ValueInvestor
January 31, 2011
The Leading Authority on Value Investing
The Other Side of Popular
It’s when one-time market gems are perceived to have lost their luster that
Weitz Funds' Wally Weitz often steps in to do his most-profitable prospecting.
H
e has been co-managing two Weitz
Funds' equity portfolios with Brad
Hinton since 2006, but Wally
Weitz says that they are still learning to be
co-managers. “If there's a weakness, it's
that we're too deferential to each other,” he
says. “Brad has trouble telling me when I
sound crazy. We’re working on that.”
Weitz has been crazy like a fox since the
1983 founding of Wallace R. Weitz & Co.,
which now manages $3.7 billion. His flag-
ship Weitz Partners Value Fund has earned
a net annualized 12.1% over the past 20
years, vs. 9.1% for the S&P 500.
With current opportunities confined
mostly to “80-cent dollars,” they are find-
ing the most upside in such areas as docu-
ment storage, drug distribution, TV shop-
ping and insurance brokerage. See page 2
Ende Game
Investing wisely in companies that themselves invest wisely has generated out-
sized returns for First Pacific Advisors’ Eric Ende and Steven Geist.
INVESTOR INSIGHT
Eric Ende (l), Steven Geist (r)
First Pacific Advisors
Investment Focus: Seek companies in
temporary disfavor but with the business
models and management acumen to pro-
duce high returns on capital over time.
INSIGHT
Inside this Issue
F E AT U R E S
Investor Insight: Wally Weitz
Finding value by zigging when the
INVESTOR INSIGHT market zags in such companies as
Iron Mountain, Liberty Interactive,
Aon and Omnicare. PAGE 1 »
Investor Insight: Eric Ende
Seeking a select breed of long-term
value compounders, today including
Copart, Wabco Holdings, O'Reilly
Automotive and Graco. PAGE 1 »
A Fresh Look: Staples
Buying a market leader when times
are tough is typically smart, but the
payoff can involve a wait. PAGE 18 »
Brad Hinton (l), Wally Weitz (r) Of Sound Mind
Wallace R. Weitz & Co.
It often makes sense to put off tough
Investment Focus: Seek companies that decisions, but delay isn’t always a
a rational buyer, despite the latest or next neutral, or benign, act. PAGE 19 »
quarter’s results, would pay significantly
more to buy than the current market price.
Editors' Letter
How value investing is like gravity;
Parsing a management ploy to deflect
unwanted attention. PAGE 20 »
INVESTMENT HIGHLIGHTS
INVESTMENT SNAPSHOTS PAGE
H
e proudly considers himself a value
Aon 7
investor, but don't expect Eric
Copart 14
Ende to go into great detail about
Graco 16
his valuation methodology. “Only a small
Iron Mountain 5
amount of our returns are from being clever
Liberty Interactive 6
on valuation when we buy,” he says.
Omnicare 8
More important is the compound growth
O’Reilly Automotive 13
of high-return-on-capital businesses for
which Ende has shown a knack in managing Staples 18
what is now $1.2 billion in fund assets for Wabco Holdings 15
First Pacific Advisors. The FPA Perennial
Fund he has run since 1995 has earned a net Other companies in this issue:
annualized 11.9% over the past 15 years, Actuant, Apollo Group, Ascent Media,
vs. 9.3% for the Russell 2500. Baxter International, Charles River Labs,
Targeting small- and mid-cap U.S. com- Dell, Grand Canyon Education, KAR
panies, Ende and co-manager Steven Geist Auction Services, Lincare, Microsoft,
see opportunity today in such areas as auto Noble, Office Depot, OfficeMax, Redwood
Trust, Texas Instruments, VCA Antech
supplies, truck equipment, car auctions and
fluid-handling devices. See page 10
www.valueinvestorinsight.com

Investor Insight: Wally Weitz
Weitz Funds' Wally Weitz and Brad Hinton describe how experience served them well – and poorly – during the crisis,
why their mood generally improves when the market goes down, why a “changing of the guard” among shareholders
can create opportunity, and why they see unrecognized value in Iron Mountain, Liberty Interactive, Aon and Omnicare.
What did you learn about your strategy
during the financial crisis?
Wally Weitz: We’ve made a good living
over time taking the other side of the pop-
ular trade. Overall that strategy was con-
firmed – that if you're buying pieces of
businesses, managed by people you trust,
at the right prices, eventually you earn
good returns.
With financials it had almost gotten to
be reflexive that if the sellers were scared,
we could make a lot of money by step-
ping up to buy. We’d done that half a
dozen times when the Fed was raising
interest rates or there was some other
externally driven restriction of credit. But
this time around it wasn’t a Fed-induced
credit crunch, it was a mortgage melt-
down. While we’d been conceptually
aware of the credit risk, we clearly under-
estimated what would happen when you
got into a negative-feedback loop where
the bad lenders with bad loans actually
spilled over and wrecked the entire mar-
ket, affecting what we thought were good
loans from strong lenders. While I'm
proud of the fact we admitted our mis-
takes and got out much earlier than we
might have, four stocks, Countrywide
Financial, Fannie Mae, Freddie Mac and
AIG, caused some permanent losses.
Brad Hinton: Beyond that I’d add that
while we saw an economic slowdown
coming, we were in retrospect too willing
to look across the valley. Even though we
felt good about them long-term, we were
too early in betting heavily on economi-
cally sensitive companies like Martin
Marietta Materials, Eagle Materials and
Lowe’s. Given the depth and severity of
the recession, we were too quick to go
after what was most out of favor.
WW: Once we were out of those four
financial stocks that had kept me up at
January 31, 2011
I N V E S T O R I N S I G H T : Weitz Funds
night because I wasn’t sure we had mod-
eled them right, I actually started to enjoy
the collapse. Given my nature, my mood
generally improves as markets go down.
We took our cash level down from 20%
or so in late 2007 to maybe 5% in March
of 2009, which is the lowest it’s ever been.
While we were early in some cases, I will
give us credit for not being paralyzed by
fear and for taking advantage of some ter-
rific bargains. That paid off for us in
2009 and 2010. Brad Hinton, Wally Weitz
Having been through the valley, has any- Through the Valley
thing changed in how you do things?
In his first interview with Value Investor
BH: The overall methodology didn’t Insight (August 29, 2005), Wally Weitz
change, but one lesson from 2008 was was well aware of the froth creeping into
that we were guilty of having a failure of asset prices: “[S]o much money has been
imagination on the downside. We develop available and cheap in recent years that
a base, high and low case for each busi- speculative excesses exist in most asset
ness we analyze and one practical adjust- classes, whether stocks, bonds, residen-
ment we’ve made is to make our low tial and vacation real estate, leveraged
cases somewhat more draconian. That
buyouts or certain hedge fund strategies.
comes into play in what we’re willing to
Human nature is such that these excesses
pay. We’re more reluctant to buy a stock
are likely to continue to build until people
that might look attractive relative to the
start to feel some real financial pain.”
base case if the downside from the low
case is too great. That’s always been true
Despite the prescience of those words,
– if the range of outcomes is wide, that
Weitz's equity funds were nonetheless hit
probably means the cash flows aren’t as
hard in 2007 and 2008. “What's most
predictable as we’d like and we require a
embarrassing and annoying to me is that
bigger discount – but it’s even more of a
we foresaw many of the credit problems
focus now.
that came to pass,” he says, “but we failed
to recognize the vulnerability of some of
Is it possible your attachment to manage-
our companies to the liquidity crisis that
ments with which you've had great suc-
occurred as the market had its emperor's-
cess – mortgage investor Redwood Trust
new-clothes moment.”
[RWT] comes to mind – caused you at
times to not see the forest from the trees
After two strong comeback years, how
in the business?
does it feel to go from star, to has-been,
WW: That’s a fair question. We’ve had a and back again many times over a 40-year
tremendous experience with Redwood investing career? “It comes with the terri-
Trust over the past 16 years and still tory,” Weitz says. “Your perceived IQ is
strongly believe in it. It is possible, directly proportional to your latest 12
though, that our confidence in manage- month's performance.”
www.valueinvestorinsight.com Value Investor Insight 2

