We saw a higher level of trading by our top managers in the most recent period.
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By Greggory Warren, CFA | Senior Stock Analyst

The end of the third quarter and start of the fourth quarter of 2010 were exemplified by strong equity market performance, with the S&P 500 Index  posting one of its best returns for the month of September in the last 85 years. This compares to the seesaw of returns posted by equities during the five months prior to September 2010, with the market dropping more than 8% in May, and another 6% in June of this year. The market rebound was driven by solid second-quarter earnings results in the face of the European credit crisis, and its potential impact on the global economic recovery.

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It was against this backdrop that our Ultimate Stock-Pickers were reviewing their portfolios, making purchases or sales that would prepare them for what they believed would be the next stage of the market. Much as we saw in the second quarter, our top managers continue to have a reserved attitude about the markets and the economy, unlike the first quarter of the year when they were imbued with a sense of cautious optimism.

As we were sifting through the holdings, purchases and sales of our Ultimate Stock-Pickers, we were intrigued by the dichotomy that continues to exist among our top managers. While most have been taking measured steps to invest in companies that have relatively stable revenue, sound balance sheets, and increasing cash balances that can be used for debt repayment, dividends, or share repurchases, a few continue to focus on more cyclically sensitive firms. As we sifted through our Ultimate Stock-Pickers' holdings, the best description of the current market environment that we could find was exemplified by the managers at the  Jensen  fund, who said the following in their third-quarter commentary:

"The economy seems to be in a state of malaise, and investors' sentiment has been marked by reactions to daily headlines rather than business fundamentals. In this environment, we live with a certain amount of "expectation risk" in our portfolio companies. As such, positives don't tend to result in stock prices being marked up significantly, but negative news drives stock prices down. Fundamental business performance�is generally good and improving. Companies are taking advantage of cheap credit, and using the proceeds to refinance debt, buy back shares, and pay growing dividends. The growth prospects in the U.S. and developed Europe will likely remain low for some time, yet the outlook for many emerging economies remains bright, allowing global companies�to pursue attractive opportunities for growth. We believe that valuations are compelling and, in many cases, disconnected from�earnings and cash flows�"

Ultimate Stock-Pickers' Top Holdings

 
Star Rating
Fair Value Uncertainty
Size of Moat
Current Price ($)
Price/Fair Value
No. of Funds
ExxonMobil 
4
Medium
Wide
69.23
0.81
5
Brkshr Hthwy 
3
Medium
Wide
79.76
0.89
11
Johnson & Johnson 
4
Low
Wide
62.30
0.81
13
Coca-Cola 
2
Low
Wide
64.11
1.12
11
Microsoft 
4
Medium
Wide
25.25
0.79
14
Wells Fargo 
5
Medium
Narrow
26.65
0.68
10
Occdntl Petrlm 
3
High
Narrow
87.65
0.95
7
Procter & Gamble 
4
Low
Wide
62.13
0.81
12
American Express 
3
High
Wide
42.27
0.78
10
Wal-Mart 
3
Low
Wide
53.74
0.90
13

Data as of 11-26-10. Fund ownership data as of funds' most recent filings.

Even with the changes made to the Investment Manager Roster at the start of the year, there haven't been any significant changes in the top ten stock holdings of our Ultimate Stock-Pickers over the last seven calendar quarters. Only three of the top ten highest conviction holdings of our 26 managers,  ExxonMobil ,  Occidental Petroleum , and  American Express , were not on the list at the end of the fourth quarter of 2008. Looking at the three names that fell off the list--Burlington Northern Santa Fe,  ConocoPhillips , and  Pfizer --each fell off for completely different reasons. As you may recall, all of the outstanding shares of Burlington Northern were acquired by Ultimate Stock-Picker  Berkshire Hathaway  during the first quarter of this year. Pfizer, meanwhile took a tumble down the list after  Fairholme dumped what had been a rather substantial holding in the health care firm. While ConocoPhillips has been the target of selling activity by Berkshire over the last seven calendar quarters, it wasn't a seller during the third quarter. Instead, it was a major sale by  Alleghany  that finally pushed it out of the top ten holdings.

Alleghany is also the reason that ExxonMobil has made such a meteoric rise up the holdings list. The insurer started buying shares of the energy giant aggressively in the fourth quarter of 2009, as it eliminated the final 1 million shares it held in Burlington Northern in the wake of news that Berkshire would be buying the railroad. Alleghany had been a longtime holder of Burlington Northern stock, with shares in the railroad accounting for 36% of the insurer's equity portfolio at the end of 2008. Almost all of the proceeds from the sale of Burlington Northern shares went into energy stocks, with ExxonMobil being the largest recipient. The energy giant made up 46% of Alleghany's stock portfolio at the end of the third quarter of 2010, with the insurer adding another 1 million shares to its existing 6 million share stake. Alleghany has funded most of its purchases of ExxonMobil this year with sales of other energy stocks, like ConocoPhillips,  Devon Energy , and  Williams Companies .

Looking at the trading activity among the other top ten holdings, our managers were net sellers of Berkshire Hathaway's common stock, with  Mutual Shares  making the most meaningful sale during the period.  Johnson & Johnson , meanwhile, was the recipient of a meaningful new money purchase by  FPA Crescent , which when combined with the other buying activity by our top managers, was enough to overcome significant sales by Jensen and  Parnassus Equity Income . While making no mention of the reason behind its complete sale of the health care firm, Parnassus was adding to positions in  Medtronic , its fourth-largest holding, during the period. The manager also made significant new money purchases of  Hewlett-Packard ,  Cisco Systems , and  Spectra Energy , several of which were discussed in a previous Ultimate Stock-Pickers' article.

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The Morningstar Ultimate Stock-Pickers Team does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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