Akre_Thinking Strategically - NASDAQ
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DESCRIPTIONChuck Akre -- memorandum regarding thinking strategically in value investment.
By InvestingDly, April 12, 2011, 05:47:00 AM EDT
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Banks of Opportunity
Top Dividend Stocks
Interview with Chuck Akre of the Akre Focus Fund
Last week, I wrote a two-part series on small-cap growth fund manager
Chuck Akre. In My Evening with Chuck Akre: Part 1 , I described how his
"growth at a reasonable price" investment philosophy is similar to
legendary Fidelity fund manager Peter Lynch. Akre looks for highly-
profitable and fast-growing companies that compound earnings at above-
average rates, while selling for reasonable multiples of free cash flow. In
My Evening with Chuck Akre: Part 2 , I discussed the difficult but crucial
analytical process Akre undertakes to determine whether a company's
historically-high growth rate in earnings is sustainable or is more likely to
The one area I didn't
cover last week was
Akre's current favorite
stocks -- other than
American Tower ( AMT
). Fortunately, my
colleague and friend Ben
Shepherd, editor of Louis
Rukeyser's Wall Street ,
had the chance to sit
down with Chuck last
month and ask him his views on the overall stock
market and what stocks he likes best now. Read on for a very enlightening interview:
By: Ben Shepherd
Most investors want to take advantage of the high-flying US equity market but remain worried about the
daunting challenges the country faces. Charles Akre, former manager of FBR Focus (FBRIX), struck
out in 2009 to launch Akre Focus (AKREX, 877-862-9556). Concerned about the US government's
huge debt burden and overextended household balance sheets, Akre loaded up on lower-end
consumer names with attractive growth potential. He also established positions in financial firms that
would benefit from rising interest rates and mounting inflation. He keeps a lot of cash on hand as both
an insurance policy and a store of dry powder to take advantage of any opportunities that might arise.
Ben Shepherd: Almost a quarter of your fund's assets are allocated to cash. Why do you maintain
such a high cash allocation?
Chuck Akre: In a recent Wall Street Journal op-ed, Charles Koch [chairman of Koch Industries and a
prominent conservative] spoke about the problems facing our country, noting the amount of debt the
federal government holds both on and off the balance sheet. He observed that the Social Security,
Medicare and Medicaid systems are unfunded liabilities of over $100 trillion. Decades ago, former
Congressman Everett Dirksen (R-Ill.) said, "A billion here, a billion there, pretty soon, you're talking real
money." Decades later Koch said, each man, woman and child in this country owes $300,000 on that
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There's an unsustainable amount of debt piled on this country. The US needs to quit kicking the can
down the road and begin to deal with this problem. The best solution is for the US to grow out of its
debt, but an unemployment rate of 9 percent or higher makes that scenario unlikely. Consumer
spending accounts for 70 percent of US gross domestic product. Elevated unemployment and
decreased borrowing capacity through home equity lines and credit cards should cap economic growth
for the foreseeable future.
The consumer is further constrained by a need to save for retirement. The assets households had set
aside suffered steep losses in 2008 and 2009. Consumers also need to pay down personal debt, which
has only declined by about 5 percent over the past few years. The consumer's ability to spend has
been greatly reduced. Don't expect the US economy to grow its way out of debt.
The most likely solution to our expanding debt is to devalue the US dollar. This will make the dollars
that the US repays to its creditors worth far less than when they were borrowed. A 1970s-style inflation
and interest rate spiral is possible. The odds of that outcome are better than even, though I'm not an
economist and I don't focus exclusively on this issue. Personally, I don't expect a massive run-up in
Even starting to resolve these problems will cause discomfort in all parts of US society. Therefore it's
wise to remain cautious. Although we've had velvet revolutions in the past, we're now witnessing violent
uprisings in the Middle East and North Africa. This turmoil continues to spread. No one knows how
those revolutions will be resolved, but the concerns about this upheaval are reflected in higher prices
of oil and gold.
We can see the impact of the Federal Reserve's quantitative easing and asset inflation programs,
which some claim are having a direct effect on food and other commodity prices.
The US is in a slow recovery. I'm an optimist, a quality that's essential to being a successful investor.