ment contributed to our holding more of
it than we should have in the past couple
of years.
Do you have favorite reasons for why tar-
geted ideas have fallen out of favor?
BH: One common reason is a difference
in time horizon, where the market is dis-
appointed in short-term results and our
interpretation is that the long-term health
and quality of the business remains intact.
That’s a function of our having at least a
five-year investment horizon, rather than
trying to trade on any given earnings
report.
For example, we bought shares in
medical-products company Baxter
International [BAX] when the share price
fell into the lower $40s last fall. The com-
pany has strong global franchises in
hemophilia, plasma, vaccines and renal
care. While there are some cyclical head-
winds in the plasma business and the
margin outlook is somewhat threatened
over the medium term due to pricing and
reimbursement concerns, we believe those
negatives have been excessively priced
into the stock. We expect Baxter to gener-
ate a healthy, growing stream of free cash
flow over time that it can use to enhance
per-share value. [Note: BAX shares
recently closed at $48.60.]
WW: In many cases we’re getting
involved when a rapidly growing compa-
ny is slowing down or maturing. There's
a changing of the guard among the share-
holder base and as that happens, there's
often a disagreement over how quickly
the growth is slowing and whether the
slowdown is permanent. When you’re
right that the market is overreacting to
the challenges faced, the investment result
can be quite positive. Dell [ DELL ] is one
example we own today, where we basical-
ly believe there's a good long-term trade
in assuming that while the company isn't
as good as it used to be, it is still better
than people think.
BH: We’ll speak in more detail about this
later, but Iron Mountain [IRM] is a good
example as well, where we have a variant
January 31, 2011
I N V E S T O R I N S I G H T : Weitz Funds
view versus the market about the sustain-
ability of its moat. It’s in the business of
storing boxes filled with paper, and while
it doesn’t get much duller than that, the
company was a growth-stock darling for
much of the past decade as they reinvest-
ed cash flow in building out a big physi-
cal network that is very difficult for com-
petitors to replicate.
The stock fell to $20 or so last
September, as investors were disappoint-
ed with the 2011 outlook. People who
were already worried about a move to a
ON MICROSOFT:
Buying it at 10x earnings is
not like having to call whether
Advanced Micro beats Intel in
the next product cycle.
paperless society seem to have extrapolat-
ed what we judge to be cyclical challenges
from the tough economy to be the start of
an accelerated secular decline in the
North American storage business. We’re
taking the other side of that.
How did something like Texas
Instruments [TXN], not what we’d con-
sider your typical kind of holding, attract
your attention?
WW: We actively seek out forums where
we can meet company management and
attended one last summer that included
Texas Instruments. I am certainly not a
semiconductor expert, but management
did an excellent job of describing how
the business had evolved, how they’d
bought a huge amount of manufacturing
capacity at 10 to 15 cents on the dollar in
the depths of the recession – giving them
a cost advantage going forward – and
how they were devoting almost all free
cash flow to share buybacks and increas-
ing dividends. They were saying all the
things we like to hear, regardless of the
business.
It so happened that Bill Gates of
Microsoft was there and challenged them
www.valueinvestorinsight.com
to explain why they weren’t just an unin-
teresting commodity chip business. They
explained that the driver of the business
was custom analog chips that go not only
into all sorts of glamorous consumer elec-
tronics like iPhones, but are also used to
do things like retrofit motors to make
them more energy efficient. These are
low-ticket, high-value items that they can
sell millions and millions of and that are
designed into product platforms that can
last 10, 20 or 30 years.
The fact that Bill Gates was so skepti-
cal initially was a clue maybe the compa-
ny was misunderstood, and seeing them
change his mind made me want to dig
into the story. It all came together and we
bought a lot of stock in the $23-24 range.
The market seems to have caught on [the
shares now trade around $34], but we’re
still happy to hold at this price.
To your point that it’s not our typical
holding, the technology companies we
typically own aren’t those characterized
by rapid-cycle change. Dell, for example,
is more of a marketing, assembly and dis-
tribution business – it only incidentally
makes products people label as technolo-
gy. Microsoft [MSFT], which we also
own, has done a mediocre to poor job in
the past of reinvesting its profits to devel-
op new products, but because of near-
monopoly market positions it is a super-
tanker of cash generation. Buying it at
10x earnings is not like having to make a
call on whether Advanced Micro Devices
has an advantage over Intel in the next
product cycle.
You’ve been avid investor over time in
companies controlled by cable-TV pio-
neer John Malone. Why?
WW: The most obvious reason is that he’s
made us a lot of money. More generally,
there’s often a significant amount of com-
plexity in his companies that, not surpris-
ingly, scares investors. We find those situ-
ations can be a fertile area for opportuni-
ty, as long as we’re able to build manage-
ment relationships that engender trust
and provide us with a direct source for
gaining understanding of the underlying
businesses.
Value Investor Insight 3

