Dear Fellow Investors,
“It breaks your heart. It is designed to break your heart. The game begins in the spring, when everything else begins again, and it blossoms in the summer, filling the afternoons and evenings, and then as soon as the chill rains come, it stops and leaves you to face the fall alone. You count on it, rely on it to buffer the passage of time.” ― A. Bartlett Giamatti
As we enter April, baseball comes to mind while the Major League Baseball Season begins. Commissioner Giamatti’s thoughts are apropos and reflect on baseball across the seasons of the year for players and the fanatics of the sport. Baseball carries many similarities to investing. There are a myriad of investment opportunities among stocks, bonds and other investment products much like there are thousands of events in a baseball season like plate appearances, outs and runs. The one constant in the investment world and baseball is change. Change during the year. Change over the years.
Both games reset all the time, asking the competitors on the field to bring their highest level of competition. There is the excitement of twilight in the summer and success in investment holdings. There can be disappointment at the end of most seasons in the fall and sometimes poor investment results. Both are part of the constancy of the games. For baseball fans, they have a team or a player they root for. However, in the world of investing, some advocate for an approach of not trying to root for or own a winner. The urge to passively participate in investing without a team to root for lies in industry jargon like volatility and risk-adjusted returns, but do those views on investing ever spell outright success like a World Series Championship or a Hall of Fame induction?
A Player to Own
Ted Williams is regarded as one of the greatest hitters in baseball history. Williams’ batting average in 1941 was .406. For non-baseball enthusiasts, a batting average above .300 is widely regarded as above average. That 1941 season was the last year a player has hit over .400! In hindsight, it is easy to evaluate the success that Ted Williams had during the 1941 season, but was it easy to sit through as the owner of his contract?
The 1941 season was only Ted’s third in the major league. He didn’t have a large body of work to prove his prowess as a great hitter. He started off the season with an injury that nagged him and as he saw more at bats in early May, his batting average plummeted to .310 for the season. A change in batting average like that sounds like a lot of volatility for an outstanding hitter to have. At that point in the season, the naysayers were probably assuming the worst for Ted’s batting average. However, by the close of the season, he had produced a most remarkable year.
Owning a Great Season vs. Owning a Great Career
Williams’ career is one of consistency, but it was not one without stumbles. He followed his 1941 season batting .356 in 1942. The owner of the team had to continue to feel good about his ownership of Williams’ contract. This all ended as Williams went to fight in World War II, missing three seasons from 1943-1945. After the war ended, Williams picked up where he left off, batting .342, .343, .369 and .343 in the four years that followed.
In 1950, Williams’ games were limited by injury, batting only .317 that year, a far cry from where his career had been up to that point. How did the owner feel about his lack of production that year? There was a lot of “volatility” in his plate appearances and batting average. He returned in 1951 to a full season of games, but still didn’t hit near as well as his prior years and finished the year hitting .317.
Prior to the 1954 season, Williams had missed parts of five seasons to the military, one season to injury and in his last full season (1951) had one of the lowest batting averages of his career. What is an owner to do? Frustrating? Yes. Did this make it pointless to continue on with Ted Williams on your roster? Indexing probably looked very attractive at this point.
Willie Mays (who some regard as the greatest baseball player ever) commented on Williams saying, “Ted Williams was the best pure hitter I ever saw.” He proved this through the remainder of his career starting in the 1954 season when he hit .345, followed by .356 in 1955 and .345 in 1956. Maybe the greatest achievement of Williams’ career was in 1957, when, at the age of 39, he led the league with a .388 average (with 33 intentional walks).” A 39-year old man hitting .388 is unheard of, but was indicative of the great hitter that people came to know as he built his Hall of Fame body of work.
Where are the Great Pure Hitters in Stocks Today?
Thanks to the use and popularity of passive investments, many market participants are asking if it is possible to find pure hitters among individual stocks. The claims are that the volatility and the lack of consistency make it impossible for investors to stay with a ten-to-twenty year contract. At Smead Capital Management, our eight criteria guide us to seek out pure hitters in stocks among the shares of companies that have already exhibited greatness in their past, much like Ted Williams.
H&R Block (HRB)
H&R Block was started by brothers Henry and Richard Bloch in 1946 in Kansas City, MO. H&R Block is the largest and most widely recognized tax preparation company in the United States of America. The original H&R Block franchise was actually a creation of circumstance. Henry and Richard tried to sell their H&R Block tax preparation practice to new operators to move to New York City to expand the H&R Block clientele. The buyers weren’t able to pay the price, so the Blochs took a payment that included future royalties on their Kansas City-based practice. Born from this situation is a large franchise model for tax professionals to leverage the H&R Block brand.
Going back to the earliest data that we can get our hands on, H&R Block has produced an 88.33 fold increase in value versus a 42.92 fold increase in the S&P 500 Index from July 31st 1980 to March 31st 2016. This was a return of 13.41% compounded over the almost 36-year period. Today, H&R Block has a market cap of around $5 billion. The company is anticipated to produce $488 million in free cash flow in 2016. Below is a look at their return on equity from 2011 through their fiscal year-end April 30, 2015.1
Much like Williams hitting .388 at the age of 39, H&R Block could produce returns on equity, which are unheard of. It’s unlike almost anything we’ve ever seen in a company. It shows the investor how little capital is needed in the day-to-day operations of their business.
H&R Block hit an all-time high in December of last year at $37.53 before a lonely fall to a price around $24.15. The depressed price is the product of both political parties promoting simplified tax code ideas and fears of consumer adoption of do-it-yourself tax preparation. Harkening back to Giamatti, that kind of price movement “breaks your heart” leaving you to “face the fall alone.” Investing, much like baseball, does that regularly. This has brought the stock to trading at 11.56 times the next 12 month earnings estimates. You can hear the naysayers in the stadium crowd complaining over the sub-par plate appearances in the interim.
Baseball and investing have their similarities and the beginning of spring is a great time to think about both of them. At Smead Capital Management, we look for meritorious companies which have stumbled or are fighting off tough seasons with an injury. In baseball terms, we have little interest in guessing which years our companies will produce the highest batting average. We’d rather understand how long they can have strong plate appearances year after year. What matters is the totality of their work, not their volatility from season to season.
Cole Smead, CFA
The information contained in this missive represents Smead Capital Management’s opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Cole Smead, CFA, Managing Director and Portfolio Manager, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.
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