Measuring Up to Jensen

 

 

A top investor explains what it would take for utilities to be included in one of the best-performing funds in the U.S.

Passing the standards for inclusion in the $1 billion plus Jensen Portfolio Fund is like being crowned the best-of-the-best in a given industry, analysts say.

That's because only the best-of-the best could support a fund that has managed to beat the S&P 500 in an economic downturn. In fact, the Jensen Fund has generated an impressive 2.25 percent a year over the 36 months to December 2002, against a 14.53 percent annualized decline in the S&P 500. During the recent economic boom, the fund delivered double-digit returns.

But to date, the investment fund has yet to include a utility stock. The fund chooses stocks using one bedrock criterion: Jensen wants companies that have posted a 15 percent or better return-on-equity (ROE) in each of the past 10 years.

Furthermore, Val Jensen, chairman of the fund, says the impact of non-recurring earnings is reviewed on a case-by-case basis to identify long-term performers that may have had a few bad years.

According to the Forbes Best Buy List, the average return on equity (ROE) for S&P 500 companies is 17 percent; the average for the Jensen Fund is 24 percent. The ROE screen alone narrows the field of candidates from 10,000 publicly traded firms to around 100 companies, according to Jensen. Then, to decide the true value of a company without regard to its current market price, the fund determines an "intrinsic value" for each of the candidates by calculating the present value of the company's estimated future free cash flows. Furthermore, the Forbes list says this discounted earnings stream is added to a pessimistic valuation of the company at the end of 10 years, which assumes just 5 percent subsequent cash flow growth.

"They want companies trading at no more than 60 percent of this hypothetical intrinsic value. Even the finalist has to be a leader in its industry and boast a stellar credit rating," says the Forbes Best Buy List report on the fund. Companies in the fund include Coca-Cola, Johnson & Johnson, Merck, and Colgate Palmolive.

Jensen says utilities traditionally have not had a high ROE, so they have not been on his list. Southern Co. has consistently produced 12 percent ROE, but never as high as 15 percent.

Furthermore, in 1992, when the fund was started, profit was regulated, so utilities were not attractive, he says. When utilities were able to get outside of the regulated sphere, "they got so far afield outside their expertise they probably didn't know enough about the businesses they were getting into," Jensen says.

In fact, Jensen remembers looking at Duke Energy early on as an investment candidate. "They did a marvelous job until they got caught up in the energy trading aspect, which was a blow that the utilities never needed. The return on trading commodities, whether you look at Enron or anybody else, is terrible. It is a very competitive environment, and no one can