Was your purchase last year of Ascent
Media [ASCMA] almost a blind-faith bet
on Malone?
WW: Ascent was spun off by Discovery
Communications and its assets a year ago
consisted of some fairly prosaic video
processing businesses and a lot of cash.
We got interested when John Malone
joined the board as chairman last Spring
and said he had some ideas on what to do
with the business. The company then
agreed to sell off nearly all its existing
operating businesses for more than $15
per share, leaving it with an empty canvas
and $40 per share in cash. Ascent has
since announced it will use roughly half
its cash hoard (and leverage) to buy
Monitronics, a security monitoring busi-
ness, for $1.2 billion.
I can't show you a blueprint for how
Monitronics will perform over the next
ten years, but the economics of the secu-
rity-monitoring business are similar to
those of cable television – a business
Malone knows better than anyone. I can
imagine a day when that original $40 per
share in cash becomes $40 per share of
equity value in an expanded security-
monitoring business. If it can earn a 15%
return on equity, that's $6 of annual
growth in per-share business value in an
asset-light, recurring-revenue, free-cash-
generating business. If that happens, the
share price would almost certainly be sig-
nificantly higher than today's level [of
just over $38].
In more traditional cases, how do you
arrive at a stock’s fair value?
WW: We try to figure out what a ration-
al, informed buyer would pay for the
whole business. We’d expect that kind of
buyer to base the price on how much
cash the business would generate over
the next 15 to 20 years in excess of
what’s needed to run the business, so true
free cash flow. We use a standard 12%
discount rate as the hurdle rate that
buyer would want to earn.
Depending on the quality of the busi-
ness, predictability of cash flow, how we
feel about management and how we feel
January 31, 2011
I N V E S T O R I N S I G H T : Weitz Funds
about the industry, we might be willing to
pay 70% of our appraised value for one
business, but only 50% for another. Some
people might use different discount rates
to reflect those variables – we use the
same discount rate, but just require a
higher margin of safety when we think it’s
appropriate.
Describe your selling discipline.
BH: We’ll typically start selling lightly as
the price-to-value gets above 80%, more
ON IRON MOUNTAIN:
We very much like physical-
network businesses because
of the competitive moats that
are built around them.
heavily as it moves above 90%, and we
should be gone when it gets to 100%.
The quality of the opportunity set can
impact that – we’ll be quicker to sell the
80-cent dollar, for example, when we’re
finding a lot of 50- and 60-cent dollars
out there.
You appear to have gotten out of
Coinstar [CSTR] before the latest earn-
ings warning slammed the stock. Lucky
or good?
WW: We’ve gotten out way too early
plenty of times, but in this case, with the
stock in the upper $50s, it was near our
estimate of fair value and we were well
aware that any sign of slowing growth
could result in a period of big disappoint-
ment on the part of the momentum guys
who had bid the stock up.
With the stock off 27% in one day two
weeks ago, is it now one of those change-
in-shareholder-constituency ideas you
described earlier?
BH: We love to return to old favorites,
but in this case we would need to see a
higher discount before coming back.
www.valueinvestorinsight.com
After worries over a changing regulatory
environment caused for-profit-education
stocks to crack last summer, you doubled
down on one holding, Grand Canyon
Education [LOPE], and dumped another,
Apollo Group [APOL]. Explain why.
BH: We think Grand Canyon has several
distinguishing characteristics: Its student
mix is tilted to graduate and bachelor’s-
degree students with previous college
experience, which has led to better-quali-
ty outcomes. Its tuition levels are lower
than most peers, making the affordability
of its programs – a key bone of con-
tention with regulators – relatively better.
Its program mix is anchored by nursing
and education, two in-demand fields
where it has a long history of successfully
preparing students for careers. Finally, in
an industry in which good management is
at a premium, the company has an expe-
rienced and highly capable team led by
Brian Mueller, who was one of the key
players behind Apollo’s growth over the
past 20 years. Given all that, when the
market lumped Grand Canyon’s
prospects in with competitors that we
expect it to outperform, we saw that as
an opportunity to buy more.
WW: In light of the current political
uncertainties, we have less confidence in
our projections of future free cash flows
than we would like. So despite the poten-
tial upside in many of the stocks, we have
chosen to focus on Grand Canyon
because of its particular advantages.
Walk us through in more detail your the-
sis on Iron Mountain [IRM].
BH: The company helps its customers
store, protect and destroy mostly physical
documents, including contracts, financial
records and human-resources-related
materials. It charges a per-box monthly
fee for storage, and there are additional
service fees any time you want to move,
access or destroy documents.
We very much like physical-network
businesses because of the competitive
moats that are built around them. The
document-management industry is frag-
Value Investor Insight 4
 I N V E S T O R I N S I G H T : Weitz Funds

mented, but Iron Mountain is the largest
player with around 20% of the physical-
storage market in North America. The
biggest competition is do-it-yourself stor-
age, but once a customer has decided to
outsource this type of thing, it’s rare that
they cancel and ask for all the boxes in
storage to be returned. All that results in
high operating margins – EBIT margins
are just under 20% – and a strong and
stable recurring-revenue stream.
There is a cyclical, economic compo-
nent to the business, as less paper tends to
be created as business activity declines.
Counteracting that somewhat have been
increasing regulatory and legal require-
INVESTMENT SNAPSHOT
ments around what must be retained and
for how long. Certainly in the mutual
fund business what we’re required to
retain has gone up significantly.
How mature is the traditional business?
BH: The overall North American physi-
cal-storage market isn’t expanding, but
Iron Mountain has the potential to grow
here through share gains and price
increases. It also has established interna-
tional businesses in the U.K., Australia
and New Zealand and is investing in
faster-growing regions of Latin America
and in Europe. The non-U.S. business is
25% of sales today, growing at a double-
digit rate over our planning horizon.
The tug and pull on the stock revolves
primarily around the speed and extent to
which increasingly digital document man-
agement impacts the business. The com-
pany has invested heavily in building out
digital-document and e-mail imaging and
storage services, which now account for
about $230 million in revenue on an
annual base of $3.1 billion. It’s a lower-
margin but still decent business, with
EBITDA margins of around 25%, vs.
40% on the physical side.
As the company navigates this digital
transition, what assumptions are you
making about growth?

Iron Mountain BH: All in, we’re expecting revenue

(NYSE: IRM) Valuation Metrics
(@1/28/11): growth in the mid-single-digit range.
Business: Provider of records-manage-
ment services, including the storage, pro- IRM S&P 500 Management has been slow to increase
tection and destruction of documents, to Trailing P/E n/a 18.2 prices as the company built out its net-
commercial and governmental customers. Forward P/E Est. 20.1 13.6 work and captured share, but has now
Share Information
stated that pricing will be a focus in
Largest Institutional Owners
(@1/28/11): (@9/30/10): North America, which should help mar-
Price 24.72 Company % Owned gins expand. We’re counting on EBIT
52-Week Range 19.93 – 28.49 margins increasing from 19% currently
Davis Selected Adv 20.2%
Dividend Yield 3.0% Goldman Sachs 5.3% to about 22% by 2015.
Market Cap $4.95 billion Vanguard Group 4.7% With 9-10% annual EBIT growth, flat
Financials (TTM): Schooner Capital 4.6% interest expense, and fewer shares out-
Revenue $3.12 billion Capital World Inv 3.4% standing – as a result of aggressive share
Operating Profit Margin 19.1% Short Interest (as of 12/31/10): buybacks – we would expect to see mid-
Net Profit Margin (-0.8%) Shares Short/Float 7.0% teens growth in free cash flow per share
over the next few years.
IRM PRICE HISTORY
40 40
With the shares trading around $24.70,
35 35 how are you looking at valuation?

30 30 BH: Now that they’ve slowed capital

spending, free cash flow is substantially
25 25 higher than reported earnings. Our esti-
mate for 2011 free cash flow per share is
20 20
$1.85, so the shares currently trade at a
15 15 multiple on that of around 13.4x.
2009 2010 2011 Using a 13x multiple on our 2015 esti-
mate of free cash flow, accounting for the
THE BOTTOM LINE cash flow earned between then and now,
Wally Weitz believes the market is misjudging cyclical weakness in the company's and discounting that all back, we value
document-handling business as the start of a secular decline. Through price increas- the business today in the low $30s. Now
es, international growth, margin expansion and share buybacks, he expects mid-teens that this is a free-cash-flow story, we
annual growth in free cash flow per share. His appraised share value: in the low $30s. expect healthy per-share growth rates
Sources: Company reports, other publicly available information combined with smart capital allocation to
generate considerable shareholder value.

January 31, 2011 www.valueinvestorinsight.com Value Investor Insight 5

 I N V E S T O R I N S I G H T : Weitz Funds

Highlighting another of your John
Malone-related picks, describe the upside
you see in Liberty Interactive [LINTA].
WW: This is one of three tracking stocks
for Liberty Media. Its primary business is
the QVC home shopping network, but it
also includes LIberty’s public ownership
stakes in Expedia, HSN, Interval Leisure
and Tree.com, as well as some small pri-
vate online retail properties like
Backcountry.com and Bodybuilding.com.
The complicated structure is going to be
simplified, as Liberty Interactive is sched-
uled to become an independent company
later this year.
ing the product mix and can adjust it on
the fly based on what’s selling at that
moment.
BH: They’ve also been very good at incor-
porating the Web into their own business
model – online sales accounted for rough-
ly one-third of QVC’s U.S. business last
year. As the Internet becomes more video-
oriented, they actually have a more
robust selling proposition online because
of all the raw material they can plug in
from the TV side. We’re well aware of the
risks from someone like Amazon.com,
but we believe QVC can more than hold
its own.
How are you valuing the stock, now trad-
ing at $15.85?
BH: We estimate QVC generated just
over $1 per share in free cash flow in
2010, in a not-so-healthy environment.
We expect that to increase to about $2 by
2015, driven mostly by top-line growth
internationally and a recovering con-
sumer retail environment in the U.S.
Using a low double-digit multiple on
our 2015 free cash flow estimate – reason-
able given that capital reinvestment
demands are fairly low – and discounting
back at 12%, we arrive at a current busi-
ness value for QVC of $16-18 per share.

