Eli Salzman loves nothing better than finding a company that is a “dog with no momentum” but on the cusp of better days. At its core, this is the purpose of value investing. Over the course of his 36-year career, Salzman has proven a knack for buying undervalued stocks shunned by the market and delivering stellar returns along the way.
Salzman is a managing director at Neuberger Berman and senior portfolio manager of $10 billion.
fund (ticker: NBPIX), along with fellow portfolio manager David Levine. As of the end of July, the fund was down 5.67% for the year, less than the Russell 1000 Value Index’s 7.08% decline. Over the three-year period, the fund is up 14.55%, outperforming 98% of its peers in the category. Over five- and 10-year periods, it has returned 12.80% and 13.51%, respectively, eclipsing 99% of its peers.
Of course, just because a stock is cheap doesn’t mean Salzmann is buying. There must be a catalyst that can improve the company’s fortunes. “Buying cheap stocks without a catalyst is called a value trap,” he says. “You have to buy a company that is earning below normal returns that has a catalyst or an inflection point, something that will change it and bring the earnings from below normal back to normal or even above normal.” The catalyst can be almost anything, from the release of a new product until a change in management.
In a recent conversation with Barron’s, Salzman discussed where he finds value today and how investors should position their portfolios defensively for an impending U.S. recession. The following is an edited version of our conversation.
Barron’s: What was the first value stock you bought?
[T], in 1997, Mike Armstrong was running the company and the stock was very much out of favor. And luckily, it worked out well. I bought it for $33 [a share], and sold it a year later in the upper $70s. For AT&T, this is a very big move.
What are you looking for in stocks?
There must be a catalyst. And in addition to looking for companies that have depressed earnings relative to normal, we also look for sectors, sub-sectors and industries that have been starved of capital and, in turn, starved of capacity.
[XOM] is your largest holding and has grown by more than 50% this year. Will it go even higher?
Absolutely. Energy is a perfect example of a sector that is starved of capital and capacity, and Exxon is one of our favorite stocks in this sector. Some of the capacity has returned. The oil rig count peaked in 2014 at around 1,600 rigs, then fell to the low 300s in 2016, then peaked again at just under 900 in late 2018, bottoming out at 172 in 2020 .and now it’s back up to just over 600. One of the reasons we’re focusing on capital capacity is that when capacity comes out, it’s always a good thing for the industry. We aggressively bought Exxon in the $30s and $40s. Today it trades around $94 per share.
What was the catalyst for Exxon?
One of the catalysts we look for is when a company thinks it’s a growth company and it’s not, and it finally wakes up and realizes it’s not a growth company and needs to start behaving like a value company . Growth companies are companies that constantly reinvest in themselves. If you’re really a growth company and you can really generate better returns by investing in yourself, then by all means you should, but it’s not our kind of stock and it probably won’t be at our valuation.
Exxon was a very poorly run company for many years, believing they had more growth than value, and they started waking up a year and a half to two years ago. Twenty years ago Exxon was considered one of the blue chip stocks and every investor wanted to own Exxon or
[GE] or Pfizer [PFE]. But that was a huge drawback. Management realized that their strategy just didn’t make sense and began to curb capital spending [capital expenditure]. They started returning money to shareholders. They started to get rid of non-core assets. And suddenly we saw a big difference in the behavior of the management. It was governed in part by proxy voting [to add new members to Exxon’s board] it happened because shareholders were also angry. But in two words they woke up. And that was a major catalyst.
What other energy companies do you own?
[CVX]. ConocoPhillips is one of the most capital-disciplined energy companies and delivers consistent distributions to shareholders, while Chevron has a strong balance sheet and a huge buyback program.
is another major holding. You are a fan of stocks.
Pfizer is a company that is truly transforming. It got rid of a lot of non-core assets. Just like Exxon, it has significantly underperformed over the past 20 years. We don’t buy companies simply because they’ve underperformed for 20 years; we had a catalyst: Covid. Pfizer is at the heart of Covid, which will be here for many years to come. Without a doubt, Pfizer leads the pack, both in reputation and in Covid research, and that’s actually a real growth lever for this company for many years to come.
We have great confidence in Pfizer. It meets that criteria for a company that is a stock dog with no momentum. And now, suddenly, you had a catalyst, and a catalyst that could actually change the world.
Where else do you find value today?
Banks and Metals and Mining. We like very much
[JPM]. The valuation dropped dramatically – it was absurdly overstated when it reached $165. And now it’s absurdly gone too far to the downside now that it’s at $114.
One of the things that initially got us very interested in JPMorgan many, many years ago was when Jamie Dimon took over. The management team he has put in place is first class.
What do you like about the metals and mining sector?
[FCX] management has done a great job running the company over the past few years. This is an example of a value stock that people overlook. We bought it for about $10. The stock is $30 today and I’d be surprised if it doesn’t outperform the market in the next few years. We are bullish on Freeport because it is a cheap stock based on mid-cycle earnings. Also, it’s an attractive takeover target for a large, diversified miner looking to go bigger in copper. We are very bullish on copper and Freeport is the world’s best pure play copper mine.
In which sectors are you overweight and underweight?
We are overweight utilities, healthcare and consumer staples. Also metals and mining. We are close to a market weight of energy. Don’t get me wrong – we really like the energy for the next five years. But since we’ve repositioned the portfolio, we’re probably closer to market weight. We are short on technology, banks, discretionary consumers and communications services.
We are positioned defensively. We have a potentially very challenging period ahead of us next year as, across the board, many of the sectors where we are undervalued are going to experience a very serious slowdown in earnings.
Would you recommend this type of positioning to others?
I would encourage investors to be very defensively positioned – so sectors like utilities and consumer goods, with a company like
Procter and Gamble
[PG], because, like it or not, in a tough economy, people still have to wash their clothes and brush their teeth. In a tough economy, you want to be in non-cyclical stocks because at the end of the day you don’t have to go out and buy new ones
[AAPL] iPhone every year. You don’t have to go out and buy a new pair of jeans every year.
But the reality is that you still have to do your laundry, you’re still going to run your electricity, etc. Same with health care. If you get sick, you will go to the doctor. The same thing from a drug perspective in terms of pharmaceuticals. So where would I like to be? I want to be in healthcare and pharmaceuticals like Pfizer.
I also like basic materials, specifically metals and mining, and energy. The years 2020 and 2021 were a very risky period. Everything went up. It was a wonderful risky environment. We are entering, beyond the short periods of risk, into a reasonably extended period of risk. So in a period of risk you have to be careful.
What is the biggest risk facing the markets?
Everyone is screaming that the Fed will definitely create a soft landing. That won’t happen. In the mid-80s, they created a soft landing. In the mid-1990s, they did, too, because there was a disinflationary environment and the Fed was raising interest rates for a strong economy. It’s the exact opposite of that. We are in a slowing economic landscape and the Fed is raising rates. Why? Because inflation really is a problem.
Remember that inflation is a lagging indicator. And as such, the Fed will continue to raise interest rates because it is determined to contain inflation and obviously reduce inflation. The problem is that the Federal Reserve is a reactive body, and as they continue to remove this massive stimulus, I can tell you that 2023 is going to be risky because we’re seeing a very serious slowdown. This does not mean that investors should not be invested, but they should know what they own. This is no longer the risky environment we were in for the last two years.
Sounds like you are seeing a recession.
Where do I fall in the recession camp? Pretty close to 100%.
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