Tuesday, June 28, 2011

Cisco and Microsoft: Two Takes on Value

Two of my favorite value-oriented money managers as an analyst and investor are Tweedy Browne and Harris Associates, which runs the Oakmark Funds. Reading the managers' semi-annual report for the Oakmark Equity Fund for the period ended March 31, 2011, we see, "The quarter's largest detractors were Cisco Systems, Microsoft...We clearly have covered ourselves with something other than glory with our investments in large-capitalization technology companies. Cisco continues to suffer profit margin erosion...Microsoft's problems appear to be more strategic, and we exited the stock."

Tweedy Browne broke its somewhat long-held aversion to technology stocks when it initiated a position in Cisco. They wrote in their most recent report,"Cisco is financially strong and we think statistically cheap." In other commentary the managers talk about not being able to understand whose router technology will prevail in the market place, and they appeal to the cheapness of the stock in relation to enterprise value which it says gives them a 30% margin of safety relative to its intrinsic value. It is a dissapointingly tepid reason for buying the stock for a shop that I've always known to be confident about having done their homework.

What's tellingly missing from Tweedy Browne's commentary is any kind of endorsement of the Cisco management, either their track record, commitment to adding value, or their having finally got the "old time religion" about working for the benefit of shareholders. In the end, an equity investor is investing in management, and hopefully alongside of management if they had significant ownership positions themselves.

Cisco may be statistically cheap, and I know it shows up on a lot of value screens. However, I suspect that's how Microsoft looked to Harris Associates when they initiated their position. What made them give up? Problems of a "strategic" nature, which are the bread and butter of management: to formulate and execute a strategy that creates shareholder value above the cost of capital. It will be interesting to watch how these two bellwethers perform in the months and years ahead.

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