For 13 years, the majority of U.S. large-cap stock fund managers have consistently underperformed the S&P 500, making it hard to justify investing in active equities for clients. However, there are exceptions to this rule. In 2022 and 2023, fund manager Jeff Muhlenkamp stood out by outperforming benchmarks and delivering positive returns to his clients. In today’s FA Alpha Daily, let’s look at Muhlenkamp’s top 15 holdings and see how his active management approach consistently outperformed the market.
FA Alpha Daily:
Friday Portfolio Analysis
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Passive investing has been blowing active management out of the water for years.
Just looking at the historical data it’s evident that indexes are yielding higher and more consistent returns versus actively managed funds.
Depending on who you ask, anywhere between 50% and 90% of active fund managers underperform their indexes over the span of one to 20 years.
That’s why when you see an active fund manager that has outperformed the market and peers, it’s worth taking note.
Jeff Muhlenkamp has managed to generate value for investors for two difficult years in a row.
Under his management, Muhlenkamp & Company has found itself among the top 1% of active managers in the last three years, after beating 95% of peers last year and 87% so far in 2023.
Muhlenkamp is willing to be patient — he doesn’t just follow the crowd. For example, when investors abandoned fast-growing technology companies in favor of value-oriented names, Muhlenkamp held his ground.
Of those stocks held were Apple (AAPL) and Microsoft (MSFT) which are up about 39% and 36% this year, respectively.
Notably, Muhlenkamp claims that he will still continue to hold these companies given their successful history of adaption and innovation. Overall, Muhlenkamp is quite open about the potential in the technology sector, especially as AI acts as a tailwind.
Moving from the technology sector, Muhlenkamp has also expressed interest in owning regional banks following the banking crisis earlier this year, and he’s starting to pile into homebuilders.
Muhlenkamp believes that homebuilders and regional banks have taken a huge hit due to macroeconomic conditions, however, he thinks that the worst could be over and these industries are poised for a rebound.
And with rising geopolitical tensions the owning of gold through royalty companies is another area that Muhlenkamp suggests may show promise in the future.
In light of these recommendations, let’s take a look at Muhlenkamp’s top holdings to see how it’s positioned today and if he can continue his reign over peers and indexes moving forward.
Economic productivity is massively misunderstood on Wall Street. This is reflected by the 130+ distortions in the Generally Accepted Accounting Principles (GAAP) that make as-reported results poor representations of real economic productivity.
These distortions include the poor capitalization of R&D, the use of goodwill and intangibles to inflate a company’s asset base, a poor understanding of one-off expense line items, as well as flawed acquisition accounting.
It’s no surprise that once many of these distortions are accounted for, it becomes apparent which companies are in real robust profitability and which may not be as strong of an investment.
See for yourself below.
Looking at as-reported accounting numbers, investors would think that Muhlenkamp & Company invests in below-average companies.
On an as-reported basis, many of the companies in the fund are significantly below-average performers. The average as-reported ROA for the top 15 holdings of the fund is 8%, which is notably below the 12% U.S. corporate average.
However, once we make Uniform Accounting adjustments to accurately calculate the earning power, we can see that the average return in Muhlenkamp & Company’s top 15 holdings is actually 28%.
As the distortions from as-reported accounting are removed, we can see that Broadcom (AVGO) isn’t a 12% return business. Its Uniform ROA is 84%.
Meanwhile, Apple (AAPL) seems like a 21% return business, but this technology conglomerate actually drives a 55% Uniform ROA.
That being said, to find companies that can deliver alpha beyond the market, just finding companies where as-reported metrics misrepresent a company’s real profitability is insufficient.
To really generate alpha, any investor also needs to identify where the market is significantly undervaluing the company’s potential.
These dislocations demonstrate that most of these firms are in a different financial position than GAAP may make their books appear. But there is another crucial step in the search for alpha. Investors need to also find companies that are performing better than their valuations imply.
Valens has built a systematic process called Embedded Expectations Analysis to help investors get a sense of the future performance already baked into a company’s current stock price. Take a look:
This chart shows four interesting data points:
- The average Uniform ROA among Muhlenkamp & Company’s top 15 holdings is actually 28%, which is much better than the corporate average in the United States.
