Several stocks have driven our outperformance YTD. Morningstar (MORN) was up 26%, Novo Nordisk (NVO) was up 44%, and Synaptics (SYNA) was up 27%. Several companies have produced significant drag through Q3 including Computer Programs and Systems (CPSI) down 21%, Collectors Universe (CLCT) down 22%, and Qualcomm (QCOM) down 22%.
I made two changes in the portfolio in Q3. Both were made during the “mini-crash” in late August. The first is Paychex (PAYX), a holding we previously owned but sold in 2013 due to valuation concerns. On August 28th the price dropped briefly by 11% and we purchased shares at a roughly 20% discount to our estimated intrinsic value. Earlier this year I wrote about PAYX and our thesis for keeping it on our watch list. In that article I wrote:
“Two companies on our watch list represent another area – payroll outsourcing in Paychex (NASDAQ:PAYX) and Automatic Data Processing (NASDAQ:ADP). Both companies provide outsourced payroll services. While this area has been relatively stagnant over the past five years, both companies have created cross-selling models that include PEO services, retirement plans, HR services, and several others. We expect these to drive growth as well as the return of normalized interest rates that provide significant “float” revenue”. We would gladly add either to the portfolio if a greater discount to our estimated fair value could be obtained”.
The second change to the portfolio was the purchase of Linear Technology (LLTC). Similar to PAYX, a revision in our estimated intrinsic value combined with a severe drop in price on August 28th gave me the opportunity to establish a position. Earlier this year I wrote about the business case for LLTC:
“Linear is the type of company we love to purchase and hold for as long Mr. Market will allow. The company is the leader in high-performance analog (HPA) chips. These require extreme precision and very high reliability in devices used across multiple sectors. Currently, their highest need is in the automobile and industrial sectors. Because of the stress on reliability of the chip (combined with the small cost related to the entire piece of equipment), many of Linear’s clients are happy to pay top dollar for their chips. What we truly love about Linear’s chips is their long product life helping the business maintain extraordinarily low capital requirements. The inability for other competitors to create similar chips at cheaper prices, the depth of Linear’s relationships with key customers, and the skill of their work force give the company a wide competitive moat in our opinion. We are also very impressed with Linear’s management. They have done an extraordinary job at maintaining a laser-like focus on the very profitable HPA market. They are quite willing to let projects go by if clients are unwilling to recognize the value of Linear’s product quality. With gross and net margins of 76% and 35% respectively, management has demonstrated their commitment to long-term profitability. In addition, over the past five years the company has generated an average ROE of 80%, free cash flow/total sales of 40%, and ROC of 38%. This is a company that is a true cash machine. Finally, the company has no short or long term debt, $1.2 billion of cash on the balance sheet and yields roughly 3%”.
These are two companies where we couldn’t be more happy as owners in outstanding businesses with excellent management and capital allocators.
I would be remiss if I didn’t take the time to write about three (3) small-cap holdings that have performed very poorly since our purchase earlier in the year. These include Collectors Universe (CLCT), Computer Modelling Group (CMDXF), and Computer Programs and Systems (CPSI). These three stocks are down 21%, 7%, and 22% respectively since our initial purchase. In each case we still believe in our investment thesis and don’t believe our estimates are impaired in any significant way. We think Seth Klarman had it right when he said, “Buying early on the way down looks a great deal like being wrong, but it isn’t. It turns out you won’t be able to accurately tell who’s been swimming naked until after the tide comes back in”. In this case, we eagerly wait for the next phase of the moon. With yields of 8.9%, 3.7%, and 5.7% respectively, I am more than happy to stay invested with management and utilize dividends to compound our returns over the long term.
Thoughts On The Quarter
While disappointed with the portfolio performance this quarter, I am pleased with YTD results (beating the broader indices by roughly 7%) and its long-term performance. I put a considerable dent in the portfolio’s cash position reducing from 15% at the beginning of the quarter to roughly 8% by quarter end. The benefits of holding so much cash became evident when we saw the markets swoon in August and I was able to put some capital to work purchasing outstanding assets at fair prices.
Notice I say fair prices. Even with the roughly 8% drop in the S&P500 the vast majority of equities are trading at fair – or slightly above fair - values. There simply aren’t many opportunities out there right now. That said the Charitable Trust has partial ownership in a selection of outstanding companies I would love to own for an extended period of time. Management that wisely allocates capital combined with such a long time horizon should provide the Trust with more than adequate compounding investment returns.