BH: QVC has been around for 25 years INVESTMENT SNAPSHOT

and is the undisputed leader in its field,
reaching 195 million cable households Liberty Interactive
(Nasdaq: LINTA) Valuation Metrics
worldwide, roughly 100 million of which (@1/28/11):
Business: Liberty Media tracking stock
are in the U.S., with the rest in Europe LINTA Nasdaq
representing primarily the QVC shopping
and Japan. It broadcasts 24 hours a day, network; also includes minority stakes in Trailing P/E 14.2 12.8
selling a wide variety of discretionary such firms as Expedia, HSN and Tree.com. Forward P/E Est. 21.4 16.1
household and personal items to a loyal
Share Information Largest Institutional Owners
target audience primarily of middle-aged, (@1/28/11): (@9/30/10):
more-affluent-than-you’d-expect women. Price 15.85 Company % Owned
Overall, QVC accounts for nearly 90% of 52-Week Range 10.08 – 16.80 T. Rowe Price 11.7%
Liberty Interactive’s total revenues. Dividend Yield 0.0% Southeastern Asset Mgmt 11.1%
The business held up quite well Market Cap $9.48 billion Dodge & Cox 9.9%
through the recession, and without the Financials (TTM): Harris Assoc 3.3%
capital requirements of bricks and mortar Revenue $8.76 billion Vanguard Group 3.2%
retailers it generates nice free cash flow. Operating Profit Margin 12.7% Short Interest (as of 12/31/10):
Adjusted EBITDA fell less than 10% Net Profit Margin 7.6% Shares Short/Float 1.4%
from 2007 to 2008, and is expected to be
back at 2007’s level of $1.65 billion for LINTA PRICE HISTORY
20 20
2010. QVC's revenues were roughly flat
from 2007 to 2009, and we estimate that
they grew by 6% in 2010 to a new high 15 15

of $7.8 billion.
10 10
To what extent do you consider online
competitors like Amazon a threat? 5 5

WW: The TV network offers an enter- 0 0

tainment element that sets it somewhat
apart and has proven to have legs against
Internet competition. The sales mecha-
nism is quite sophisticated – a chef selling
her cookware on QVC, for example, has
the producers whispering in her ear and
suggesting she point to the purple pot
because call volume picks up whenever
she does that. They’re constantly refresh-
2009 2010 2011
THE BOTTOM LINE
Uncertainty over the timing and final terms of its formal spinoff from Liberty Media is
causing investors to underestimate the resilience and competitive strength of the com-
pany’s QVC shopping network, says Brad Hinton. He pegs the current value of QVC
and other marketable securities the company owns at $21-23 per share.
Sources: Company reports, other publicly available information

January 31, 2011 www.valueinvestorinsight.com Value Investor Insight 6

 I N V E S T O R I N S I G H T : Weitz Funds

The marketable securities at current prices rates have been low, limiting what they have increased over the past few years
are worth another $5 or so per share. can earn on their float. from 16% to an estimated 20.5% in
2010, but we think there’s still room for
Are there any risks around the spinoff? So is your bet primarily on those nega- improvement as the business turns up and
tives going away over time? management keeps a lid on costs. On the
WW: There is an ongoing suit, expected consulting side, we expect margins to
to be heard in February, by Liberty Media BH: That’s certainly an important part of increase from today’s 16.5% as Hewitt is
bondholders claiming that the security of it – risk units will come back as the glob- integrated. Aon has targeted $350 million
those bonds will be impaired by this spin- al economy recovers and sooner or later in cost synergies from the merger, which
off. That uncertainty probably leaves we will have a hard insurance pricing more than tripled the size of Aon’s con-
some investors cold, as does the fact that market. But we don’t have to build in sulting business. On top of that, manage-
Liberty has reallocated assets among the much optimism on those fronts to see this ment sees considerable revenue synergies
tracking stocks in the past and could do as attractive. from cross-selling among practice areas.
so again before the spinoff gets done. We We see room for margin expansion in We’ve chosen to wait and see on that, but
don’t consider either of those a big risk, both brokerage and HR consulting. that would cause an incremental bump to
because we trust Liberty management to Pretax margins in the brokerage business earnings and margins.
insure that the value they said would be
delivered to LINTA shareholders will be INVESTMENT SNAPSHOT
delivered.
Aon Corp.
(NYSE: AON) Valuation Metrics
What attracted you to insurance broker (@1/28/11):
Business: Provider of insurance brokerage
and HR consultant Aon Corp. [AON]? AON S&P 500
and related risk- and human-resources-
related consulting services to primarily cor- Trailing P/E 18.8 18.2
WW: We owned Hewitt Associates when porate customers worldwide. Forward P/E Est. 13..2 13.6
Aon agreed to buy it last year. Aon was
Share Information Largest Institutional Owners
on our monitor list because we like the (@1/28/11): (@9/30/10):
insurance brokerage business and the Price 45.32 Company % Owned
shares were reasonably priced. When the 52-Week Range 35.10 – 46.33 Southeastern Asset Mgmt 8.7%
acquisition was announced and Aon Dividend Yield 1.3% T. Rowe Price 7.1%
stock came under pressure, we took the Market Cap $12.28 billion Capital World Inv 5.7%
other side of what the arbs were doing, Financials (TTM): State Street Corp 5.6%
selling them our Hewitt stock while buy- Revenue $7.68 billion Vanguard Group 4.6%
ing Aon. Operating Profit Margin 13.9% Short Interest (as of 12/31/10):
Net Profit Margin 8.8% Shares Short/Float 2.3%
What do you like about the insurance-
brokerage business? AON PRICE HISTORY
50 50

BH: It’s another capital-light business and

basically an oligopoly, with Aon, Marsh
& McLennan and Willis Group control-
ling a significant share of the large-corpo- 40 40
rate-client market. It generates 20% oper-
ating margins for Aon even in a soft mar-
ket, with 20%-plus returns on capital and
significant free cash flow. 30 30
Because of the economic contraction, 2009 2010 2011
insurance risk-unit demand has been
weak globally, as companies have less to THE BOTTOM LINE
insure or choose not to insure certain Expecting only modest improvements in global demand for insurance “risk units” and in
risks. Excess supply among insurers has what has been a soft insurance pricing environment, Brad Hinton believes the company
also exacerbated a soft pricing market, can earn $5.75 per share in cash earnings by 2015. Using a 13x terminal multiple and
which hurts Aon because it gets two- discounting back to the present, he believes the shares today are worth closer to $65.
thirds of its brokerage revenues from Sources: Company reports, other publicly available information
commissions. On top of all that, interest