That being said, it's best to remain cautious. That means holding ample cash so that you can take
advantage of the opportunities created when the market takes the occasional spill. After all, the market
is up nearly 100 percent from its March 2009 lows.
Ben Shepherd: Despite your concerns about US consumer spending, you seem to have a very
consumer-oriented portfolio. What explains this ostensible contradiction?
Chuck Akre: We hold shares of CarMax ( KMX ). New car sales are rising, but used car sales have
rebounded as the economy remains less than robust. CarMax is the best in the business and controls
about 3 percent of the US used car market, so they have plenty of room to ramp up.
We also hold shares of Dollar Tree ( DLTR ), which operates a chain of dollar stores. The stock trades
at 11 times earnings, and the company boasts a record of compounding free cash flow in the upper
teens. This is a business that performed wonderfully in robust economic times and is well-suited for a
time when consumers are still trying to stretch their dollars.
We also own Ross Stores ( ROST ) and TJX Companies ( TJX ), two retailers that specialize in off-
price apparel. These stocks have similar characteristics, with a valuation of 10 to 12 times free cash
flow and histories of compounding shareholders' capital by nearly 20 percent. Ross Stores and TJX
tend to do well when consumers are cost sensitive.
These three companies have wonderful balance sheets. One of them has no net debt and the other
two have very modest amounts of debt. And they're extremely well-positioned to attract cash-strapped
consumers, who still requires clothes, house wares and other necessities.
We also hold TD Ameritrade (AMTD) and optionsExpress Holdings (NSDQ: OXPS). These
companies provide online trading for consumers who prefer to manage their brokerage accounts on
the Internet instead of calling their cousin Dick down at Merrill Lynch.
These companies don't have much to do with a constrained consumer; the investment case is related
to individual investors returning to the market. The Federal Reserve's efforts to inflate asset values
have prompted investors to shift their assets into equities from cash, US Treasury notes and other safe
TD Ameritrade is also an indirect play on interest rates. The huge customer balances enable the firm to
earn a spread on that money. Rising rates can make a substantial contribution to the company's
income and revenue streams.
OptionsExpress is a specialty company that deals entirely with options strategies. It's a terrific business
whose stock sports a modest valuation.
The one holding that provides our portfolio with direct exposure to the consumer discretionary segment
is Penn National Gaming (PENN). Visits to casinos are down for the third year in a row. Play per visit
is down. Competition within the space continues to intensify. The outlook for Penn's organic growth isn't
as robust as it used to be.
Why do we own it? The CEO has been the best in the industry at building shareholder value. The
company has been very aggressive in adding new casinos. Penn is building a new gaming location in
Kansas City and two new facilities in Ohio that will beef up their existing presence in the state. The firm
also has operations in Texas, Florida and Maryland.
Ben Shepherd: We're seeing a lot of heady predications that corporate earnings will break another
record this year. Do you subscribe to this outlook?
Chuck Akre: First of all, many businesses -- for instance, health care and manufacturing -- aren't
directly consumer oriented. These will continue to grow nicely. Businesses cut costs to the bone three
years ago and, by and large, have yet to rehire, so general and administrative costs are much lower
than they were at that time. Add in solid growth and lots of sectors could post higher earnings.
Take the retailers that we own. They're growing square footage and if all goes well they'll have some
margin improvement off a larger base. Some stores they opened last year will mature and grow sales.
As a result, our retail holdings could post a free cash flow growth rate in the mid-teens.
If we focus on companies whose shares trade at very modest multiples, we can limit risk without
constraining potential upside.
Ben Shepherd: What's your best piece of advice for investors?
Chuck Akre: Don't be overwhelmed by a rising market and don't be driven by the fear of missing out.
Make sure you have a margin of safety in your pool of assets. Also make sure that you're prepared for
a rainy day should it come--not that I'm predicting one.
Akre Focus Fund Top-Five Holdings
Company Return on EquityPrice to Free Cash FlowMarket Cap
Lamar Advertising (LAMR) -4.86% 13.2 $3.1 billion
Dollar Tree Stores ( DLTR )27.51% 19.1 $6.9 billion
Ross Stores ( ROST ) 44.56% 16.3 $8.4 billion
MasterCard (MA) 42.32% 18.0 $34.6 billion
Markel (MKL) 9.0% 20.4 $4.1 billion