put new money to work in  Carefusion ,  Stryker , and  Wal-Mart during the quarter, albeit at significantly lower levels of conviction than with the tax preparer. As for outright sales, the fund completely eliminated its stake in  Williams-Sonoma , which it had purchased for the portfolio less than a year ago--no doubt taking advantage of the more than tripling of the retailer's stock price from its lows during November of 2008.

Focused on the Four Conviction Purchases
While not all four of these names are currently trading at 5-Star prices, they are stocks that are looked upon favorably by our analysts, and were attractive enough for the Yacktmans to make a significant commitment of capital to them in the most recent quarter:

 Comcast Corporation
Comcast was literally a new money purchase for Yacktman as its weighting in the overall portfolio jumped from less than 1% at the end of March quarter to 5% by the end of September. According to the Yacktman team, Comcast was inexpensive, as its shares were selling at less than 12 times cash earnings. Besides being the largest cable provider in the U.S, Comcast is also a significant provider of Internet and telephone services. Our analyst Michael Hodel believes that Comcast's advantage stems from the fact that no other company can match the firm's ability to offer multiple services over one connection within the territories it serves. In addition to greater customer loyalty, delivering multiple services leads to higher cash flow per subscriber because the variable cost of adding services is modest.

 H&R Block
Yacktman unloaded a minor stake in H&R Block during the March quarter only to come back with a bang during the third quarter when they built up a nearly 3% position in the name. According to our analyst Vishnu Lekraj, H&R Block is the clear leader in the tax preparation market, with about 16% share of that market. This wide moat player's competitive position stems from its vast network of offices, scale advantages, market-leading position, wide array of financial products, and low incremental investment requirements. The company’s position is further strengthened by the fact that taxes are inevitable, and the increasing complexity of the U.S. tax code likely means that more and more people will be looking to experts to help with file their tax returns, which puts H&R Block in a favorable position.

 Procter & Gamble
The fund increased its stake in this consumer products giant over the last two quarters, with its weighting in the portfolio increasing from less than 3% at the end of the first quarter to more than 6% at the end of September. Our analyst Lauren DeSanto strongly believes that P&G knows the consumer. With brand offerings that span the spectrum from value- to premium-priced, the firm is well-positioned to hold market share in its categories. DeSanto also thinks Procter & Gamble's ability to consistently reinvent itself and refocus on improving its capabilities will serve it well in the current environment, as firms with moats as wide as Procter & Gamble's tend to have greater resilience with their structural competitive advantages showing through during periods of economic weakness. DeSanto also contends that P&G has the opportunity to improve productivity, reduce costs, and generate outsize sales growth in emerging markets where it is still underpenetrated.

 Pfizer
One of Yacktman's biggest moves over the last two quarters has been to raise the ante significantly on its stake in Pfizer. The father and son duo believe that "concerns about upcoming patent expiration on products such as Lipitor, unhappiness about the price the company offered to acquire Wyeth, and general investor discomfort about changes in the American healthcare system are overblown." Having felt that the shares were extremely cheap, they raised their stake from less than 500,000 shares at the end of the first quarter to nearly 3 million shares at the end of September. Our analyst Damien Conover believes that Pfizer's sheer size provides it with the largest economy of scale in the pharmaceutical industry, and that was even before the Wyeth acquisition was announced. He believes the integration of Wyeth will not only strengthen Pfizer's diverse drug offerings, but offer substantial opportunities for further cost savings for the pharmaceutical giant.

We'd also encourage investors to look at the other recent purchases by the Yacktman Fund, like  Coke and  Pepsi , both of which were mentioned in a recent article on the top 10 Consumer Goods stocks being purchased by our Ultimate Stock-Pickers, by reading through the analysts reports we have prepared for them on Morningstar.com. While they might not be trading at 5-star prices today, it always pays for investors to put together a watch list of stocks that represent strong businesses that they'd be willing to hold for the long term.

Disclosure: Swami Shanmugasundaram does not own shares in any of the companies mentioned above.