January 31, 2011 www.valueinvestorinsight.com Value Investor Insight 7

 I N V E S T O R I N S I G H T : Weitz Funds

At a recent $45.30, how cheap do you had been president of McKesson’s U.S. That’s driven both by a continued shift in
consider the stock? drug-distribution business, as the perma- the product mix toward generics – on
nent CEO. which Omnicare earns higher margins –
BH: The shares trade at less than 11x our and from nuts-and-bolts operating
$4.25 per share estimate of cash earnings On what should management be focused? improvements.
in 2011. We’re expecting cash earnings to
increase to $5.75 per share by 2015. WW: A lot of it is just making simple Is the business growing?
Using a conservative 13x terminal multi- operating improvements: Support the peo-
ple and including the present value of ple in the field interacting with customers. BH: The number of beds served, at
cash generated in the interim, our current Create an internal culture in which every- around 1.4 million, has declined slightly
appraised value is in the mid-$60s. one is working toward common goals. over the past four years, but we do expect
Take better advantage of the company’s the sales and service upgrades to help turn
WW: This is a classic example of the scale in areas like procurement. that modestly around. We’re projecting
kind of opportunity we pursue. Other Without assuming anything heroic, we 4% annual top-line growth over our fore-
investors who like the business, its man- expect EBIT margins to expand from a cast horizon, which with margin expan-
agement team and even its share price current 8.5% to 9.5% or so in 2015. sion translates into mid-single-digit annu-
are deterred by the soft insurance mar-
ket. They seem to think they’ll magical- INVESTMENT SNAPSHOT
ly be able to buy just before the market
firms. We believe they’ll pay a higher Omnicare
(NYSE: OCR) Valuation Metrics
price at that point, which could start a (@1/28/11):
Business: Purchases, repackages and dis-
sharp revaluation upward. We’d rather OCR S&P 500
tributes pharmaceuticals to nursing homes,
own it now and benefit fully when that hospices and assisted-living centers repre- Trailing P/E 77.5 18.2
happens. senting 1.4 million beds in 47 states. Forward P/E Est. 11.7 13.6
Share Information Largest Institutional Owners
You’ve traded in and out of drug distrib- (@1/28/11): (@9/30/10):
utor Omnicare [OCR] for years. Why is it Price 25.95 Company % Owned
interesting now? 52-Week Range 19.14 – 30.63 Harris Assoc 5.0%
Dividend Yield 0.5% Glenview Capital 5.0%
WW: Almost in spite of itself, the compa- Market Cap $3.02 billion Schroder Inv Mgmt 3.8%
ny has staked out a strong leadership Financials (TTM): Wallace R. Weitz & Co 3.8%
position in selling pharmaceuticals to Revenue $6.13 billion Vanguard Group 3.7%
geriatric clients living in nursing homes, Operating Profit Margin 8.2% Short Interest (as of 12/31/10):
assisted-living facilities and long-term- Net Profit Margin 0.6% Shares Short/Float 7.2%
care facilities. Its value-add is in packag-
ing the drugs in ways meant to improve OCR PRICE HISTORY
35 35
compliance and accuracy of usage, and it
uses its scale to negotiate better terms
with suppliers and to fend off smaller 30 30

competitors.
While there are challenges to the busi- 25 25
ness overall, the biggest negative to the
story in our opinion was removed last 20 20
August when the board replaced the long-
time CEO, Joel Gemunder. He tended to 15 15
pick fights with executives internally and 2009 2010 2011
scrimped on customer-facing sales and
service, all the while paying himself a lot. THE BOTTOM LINE
The interim CEO was board member With its long-time CEO having been replaced, Wally Weitz believes the company’s
Denny Shelton, with whom we had an greater emphasis on sales and service combined with nuts-and-bolts operating
excellent experience when he was CEO of improvements can drive free cash flow growth from an estimated $3 per share this
Triad Hospitals several years ago. He has year to $4.70 by 2015. With those assumptions, he values the shares today at $35.
since become non-executive Chairman Sources: Company reports, other publicly available information
with the naming of John Figueroa, who

January 31, 2011 www.valueinvestorinsight.com Value Investor Insight 8


al EBIT growth. It all gets more interest-
ing on a per-share basis, given the compa-
ny’s opportunity to use free cash to signif-
icantly shrink the share count over the
next five years. We estimate free cash
flow of $3 per share in 2011, rising to
$4.70 by 2015.
What upside do you see in the share price,
now around $26?
WW: Our appraised value today is
around $35, and we believe the stock
could move to that level simply by regain-
ing respectability in investors’ eyes. If
they generate the earnings growth we
expect, we could easily see a premium to
the 13x multiple we assume for 2015.
The stock traded at $60 a few years ago
and there’s no reason it couldn’t again.
What are the key risks?
WW: We expect continued pressure on
reimbursement rates, but we are assum-
January 31, 2011
I N V E S T O R I N S I G H T : Weitz Funds
ing that as the company gets squeezed, it
will figure out how to adjust in order to
maintain the spread. If it doesn’t succeed
in doing that, our margin estimates will
be too high.
In an operating turnaround, there’s
also always execution risk. In addition to
our having faith in new management, the
good news here is that the comparisons
should prove to be fairly easy.
Wally, you mentioned your mood
improving as stocks get cheaper. How is
your humor today?
WW: The stocks in our portfolio are obvi-
ously not as undervalued as they were a
year ago, and are certainly much more
expensive than they were two years ago.
In March 2009 the average stock we held
sold for less than 50% of our estimate of
business value, and that was with
extremely conservative expectations.
Today our stocks on average sell at about
75-80% of appraised value, a level from
www.valueinvestorinsight.com
which we’ve earned reasonable returns in
the past, but not one that gets us very
excited.
We've been selling into the rally and
now have 15-20% cash in our two largest
equity portfolios. If the market keeps
going up the cash will be a drag on our
performance, but the opportunity cost of
having some extra cash right now doesn't
strike us as particularly high. Buying
opportunities seem to crop up when, and
where, you least expect them.
Morningstar calls your funds’ perform-
ance “streaky but good.” Are you OK
with that?
WW: Given that our funds are concen-
trated both in the absolute number of
positions we hold and in the number of
industries that are represented, it's natu-
ral for our performance to be lumpy. If
the alternative is being consistent and
mediocre, we would much prefer to be
streaky but good. VII
Value Investor Insight 9

