Kevin Holt, manager of Invesco's Comstock fund, studies companies over a 20-year cycle. Energy, healthcare stocks also make his list. By Debbie Carlson
Managing one mutual fund for 25 years is a rare feat. Managing that fund and beating your peers and respective index is tougher still.
Just ask Kevin Holt, 56, who has managed the large-cap value Invesco Comstock fund (ticker: ACSTX) since August 1999. From that distant date through May 31, the fund's Class A shares have returned an annualized 8.3%. The fund, with $11.5 billion in assets, has outperformed its Russell 1000 Value Index benchmark by 1.2 percentage points on an annualized basis, and its large-value Morningstar category by 1.8 percentage points, according to Morningstar Direct.
This year, Comstock is up 8% compared with peers and the index, which have returned about 7% each.
Holt, who has run the fund with Devin Armstrong since 2007, applies classic value-investing techniques espoused by Benjamin Graham, considered the father of value investing. The pair seeks to identify a company's normalized profitability and cash flows, and might dig through 20 years of history to better understand a company and its industry. Diligent research and patience have allowed Holt to make contrarian bets and wait five years or more for them to pay off.
In addition to managing Comstock, Holt is Invesco's chief investment officer for the asset manager's $63 billion in value strategies. He recently spoke with Barron's about his focus on free-cash-flow yield and management incentives, and why he likes Meta Platforms, health insurers, and other unloved shares.
An edited version of the interview follows.
Barron's: Why go back 20 years when investigating a company as a potential investment?
Kevin Holt: I've always been big into history and analytical proof. You want to make sure you're accounting for cyclical tendencies in businesses. One of our competitive advantages is our ability to look at businesses over a long period and say, this is your normalized earnings and cash flow. If businesses don't change, then it's relatively easy, but businesses change.
Relying on cash flows is tangible. At the end of the day, what's in your checking account is what you're worth, not what you say you're worth. It's a fundamentally based, conservative approach to investing.
We start with a screening process, looking on a long-term basis for stocks that are selling at a historical discount on the metrics most relevant to identify value. In financials, price-to-book relative to a company's history still has a lot of relevancy. For growth areas such as technology, consumer staples, and healthcare, we're looking at historical price-to-cash flow multiples relative to the market.
Where do you go from there?
Once we identify inexpensive stocks, we ask why they are inexpensive. We look at three or four key issues and ask ourselves whether we agree or disagree with the consensus view. Maybe there is a cyclical reason why the stock is cheap, or maybe there is a short-term blip in capital allocation. Maybe it's a misstep by the management team that is correctable.
When we talk to management at any company outside of financials, we ask if revenue and operating margins are depressed, and if so, why. We ask banks what the market doesn't understand about their loan book or business model. What is the normal return on tangible common equity?
What are some lessons you've learned in the past 25 years?
Companies that make a lot of acquisitions typically don't integrate the acquisitions. They typically don't have good returns on capital because they buy earnings and overpay for them. That dilutes shareholder value. Also, there is no substitute for good management. You need compensation metrics that drive the CEO and boards to run the company for shareholders.
About five or six years ago, my co-manager Devin Armstrong and I reviewed our performance, studying how we could have improved. We found those three common characteristics in about 20 stocks that we had owned: owning acquisitive companies, owning companies whose management wasn't as strong as it could be, and owning companies whose managers weren't acting in shareholders' best interest. If we could have eliminated those stocks, our performance, while good, could have been a fair bit better. We've put more emphasis in these three areas with the younger members of our team, and it has helped with execution of the strategy.
You own Meta Platforms, which most people don't think of as a value stock. What is the attraction?
I don't like when people call stocks growth or value stocks. There are inexpensive stocks and expensive stocks. You have to understand how to value different industries and what to look at.
We got fortunate with an opportunity to buy Meta in 2022, when there were privacy-rights issues with the Apple iPhone and Meta's advertising went down. [Apple's 2021 iOS 14 update hurt Meta's revenue by affecting how the social-media giant served ads to its users.] It became more challenging to project advertising growth. Advertising set a new base, and now it just grows off that base.
