Value investor Ingrid Hendershot focuses on high quality stocks that warrant a holding period of five, ten, or more years. Here, the money manager and editor of Hendershot Investments explains her long-term investing philosophy and highlights a trio of favorite stocks from the healthcare, medical, and biotech arenas.
Steven Halpern: Our special guest today is Ingrid Hendershot, Money Manager and Editor of Hendershot Investments. How are you doing today, Ingrid?
Ingrid Hendershot: I’m terrific, thank you.
Steven Halpern: Why would such investment luminaries as Benjamin Graham and Warren Buffett focus on a long-term value philosophy, emphasizing that your goal is to find great businesses with great managers and strong financials? How important are these factors?
Ingrid Hendershot: Well, the factors are extremely important to us. We’re seeking high-quality businesses at reasonable valuations that we can hold for the long-term and we want to invest in high-quality businesses because we’re searching for businesses that have a durable competitive advantage that will enable them to generate high returns on shareholders’ equity.
We’re looking for companies that have generated returns on equity greater than 15% for at least five years and preferably longer. We want the high returns because the returns that a business generates over time, that’s what a shareholder should also expect.
A company that has durable competitive advantage has some sort of moat around their business that prevents the competitors from coming in to erode those high returns.
The competitive advantage could be anything from a strong brand like PepsiCo (PEP) has with their snack and soda products, or a patent such as Johnson & Johnson (JNJ) has, or be a proprietary technology like Apple (AAPL) has, or a low-cost provider such as a company like Wal-Mart (WMT).
We also think it’s very important to have businesses with strong balance sheets, preferably with little or no long-term debt; so the more cash and the less debt on the balance sheet, the better we like the business. Strong financials are important because it allows a business to not only survive but to thrive during the inevitable economic storms that will come along.
We’re very much focused also on businesses with growing cash flows. With strong cash flows, management becomes important because they have the ability to reward shareholders either by reinvesting in the business, or making acquisitions to spur future growth, or by paying a dividend, or repurchasing shares.
Steven Halpern: You’ve outlined the factors that you think go in making a great business but in your value approach, it’s not enough to just find a company with these great business attributes. You state that your number one role is to not overpay for a stock and then when you own a stock, you maintain an equally stringent sell discipline. Could you expand on how important the buy-and-sell criteria are?
Ingrid Hendershot: Yes. Once we identify a high-quality company, we only want to invest in the business when we can buy it a reasonable valuation.
We look at a variety of valuation measures including the P/E, the price-to-sell ratio, the price-to-book dividend yield, free cash flow yield, etcetera, but the intrinsic value of any business is the present value of the discounted cash flows that can be taken out of the business over its lifetime.
We only want to invest when we can buy a company at a discount to its intrinsic value, which provides us with an adequate margin of safety in case some of our assumptions are wrong or if business conditions change much more than we might be expecting.
Then, in terms of selling stocks, we truly are long-term investors with low portfolio turnover. We agree with Phillip Fisher who said if the job has been done correctly when the stock is purchased, the time to sell it is almost never. Many of the stocks we own we’ve owned for five to ten years and some for 15 to 20 years as long as we’ve been in business.
There are a few reasons we do sell, though, and one is valuation. If a stock does approach our estimate of its intrinsic value, we’ll trim back the position.
Another reason we might sell is if the business fundamentals have changed and it appears more than a temporary problem, we’ll sell. Then, if there’s a better opportunity available and we don’t have the cash to take advantage of it, we might sell a stock that’s more fully valued to reinvest in the better opportunity.
Steven Halpern: Today, I’d like to talk about three stocks in particular that you have as buy-rated in your portfolio, and each of these are in the healthcare sector. One is AbbVie (ABBV). What’s the story here?
Ingrid Hendershot: Well, we received AbbVie as a spinoff from Abbott. It’s a biotechnology company and their primary pharmaceutical product is Humira, which is a treatment for autoimmune diseases such as arthritis. They also recently launched a very successful treatment for hepatitis C.