Investor Insight: Eric Ende
First Pacific Advisors' Eric Ende, Steven Geist and Gregory Herr explain what matters most in identifying stocks they
hold for an average of seven years, the mistake they find most difficult to avoid, why they’re “on the cowardly side” in
establishing positions, and why they see particular upside in O'Reilly Automotive, Copart, Wabco Holdings and Graco.
Your strategy descends from none other
than Warren Buffett and Charlie Munger
(see box on this page). Describe its basic
outlines.
Eric Ende: Your recent interview with
Morris Mark (VII, December 2, 2010)
kind of took away our thunder, as most
of what he said about strategy sounded
awfully familiar. We put the same empha-
sis on companies that earn high returns
on capital and have attractive reinvest-
ment opportunities. They have strong
balance sheets, with debt accounting for
no more than 35% of total capital and
usually much less. For example, our com-
panies today have on average about 10%
net debt.
We believe the most important con-
tributor to the long-term investment per-
formance of the companies we own is
earnings growth, not a change in valua-
tion. Because growth is driven by earning
high returns on capital and successfully
reinvesting cash flow, we tend to be very
long-term investors – our average hold-
ing period runs about seven years – in
order for this virtuous process to bear
fruit. Because of that orientation, we put
primary emphasis on market structure,
the sustainability of the business’s com-
petitive advantage, and management’s
track record in creating shareholder
value over time.
If you step back and think about the
basics of what we’re doing, we’re interest-
ed in companies that are better than their
competitors and which have shown the
ability to take the cash they earn and do
something smart with it. There’s nothing
earth-shattering about that, but to the
extent you can apply it, understand the
business dynamics and not pay foolish
prices for things, there’s no reason you
shouldn’t get the attractive long-term
returns we believe we and our predeces-
sors have produced.
January 31, 2011
I N V E S T O R I N S I G H T : First Pacific Advisors
What constitutes not paying foolish
prices for things?
EE: We’re basically willing to pay average
or below-average valuations for compa-
nies we believe will continue to have bet-
ter-than-average performance. Relative to
more elaborate valuation disciplines you
may hear about from others, ours is rela-
tively simple. Historically we’ve managed
to pay mid-teens trailing earnings multi-
ples for pretty good companies, low-teens Eric Ende, Steven Geist
if we’re really fortunate. If you have
enough time, paying a high-teens multiple Down the Line
can work out, but it’s more of a burden.
If you have to compromise somewhere, While they took unconventional paths to
however, our view is that compromising become investors – Eric Ende worked for
on quality is not a good thing to do – pay- 13 years in corporate finance, while
ing a little more for a consistently good Steven Geist spent a comparable period
business is the better way. as an engineer – they both had the good
fortune to land at First Pacific Advisors
No discounted-cash-flow models? under the wing of George Michaelis.
Dubbed by one author as the “apostle of
Steven Geist: We find that even using a return on equity,” Michaelis delivered mar-
consistent discount rate you can come up
ket-trouncing returns at FPA’s Source
with anything you want in a DCF model.
Capital closed-end fund before dying in a
You often see these 2x2 or 3x3 valuation
bicycle accident in 1996. Ende took over
tables in Wall Street research that give
Source that year, and now co-manages it
share-price targets under a mix of
and the FPA Paramount and FPA
assumptions on the key inputs, and they
Perennial mutual funds with Geist.
conclude the true number is somewhere
in the middle of the box. The problem is
Michaelis' mentors were none other than
that the range of supposedly legitimate
Warren Buffett and Charlie Munger, who
potential outcomes can be a share price
independently bought shares of Source in
from $10 to $100. The assumptions you
the mid-1970s when the floundering fund
have to make tend to be so uncertain that
traded at 50% of net asset value. They
we don’t find it a particularly useful way
redirected it under Michaelis to focus on
to look at a company.
high-quality businesses that can com-
pound shareholder value at high rates for
Describe how you define your circle of
many years. The strategy, still in place
competence.
today, informed Buffett and Munger's orig-
EE: We’re looking at companies that inal thesis for Source Capital itself. “It's all
trade primarily in the United States with very good to buy $1 for 50 cents,” says
market caps between $500 million to $5 Ende, “but if that $1 is being managed
billion. We try to avoid fast-changing incompetently or following a dumb strate-
businesses with short-life-cycle products gy, then maybe it's not a very good deal.”
www.valueinvestorinsight.com Value Investor Insight 10

because they’re inherently more difficult
to forecast. We also tend to avoid compli-
cated technology and biotechnology busi-
nesses, where we have to ask what our
competitive advantage is in analyzing the
business.
So we focus on relatively easy-to-
understand businesses, often with fairly
concentrated industry structures. We
recently went through the portfolio and
found that roughly one-third of the
names, and probably representing a high-
er portfolio weight, were companies in
industries that were essentially two-firm
oligopolies. You can have an irrational
market whether there are two firms or
ten, but most of the time the more con-
centrated businesses are well-behaved,
which is quite helpful for profitability and
allows companies to make rational rein-
vestment decisions.
We were surprised to see decent represen-
tation in your portfolio of highly cyclical
oil-services stocks, like Noble [NE] and
FMC Technologies [FTI].
EE: We’re generally reluctant to invest in
crummy-return businesses, and historical-
ly that’s been true of those tied to com-
modities. There’s a legitimate question as
to whether the world has changed in com-
modities, but over time in the past they
haven’t done better than provide com-
modity returns, so we didn’t care.
We consider oil services different in its
fundamentals from the exploration and
production side of the business. There’s
clearly a strong cyclical component, the
impact of which can be reduced by the
length of our time horizon, but we also
believe that the way the companies are
managed can generate incrementally
higher returns on capital. Noble, for
example, has done an excellent job over
time in timing capital investments, deliv-
ering capital projects on time and on
budget, and leasing out capacity on new
deepwater vessels and rigs prior to actual-
ly committing the cash to buy them. All
that greatly reduces risk and has resulted
in better-than-average returns.
After hoarding capital the last few
years, Noble last June announced the
$2.7 billion acquisition of smaller com-
January 31, 2011
I N V E S T O R I N S I G H T : First Pacific Advisors
petitor Frontier Drilling, and also
announced $1 billion in spending to buy
two ultra-deepwater drillships, backed by
10-year contracts from Royal Dutch
Shell. Those deals increase Noble’s back-
log from $7 billion to $13 billion, second
in the industry only to Transocean. More
important, they demonstrate an ability to
add well-priced assets at an opportune
time, which should result in good returns
for shareholders.
ON DIVERSIFIED RIVALS:
We’re either impressed they
can track 150 or more compa-
nies . . . or skeptical of their
ability to credibly do so.
How do ideas tend to get on your radar
screen?
SG: We maintain a list of companies that
meet all the criteria Eric mentioned and
monitor it to identify when the market is
giving us an opportunity to buy. Often
it’s as simple as a missed quarter or a
change in analysts’ estimates, which is all
a lot of noise much of the time and isn’t
relevant to whether the company is in an
attractive business and is likely to rein-
vest its money successfully over a five- or
ten-year period.
Gregory Herr: We’ll often follow a busi-
ness for years until for company-specific
reasons or due to market conditions an
opportunity presents itself. A good exam-
ple of that in the portfolio today is VCA
Antech [WOOF], the largest operator of
animal hospitals and veterinary diagnos-
tic labs in the U.S. This had been a buy-
out by Leonard Green & Partners, the
private-equity firm, which came public in
2001 and caught our attention for the
attractive reinvestment potential in buy-
ing veterinary practices and for the excel-
lent profitability of the lab business,
which is a duopoly. It had everything we
like in a business, but the valuation
reflected that until the downturn in late
www.valueinvestorinsight.com
2008 and we were able to buy it at a price
that made sense.
In this case, the price has remained
attractive because the volumes at the vet
hospitals have been anemic for the last 18
to 24 months. You wouldn’t think spend-
ing on pet healthcare would be that dis-
cretionary, but people have clearly been
putting off or skipping some treatments
for their pets. That’s still weighing on the
stock, but we don’t believe that tendency
will persist for the long term.
VCA Antech was an example of a
company whose debt we owned in
Source Capital [First Pacific’s closed-end
balanced fund], that eventually became
attractive as an equity investment.
Another example of that we own is
Actuant [ATU], a small conglomerate of
energy-focused industrial businesses that
was split off from the electronics business
of Applied Power maybe 10 years ago.
As bondholders, we knew the company
well and as it paid down debt, the bal-
ance sheet became clean enough that we
we’re able to invest in the equity a couple
years ago.
Your portfolios tend to hold 30 to 40
positions. Why have you decided on that
level of concentration?
EE: When we see competitors holding 75-
100 positions, with 75-100% annual
turnover, we’re either very impressed with
their ability to keep track of 150 or more
companies … or we’re skeptical of their
ability to credibly follow that many com-
panies. We don’t have anywhere near that
many good ideas in a year.
Given our number of holdings and our
turnover, we can devote 10 times the
amount of time some others can spend on
any given position, which means we
should know the business better, reducing
the possibility that things are going to hit
us from left field. That depth of knowl-
edge, combined with the quality of the
businesses we want to own, is our pri-
mary risk-management tool.
How do you size positions?
EE: We consider a position full at about
3% as we’re purchasing it, but we tend to
Value Investor Insight 11

