Mr. Scharf: Scharf Investments is a registered investment adviser. We manage money for high-net-worth individuals and institutions. We ended the year with about 750 million under management, which was a record high. We also ended the year with a record number of clients. Philosophically, we try to buy growth stocks at value prices. We look for situations where earnings, cash flow and/or book value are likely to grow, and where the price/earnings, price/cash flow or price/book value multiple is likely to rise. When higher earnings, for example, are multiplied by a higher p/e, you get an exponential increase in stock price.
TWST: PHow did the volatility and the events in the market impact your investing? What changes did you make to overcome these challenges?
Mr. Scharf: We've had the overall thesis for a number of years that the 2003-2007 period was an extraordinary era where earnings routinely exceeded estimates. As that era lengthened, investors gravitated more and more to stocks with cyclical business models and inherently unpredictable earnings because those stocks produced the biggest upside surprises. As a consequence, stocks with predictable, steady earnings, like consumer staples and health care, became more and more undervalued because they didn't have the same earnings surprises that more cyclical stocks had. In the recession, earnings fell apart for the S&P as a whole, but the earnings for our stocks held up pretty well. But the general selling hysteria drove the price of everything down. So even though the earnings on our stocks held up better, their valuations did not hold up as well as we thought they would. At the market low, you could buy Microsoft for nine times earnings, which was just ridiculous, or Johnson & Johnson for 10 times earnings. All in all, our stocks did not go down as much as the market, and most of the decline in our stocks occurred because valuations declined unreasonably.
We lost less than the market in 2008. We were down 27.6% and the S&P was down 37%. In 2009, we beat the market by a little bit. For the two years combined, we were down 8% while the S&P was down 20%. We need to make 9% to get back to even while the S&P needs to go up 25%.
Tickers included in this excerpt: ACL, ADP, CBY, CNI, DST, FISV, HPQ, JNJ, MSFT, NSRGY, NVS, WMT
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