What we like about them is they’re generating strong growth. The revenues were up 18% on an operational basis in the first quarter thanks to Humira and their hepatitis C drug.
Management expects that Humira will continue to be a growth driver for many years, but they’re also looking to expand into other areas and they just recently acquired for $21 billion, Pharmacyclics, which has a highly effective treatment for blood cancer such as leukemia. This should really enable them to strengthen their oncology presence.
They have a robust product pipeline with more than 40 active programs underway. They recently increased their dividend 4%, which brought their dividend yield up to more than 3%; so it has a nice dividend, which we think management will be able to continue to increase in the years ahead.
Given their strong start to the new year, they’ve raised their earnings outlook for fiscal 2015 with earnings expected in the 357 to 377 range. They’re just a high-quality company that should provide us with healthy total returns in the years ahead given their dividend yield and the future growth from a robust product pipeline.
Steven Halpern: Now, also in the healthcare sector, you recommend Becton, Dickinson (BDX). What’s the attraction with this company?
Ingrid Hendershot: Well, Becton Dickinson is a medical supply company that’s 118 years old. We’ve owned it for about 13 years and the stock has gone up about fourfold over that time. They manufacture everything from syringes to laboratory equipment to diagnostic products.
They also recently completed a $12.2 billion dollar acquisition of CareFusion, which is a leader in medication safety and the prevention of healthcare associated infections. We think this acquisition should nicely complement their other offerings to hospitals and give them economies of scale.
They’re seeing their strongest growth in emerging markets, which now make up about 25% of their sales. The company has always been very prudent financially and they’ve already paid back about $650 million of the debt incurred with the acquisition. They use their strong cash flows to increase their dividends, which they’ve done for 43 straight years and the dividend right now yields about 2.4%.
We think this year they’ll generate about $1.4 billion of free cash flow. The revenues and earnings both should be up about 20% because of the acquisition, but they also on an organic basis should be on a healthy basis.
We just think it’s a good, high-quality market leader that investors may want to consider sticking in their portfolio given its leadership, strong cash flows, and steady dividend growth.
Steven Halpern: Now, finally, when we last spoke in March, you suggested our listeners look at Gilead Sciences (GILD), and the stock is now up 20% since then and you still consider it a buy. Could you share your thoughts on the company looking forward?
Ingrid Hendershot: Yeah, Gilead Sciences is a leading biotechnology company and we first purchased the stock about five years ago when it was trading for about $18 a share and its leading treatments at that time were for HIV. Today, the stock is at $118 a share and we still think it’s attractively valued as they launched a new hepatitis C drug last year that has turned into a blockbuster drug.
That contributed to their sales more than doubling to about $25 billion last year and their earnings quadrupling. While they are facing some new competitors—including AbbVie, that we just spoke about—we think that their hepatitis C drug, which cures hepatitis C in eight weeks with patients taking one pill a day, has the best profile to enable patients over competitor products.
We think that they’re also generating very strong cash flows. Their free cash flow yield even after the 20% increase is about 9% and they generated about $4.7 billion in cash from operations in the first quarter and spent $3 billion of that cash to repurchase about $30 million shares at an average price of $101 per share.
Management is so competent, and strong cash flows, that they also initiated a dividend for the first time. The dividend yield is about 1.5%. Then they also expanded their share buyback program to $15 billion over the next five years. We think the sale should be about $28 billion to $29 billion in fiscal 2015, which represents about 14% to 18% growth.
The stock is trading about 11 times expected 25 earnings of $10.82 per share, which we think is a very attractive valuation for such a high-quality company with strong growth, strong cash flows, and a robust product pipeline for future growth.
Steven Halpern: Again, our guest is value expert, Ingrid Hendershot, of Hendershot Investments. Thank you so much for your insights today.
Ingrid Hendershot: Thank you.