be on the cowardly side at the beginning,
starting with 50- to 100-basis-point posi-
tions. We’re most comfortable buying
stuff that is going down, so we’ll take our
time building a position and hopefully the
passage of time will increase our under-
standing of the business and our confi-
dence in what the future looks like. If the
share price cooperates, we’ll buy up to the
3% position. At the same time, if we buy
and the stock pops 20%, we don’t feel
compelled to move from a less than “full”
position.
Larger positions are mostly the result
of success. We bought well, the company
has performed, and we’ve owned it for a
long time. When something like that gets
to 6-7% of the portfolio, we’ll probably
start trimming it back. That’s doubly true
when the valuation is also pushing the
upper limit of what we would consider
reasonable.
Can you generalize about where you’ve
tended to make mistakes?
EE: Given our focus on companies that
reinvest wisely, we spend a lot of time try-
ing to understand how management has
reinvested cash flow in the past and the
criteria for how they plan to do so in the
future. The problem that’s very hard to
foresee is when management acts totally
out of character and makes a horribly
destructive investment. The most vivid
example of that was four or five years ago
when what was then called Oshkosh
Truck [now Oshkosh Corp.], after ten
years of making smart acquisitions in
related businesses they understood well,
bought a company called JLG Industries.
It was outside their core business, highly
cyclical, and they overpaid for it. When
they announced the deal the stock went
down 15-20% and we got out as quickly
as we could. The only consolation was
that we avoided it going from $45 down
to $4 in the financial crisis.
Did something similar happen with
Charles River Labs [CRL] last year?
EE: In many ways, yes. The company’s
core business of selling research models –
January 31, 2011
I N V E S T O R I N S I G H T : First Pacific Advisors
basically rats and mice – is a great busi-
ness, with dominant worldwide market
share and low-30% operating margins.
They had been adding to that core with
related businesses that support healthcare
research or drug development. Then in
April of last year they announced they
planned to pay $1.6 billion to buy WuXi
PharmaTech, the leading Chinese
provider of early-stage drug development
ON MISTAKES:
It’s very hard to foresee when
management acts totally out
of character and makes a hor-
ribly destructive investment.
services. While there was a legitimate
strategic rationale for the deal, the price
was 6x WuXi’s sales and 30x EBIT, at a
time when Charles River shares traded at
2x revenues and 11x EBIT. We also saw
significant integration risks in the acquisi-
tion, primarily the challenge of keeping
WuXi’s two thousand Chinese scientists
happy. The deal made us lose confidence
in management’s ability to intelligently
reinvest cash flow, so we sold immediate-
ly. As an addendum to the story, some of
the remaining shareholders revolted and
with the help of new activist owners
forced the company to abandon the deal
in July.
How did you handle long-time holding
Lincare [LNCR] after healthcare regula-
tory concerns knocked a third off the
share price last summer?
EE: We’ve owned Lincare, which is the
leading provider of home oxygen equip-
ment, since 2000. In almost all respects
it’s superior to its competitors, but there’s
a good deal of uncertainty, to put it mild-
ly, about where reimbursement rates are
going for its products and services. In July
the Center for Medicare Services
announced the results of a competitive
bidding process in which overall prices
fell more than expected, and Lincare lost
www.valueinvestorinsight.com
the ability to take on new customers in
certain test markets.
Our thesis has been that Lincare’s cost
advantage over its competition will allow
it to earn decent returns while others lose
money and withdraw from markets. That
should result in it taking significant mar-
ket share, prior to regulators backing off
on price cuts because of sharp declines in
service levels. Needless to say, this thesis
is controversial. We continue to hold our
position and with new rates going into
effect in the test markets now, we should
know relatively quickly whether our
argument is valid.
Walk through your investment case today
for O’Reilly Automotive [ORLY].
GH: O'Reilly is one of the three big auto-
parts retailers in the U.S., along with
AutoZone and Advance Auto Parts.
What sets it apart is its traditional cus-
tomer mix, with roughly 50% of the busi-
ness from the professional mechanic and
garage trade, and 50% from the retail do-
it-yourselfer. Serving the professional
trade requires bigger investments in dis-
tribution and service, but the resulting
higher sales productivity per store has
generated excellent returns for O’Reilly
over time.
The story here revolves around the
July 2008 purchase of CSK Auto, which
resulted in a 70% increase in O'Reilly's
store base and gave it a national platform
to roll out its dual-market strategy. CSK
was in almost all respects a suboptimal
operator and commercial sales represent-
ed only about 10% of its revenues, so
there was significant opportunity for
O’Reilly to enhance the productivity of
the acquired stores as it merged them into
its infrastructure and strategy.
Over the past two years management
has been methodically integrating the two
businesses. They have completely over-
hauled the inventory and layout of CSK
stores, while significantly improving parts
availability and service by adding new
distribution capacity. That’s critical to
success on the commercial side of the
business, where mechanics typically work
with time-sensitive schedules.
Value Investor Insight 12
 I N V E S T O R I N S I G H T : First Pacific Advisors

The results of all this have already
been positive, but we believe the biggest
upside is still to come. The CSK stores
were generating around $1.4 million in
average sales prior to the acquisition, and
management and Wall Street are focused
on that getting before long to around
$1.8 million. But if the productivity ulti-
mately gets to the level of O’Reilly’s tra-
ditional stores, average sales will be in
the $2.5-2.7 million range. To put that in
perspective, if they get to $2 million per
store, with 1,300 stores you’re talking
about an additional $300-350 million in
sales over current levels – worth proba-
bly 25 cents per share in earnings. If they
INVESTMENT SNAPSHOT
O’Reilly Automotive
(Nasdaq: ORLY)
Business: Retailer of automotive aftermar-
ket parts, tools, supplies, equipment and
accessories sold to both professional and
do-it-yourself customers in the U.S.
Share Information
(@1/28/11):
Price 56.51
52-Week Range 37.58 – 63.05
Dividend Yield 0.0%
Market Cap $7.89 billion
Financials (TTM):
Revenue $5.26 billion
Operating Profit Margin 13.2%
Net Profit Margin 7.3%
ultimately get to $2.7 million, you’re who has been very skilled at getting cash
talking $1.2 billion in extra sales and flow out of the business – one way of
maybe 75 cents in incremental EPS. which to do so has been to minimize rein-
There’s no guarantee they get there, but vestment. That’s been financially success-
we believe it’s a legitimate possibility ful, but it has made AutoZone a much
over the next five years. more benign competitor. That’s been true
for years and we expect it to continue.
What’s the competition doing while all
this is going on? Does O’Reilly face a headwind if the new-
car market continues to improve?
EE: Advance Auto Parts doesn’t have a
presence in the Western markets in which GH: The auto-parts business is somewhat
CSK was strong, which leaves AutoZone countercyclical, as an economic slow-
as the main competitor. The key point down causes people to hold on longer to
there is that the company is controlled by their old cars, which require more
Eddie Lampert, the hedge fund manager, upkeep. But given the magnitude of what
can happen with the CSK stores, we don’t
expect growth to be overly impacted by
an uptick in new-car sales.
There’s also growth potential outside
Valuation Metrics
(@1/28/11):
of the CSK stores. O’Reilly is still mostly
ORLY Nasdaq absent in Florida and in the Northeast,
Trailing P/E 20.5 12.8 and there’s opportunity to fill in where
Forward P/E Est. 16.3 16.1 they already have a store footprint. They
opened 150 new stores in 2010, expect
Largest Institutional Owners
(@9/30/10): another 170 this year, and believe 200-
Company % Owned 225 per year is a reasonable expectation
in coming years. Overall, from new stores
T. Rowe Price 13.0%
Vanguard Group 4.9% and increased sales at existing stores,
State Street Corp 3.4% we’d expect annual top-line growth of
Lone Pine Capital 3.3% around 10%. With higher margins and
Select Equity Group 3.2% the fact that they’re embarking on their
Short Interest (as of 12/31/10): first-ever share buyback plan, EPS growth
Shares Short/Float 2.1% may be closer to 15% annually.

