By Philip van Doorn, MarketWatch
Investors in stock index funds have had a good run as most actively managed funds have lagged behind their benchmarks. But that may change, as record-high equity indices favor skilled stock pickers.
Larry Pitkowsky and Keith Trauner, who worked with investing legend Bruce Berkowitz for nine years and now manage the GoodHaven Fund /zigman2/quotes/200621018/realtime GOODX +3.41% , said in a July 20 interview that the strategy of following an index, such as the S&P 500 /zigman2/quotes/210599714/realtime SPX +2.03% , can backfire as stocks get expensive. Too many investors buy when the market is at a peak and sell during a downturn.
Pitkowsky and Trauner, whose fund’s 14.4% return this year has risen at twice the pace of the S&P 500, highlighted Barrick Gold Corp. and Staples Inc. as attractive values in an overheated market.
Barrick, the GoodHaven Fund’s top stock holding, has soared 169% this year, rebounding from a plunge caused by too much debt stemming from a poor acquisition. The miner is down 60% from where it was five years ago.
“When we really started to aggressively buy Barrick, it was not because we were gold bugs or because there was an apocalypse coming, but Barrick had a valuable base of assets, made a poor acquisition that levered up the company and created a firestorm leading to major changes in corporate governance,” Trauner said. He was referring to the company’s $7 billion acquisition of Equinox in 2011.
Trauner said that John Thornton, Barrick’s chairman, has “in a very short period materially reduce[d] leverage and overhead and operating costs of individual properties.”
Barrick is still a favorite. “Management is on the way to constructing a business that can grow over many years, no matter what the price of gold does,” Pitkowsky said.
Staples features a dividend yield of 5.27%, more than twice that of the S&P 500 and three times that of the 10-year Treasury note.
The dividend on the office-supply chain appears safe. A way to gauge a company’s ability to cover its dividend and the possibility of a dividend increase is to look at its free cash flow yield. A company’s free cash flow is its remaining cash flow after planned capital expenditures. Staples’ free cash flow yield, based on its past 12 months’ financial results and its closing stock price July 25, is 9.96%, according to data supplied by FactSet. This leaves “headroom” of 4.69%, which is higher than classic dividend payers such as AT&T Inc. /zigman2/quotes/203165245/composite T +2.31% and Verizon Communications Inc. /zigman2/quotes/204980236/composite VZ +1.11% .
The high free cash flow yield makes it appear very unlikely that Staples will need to lower its dividend to preserve cash. And in this market, investors who have been hungry for yield seem to be overlooking Staples.
Staples and Office Depot Inc. /zigman2/quotes/204015456/composite ODP +2.72% gave up on their merger deal in May, after losing an antitrust fight against the Federal Trade Commission, after which both stocks took a beating. Shares of Staples are down 1.8% this year, with dividends reinvested.
Pitkowsky said Staples has reached “an inflection point,” with good prospects on the strength of its services to medium and large companies, “where they are dominant.”