Morningstar Advisor - Spring 2008 - (Page 54) Morningstar Conversation others are massively overreacting to the problems facing many financial companies. He is convinced that stock prices for many notable financials already reflect some very negative news, so his firm recently went as far as to launch a financials-only portfolio for institutional accounts. Such conviction has served Pzena well in the past, and he’s certainly expecting the same again. In fact, he isn’t shy about comparing his current malaise to what he went through during the Internet heyday. This time, however, the company he’s keeping is more modest, with many notable value managers positioned quite differently. Why is he standing firm? To find out, we visited him on March 6 at his New York offices. Kunal Kapoor: You’ve said that you look for good businesses experiencing temporary problems that should be earning more than what they’re currently earning. What are some things that you look for to determine whether you think the firm can correct its issues and move forward? Richard Pzena: First, is it a good business? A good business is a business where you can identify one or more reasons why it should, in the long run, earn a good return on its invested capital base. It could be anything: a competitive cost structure, physical assets or location, a customer base that’s difficult for a competitor to unseat, a brand or a franchise or a technology—something that makes us think that even if the current management fails in its efforts to restore the earnings back to normal, someone else is going to want to try. But sometimes, it’s industry conditions, like with what we’re experiencing today with financials, consumer cyclicals, and housing and housing-related. These are all businesses that are currently impaired, and they’re impaired by industry conditions more so than any company-specific situation. The questions are, how permanent are these, and is there any industry data that you can look at to convince yourself that they’re not permanent? KK: Do you place a premium on management? RP: It’s an interesting question, because we are Then, we have to make a judgment, and this is the hardest part, because the judgment is, will the management’s plan likely cause the earnings to rebound? Obviously, we buy before we know if the plan’s going to work. So it’s a judgment. We’re making an assessment. relying on the management to execute a plan to restore the earnings power. On the other hand, very often it’s the management that got them into the place they’re in. Obviously, we’re not looking to invest in companies that we think are ineffectively managed, but we recognize that the people running these companies are human beings and that people make mistakes. The standard Wall Street view 54 Morningstar Advisor Spring 2008
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