We were able to buy Meta with a 6% free-cash-flow yield when the market was selling at a 4% free-cash-flow yield, so we paid a 50% discount to the market. Free-cash yield -- or free cash divided by market value -- is the ultimate litmus test of value for a stock. It doesn't require discounting any growth. We have sold some of our Meta holding because the risk/return calculus has changed, but I still like it a lot.
You made a contrarian bet on energy a few years ago that paid off, and it started with persuading management in the industry to change its compensation metrics. Explain what happened.
We liked the assets of energy companies, and they had a lot of cash-flow potential, but managers were compensated for growth, not returns. To make the cost of capital, companies needed oil to be around $75 a barrel. Instead [in 2015-16], oil was trading around $40-$45 a barrel because there was too much oil around.
We approached a lot of companies and said, you're not making your cost of capital, and you should run your business appropriately. The stocks hadn't performed in eight or nine years. In any industry, there is a high correlation between increased return on capital and improving stock prices. We went substantially overweight energy in 2017-18. When Covid hit and oil prices went negative in 2020, we bought more.
From 2017 to 2020, the energy industry slowly changed its compensation metrics to emphasize cash-flow generation and return on invested capital. It is now an investible group over a whole cycle, as opposed to an industry growing just for growth's sake. The companies' value proposition is the dividends that they pay and the cash they return to shareholders. By the end of 2022, the stocks' returns were astronomical.
What do you think of energy today, and the energy acquisitions we're seeing? Chevron is buying Hess, and ConocoPhillips is buying Marathon Oil, to cite two examples.
I still like oil stocks; I just don't like them as much as I used to because valuations have gone up a lot. There were stocks that we bought in 2020 with a 25% to 30% free-cash-flow yield on normalized oil prices. Now, the group sells for an 8% or 9% free-cash-flow yield based on today's oil price.
Acquisitions are mostly happening because the shale-oil companies are running out of inventory, so they have to either merge with someone else, or sell to a larger company. Chevron is in my top 10. We were historically owners of Pioneer Natural Resources and Hess, which were bought by Exxon Mobil and Chevron, respectively. It all comes down to, what are the prices? Are you buying good assets, and are you buying at a fair price? I own all those companies. I'm happy with the transactions, in general.
Among bank stocks, Wells Fargo and Bank of America are your top two holdings. Why?
With rates at 5%, you have 5% top-line growth. You have to pay a lot of it back to [depositors], but not all. Higher rates give banks more latitude to generate revenue.
Banks had to write down their tangible book value because they invested customer deposits in five- and six-year-duration bonds, and those bonds went down in value when rates went up. We view that as a transient issue. Unless you have a run on the bank, those bonds will mature, and the tangible book value will creep back up. We can wait for it because of our five-to-seven-year time horizon.
The book value weakness affects regional banks more, but even Wells Fargo an Bank of America suffer from this. These are good, stable banks with good deposit bases. Wells Fargo still has the government-mandated asset cap in place, which we're hopeful will be lifted at some point in the next year or two.
What is undervalued now?
We like the health maintenance organizations, which are cheap on the basis of price/earnings multiples relative to history. HMOs and health-insurance stocks are going through government reimbursement changes because the government is paying a little bit less in the near term for Medicare. Elevance Health [formerly Anthem] is a top 10 holding.
More people used Medicare in 2023 as they underwent medical procedures after Covid ebbed. The companies that turn in Medicare pricing bids didn't price the business appropriately. Some are losing money, some are marginally profitable, and all the stocks have sold off. We think the Medicare HMO stocks are oversold.
In the next two years, we expect these companies to get operating margins on their Medicare business back to 3.5% to 4%. This isn't a high-margin business, but it is still a good business. Looking out a few years, the market is underappreciating the return of earnings power, maybe not all the way back to where it was, but to 80% of where it was.
Value is underperforming as artificial intelligence pushed up tech stocks, so why might value perform better in the future?
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