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Chuck Akre -- memorandum regarding thinking strategically in value investment.


  • By InvestingDly, April 12, 2011, 05:47:00 AM EDT

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    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

    peter out.

    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:

    Thinking Strategically

    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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  • debt.

    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 h


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