- The analyst-expected Uniform ROA represents what ROA is forecasted to do over the next two years. To get the ROA value, we take consensus Wall Street estimates and convert them to the Uniform Accounting framework.
- The market-implied Uniform ROA is what the market thinks Uniform ROA is going to be in the three years following the analyst expectations, which for most companies here are 2023, 2024, and 2025. Here, we show the sort of economic productivity a company needs to achieve to justify its current stock price.
- The Uniform P/E is our measure of how expensive a company is relative to its Uniform earnings. For reference, the average Uniform P/E across the investing universe is roughly 20x.
Embedded Expectations Analysis of Muhlenkamp & Company paints a clear picture. Over the next few years, Wall Street analysts expect the companies in the fund to slightly drop in levels of profitability. Meanwhile, the market has expectations for these companies to remain at their current performance.
Analysts forecast the portfolio holdings on average to see Uniform ROA slightly decrease to 27% over the next two years. At current valuations, the market’s expectations are higher than analysts and it expects a 28% Uniform ROA for the companies in the portfolio.
For instance, Dow (DOW) returned 7% this year. Analysts anticipate its returns slightly decrease to about 4%. Comparably, the market thinks the company’s profitability will remain at current levels therefore pricing its Uniform ROA to remain at 6%.
Similarly, Apple has a Uniform ROA of 55%. Analysts expect its returns to see a decline to around 46%, but the market is more optimistic about the company and pricing its returns to be around 49%.
Muhlenkamp’s historical returns have been quite indicative of his future performance over the last couple of years. Moreover, his top holdings are clearly reflective of the different areas that he sees promising in the future.
Additionally, Muhlenkamp’s top holdings include high-quality names with strong competitive moats in their respective sectors that have been able to maintain high profitability.
While the market seems to be fairly pricing the companies in the portfolio currently, these high-quality names have been renowned as delivering strong returns historically.
However, investors should be careful while evaluating the companies in Muhlenkamp’s portfolio and analyze current valuations in a detailed way as they might not be as clear-cut as prior years.
Lastly, Muhlenkamp has shown his market expertise, especially in the last two years in a market environment with high volatility and uncertainty. Therefore, investors should also consider the different growth areas suggested by Muhlenkamp, it may just pay off.
This just goes to show the importance of valuation in the investing process. Finding a company with strong profitability and growth is only half of the process. The other, just as important part, is attaching reasonable valuations to the companies and understanding which have upside which has not been fully priced into their current prices.
To see a list of companies that have great performance and stability also at attractive valuations, the Valens Conviction Long Idea List is the place to look. The conviction list is powered by the Valens database, which offers access to full Uniform Accounting metrics for thousands of companies.
Click here to get access.
Read on to see a detailed tearsheet of one of Muhlenkamp & Company’s largest holdings.
SUMMARY and EQT Corporation Tearsheet
As one of Muhlenkamp & Company’s largest individual stock holdings, we’re highlighting EQT Corporation (EQT:USA) tearsheet today.
As the Uniform Accounting tearsheet for EQT Corporation highlights, its Uniform P/E trades at 13.2x, which is below the global corporate average of 18.4x, but above its historical average of 4.7x.
Low P/Es require low EPS growth to sustain them. In the case of EQT Corporation, the company has recently shown 254% Uniform EPS shrinkage.
Wall Street analysts provide stock and valuation recommendations that, in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, EQT Corporation’s Wall Street analyst-driven forecast is for EPS to shrink by 30% in 2023 and to grow by 51% in 2024.
Furthermore, the company’s return on assets was 11% in 2022, which is 2x the long-run corporate averages. Also, cash flows and cash on hand consistently exceed its total obligations—including debt maturities and CAPEX maintenance. These signal low dividend risk and moderate credit risk.
Lastly, EQT Corporation’s Uniform earnings growth is in line with peer averages, and in line with peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
This portfolio analysis highlights the same insights we share with our FA Alpha Members. To find out more, visit our website.