Why a star fund manager is bullish on Bank of America and Apple buybacks
FORTUNE — The news this week that Bank of America ( BAC ) is suspending its dividend increase and $4 billion stock buyback plan due to an accounting error would not seem to please Bill Nygren. After all, not only is Bank of America Nygren’s biggest holding, making up more than 3% of his $13.3 billion flagship Oakmark Fund ( OAKMX ), but the value investor’s second-most prized criteria in a company — after a bargain price — is dividend yield and expected EPS growth that at least match the market average. Still, as Bank of America shares sank 6% Monday, Nygren’s bullishness remained unflappable. Sure, investors have long awaited an increase in the bank’s quarterly dividend, which has stayed at a single penny since the financial crisis (and would have risen to a nickel under the plan). But Nygren, who expects to hold companies for at least five years, believes continued patience will pay off. He recently spoke with Fortune about his views on Bank of America and Apple ( AAPL ), among other topics. (For more of his investing insights, see his Q&A in the May 19 issue of Fortune.) Below, some edited excerpts from our conversation:
Fortune: Bank of America is your largest holding. Does the suspension of its buyback and dividend increase change your views at all?
Nygren: No, the events have not changed our thesis. Most of the big banks today are either at or very close to the Basel III capital requirements. Unless loan growth — which has been pretty much nonexistent since the bottom of the recession — returns (which would be a good thing), [BofA] management thinks that within a couple years, it should be able to return almost all its income to shareholders. Say they pay out a third of that in dividends, that would potentially be a $0.75 dividend, something like a 4.5% yield, on a stock that today sells at a pretty significant discount to book value. The bears would say yes, but it doesn’t grow. Well, the two-thirds of the earnings that aren’t getting paid out in dividends could be used for share repurchase. They could be buying 9% of their stock, per year. So you get a company that without top-line growth could have a 10% EPS growth rate, and a 4.5% dividend yield. The market would never allow it to stay at this price if that was expected of them, and we think that is the likely outcome in several years for Bank of America. It will probably be selling at a much higher price than it is now.
How do you feel about the activist investors who have pressured Apple to do buybacks, among other companies?
The balance sheet of Apple has so much cash on it. Lots of people from David Einhorn to Carl IcahnIEP have tried to convince Apple that even though it sounds good that they’re building a fortress balance sheet, that’s not using their cash effectively. There are definitely some things that activists push for that might help in the short term but aren’t in the long-term interest of shareholders — but in this case, we have complete overlap with them. There are opportunities today for Apple to repurchase their shares at relatively low prices, and it would be a shame to be sitting here two years from now with an even bigger mountain of cash on the balance sheet and see that they missed the opportunity to buy cheap stock. If you think five years out, it’s likely to have substantially fewer shares outstanding. So even with average top-line growth, you should still see above-average EPS growth.
But when we buy companies, we generally look for management teams whose economic interests are aligned with the outside shareholder. Some think mutual funds should be much more involved in trying to reform bad management teams, and I guess I’m more old-school than that; if I turn on a TV program that I think is inappropriate, my reaction isn’t to write my congressman, it’s to switch the channel.
Several of your holdings have been active in M&A, including Forest Laboratories FRX, which gained 149% and was acquired by Actavis ACT in February — all in the first year you owned it. Do you look for companies that could be takeover targets?
We never purchase a company because we believe it’s an acquisition target. On the other hand, when you think about the criteria we’re using — stocks that are selling at a big discount to their intrinsic value, businesses that are likely to grow at least at average rates, managements that are thinking as owners — I don’t think it’s surprising that even though we’re not trying to target them as acquisition candidates, many of the companies we purchase are acquisition candidates. We’re not looking for things that are very different than what either a corporate M&A department, or a private equity firm would be looking at.
You own Comcast CMCSA, and told Fortune in 2010 that you supported its acquisition of NBCUniversal. What about its planned merger with Time Warner Cable TWC?
We liked the NBC acquisition, we like the Time Warner Cable acquisition, and we think the stock is more attractive than average, but the market today is valuing Comcast at over $50 a share, which is not nearly as attractive as when they did the NBC deal, when there was more concern about cord-cutting than there is today. So I think investors aren’t as concerned about the increasing ability we have to see video on lots of technology platforms on lots of different screens; they’re no longer concerned that the cable company is going to get bypassed. Basically, subscribing to Netflix ( NFLX ) doesn’t eliminate my desire to have ESPN live.