ORLY PRICE HISTORY With the shares at $56.50, how are you
80 80
looking at valuation?
70 70
GH: The company likely earned about $3
60 60
per share in 2010, with consensus esti-
50 50 mates calling for $3.50 this year and bit
40 40 under $4 in 2012. We don’t pay that
much attention to forward multiples, but
30 30 the earnings-growth potential here is
20 20 good enough that a 19x trailing multiple
2009 2010 2011 is more than palatable. We think there’s
an argument for earnings power within a
THE BOTTOM LINE few years of closer to $5 per share.
The market isn’t recognizing upside still available from integrating acquired CSK Auto One balance sheet issue I’d mention is
stores into the company’s infrastructure and strategy, says Gregory Herr. While some- that the company just refinanced its cred-
what pricey on trailing earnings, the shares are far more attractive against the $5 per it facility, which had limited O’Reilly’s
share in earnings power he believes the company can generate in the next few years. use of vendor financing because invento-
Sources: Company reports, other publicly available information
ry had to be pledged as collateral. That
restriction has gone away, and we expect

January 31, 2011 www.valueinvestorinsight.com Value Investor Insight 13

 I N V E S T O R I N S I G H T : First Pacific Advisors

the company to free up working capital
by increasing its payables-to-inventory
ratio from a current level of around 48%.
Every 500-basis-point increase in the
ratio is worth $100 million in cash flow.
For comparison, Advance Auto’s
payables/inventory ratio is 71%, while
AutoZone’s is 107%.
EE: We’ve met O’Reilly management at
least 15 to 20 times over the years and
they are absolute straight-shooters – you
ask a question, they give you an honest
answer with no spin. We trust them, and
the track record over a long period of
time justifies that.
with Copart’s operating margins typically
coming in above 30%.
What are the key demand drivers?
EE: The most important generator of
demand is accident frequency, which is
tied almost entirely to miles driven, mak-
ing it modestly correlated with economic
activity. The severity of accidents is also
important, and here there has been a sec-
ular increase in the percentage of acci-
dents that result in cars being totaled.
That’s a result of more expensive stuff
being built into cars, such as airbags and
fancier lighting systems. When they go,
the car is more likely to find its way to
Copart.
Are there other growth opportunities?
EE: Copart still does make acquisitions in
the U.S., which basically involves buying
holding lots in order to better serve cus-
tomers and to reduce the distance the cars
have to be towed.
The company expanded into the U.K.
a few years ago and now has a leadership
position there, with some 25% of the
market. They’ve shown an ability to suc-
cessfully take their model outside the U.S.
and we think there are other markets in

Staying within the automotive world, INVESTMENT SNAPSHOT

describe what appeals to you about car-

auction company Copart [CPRT]. Copart
(Nasdaq: CPRT) Valuation Metrics
Business: Seller through online auctions of (@1/28/11):
EE: Copart’s primary business is manag- “totaled” and high-mileage cars for insurance CPRT Nasdaq
ing auctions for salvage vehicles. If an companies, fleet owners, banks, charities Trailing P/E 21.6 12.8
Allstate client has an accident and the and auto dealers in the U.S. and U.K. Forward P/E Est. 15.0 16.1
determination is made that the car can’t Share Information Largest Institutional Owners
be fixed at a reasonable cost, Allstate will (@1/28/11): (@9/30/10):
contract with Copart to haul the car Price 39.11 Company % Owned
away, store it and then auction it off to 52-Week Range 31.28 – 40.87 Concert Wealth Mgmt 10.7%
the highest bidder, retaining a percentage Dividend Yield 0.0% Baron Capital 5.6%
of the proceeds as a fee. Market Cap $3.21 billion Capital Research Global Inv 4.2%
The auctions are done entirely on the Financials (TTM): Neuberger Berman 4.1%
Internet, which has expanded the poten- Revenue $800.1 million Wasatch Adv 3.6%
tial buyer base significantly, especially Operating Profit Margin 30.3% Short Interest (as of 12/31/10):
outside the U.S. Just because Allstate Net Profit Margin 19.3% Shares Short/Float 2.2%
decides not to fix a car in Los Angeles,
that doesn’t mean someone in Nigeria or CPRT PRICE HISTORY
50 50
Venezuela or Poland, where there are dif-
ferent regulations and cost structures,
can’t fix it economically. 40 40
We like that the business has substan-
tial barriers to entry. The primary assets
are the holding lots, which you need a lot 30 30
of to minimize hauling distances. The
real estate itself can be difficult to find,
and getting zoning approvals can make it 20 20
even harder. Broad scale is also impor- 2009 2010 2011
tant, as national insurers prefer to deal
with a salvage company with a national THE BOTTOM LINE
footprint. The company has capitalized on its strong market position and expanded successfully
As a result of all this, there are only into new geographic and product markets that leverage its online selling platform, says
two companies of size in the market, Eric Ende. With expected annual EPS growth in the double digits and a management
Copart and KAR Auction Services team with an “owner’s mentality,” he expects to “hold on to this for a number of years.”
[KAR], which share around 75% of mar- Sources: Company reports, other publicly available information
ket. Profitability levels are quite high,

January 31, 2011 www.valueinvestorinsight.com Value Investor Insight 14

 I N V E S T O R I N S I G H T : First Pacific Advisors

continental Europe, including Germany
and France, with similar potential.
They have also built a profitable busi-
ness selling what they call “high-mileage”
vehicles, which might be cars coming off
lease, or repos, or fleet cars that dealers,
banks or companies may be looking to
unload on a regular basis. Because of
their buyer base and established online
selling platform, they believe they can get
attractive prices compared to the used-car
auctions of companies like Manheim.
This business now accounts for 20-25%
of Copart’s vehicles sold, and has the
potential to continue to grow nicely.
While still not back to pre-crash levels,
the stock at a recent $39 has done quite
The market has two premier players,
with Wabco holding a 40-50% global
share, followed by Germany’s Knorr-
Bremse at #2. Emerging-market competi-
tors are generally limited to low-end
products, where Wabco is less active.
Given the premium in the market on tech-
nological innovation, quality and safety,
we wouldn’t expect Wabco’s competitive
position to be under threat for some time.
The downturn hit the company hard,
with revenues falling from $2.4 billion in
2007 to $1.5 billion in 2009. But they’ve
done an excellent job of using that adver-
sity to cut costs. They eliminated 23% of
their global workforce and have acceler-
INVESTMENT SNAPSHOT
ated shifts in manufacturing and the
sourcing of parts and materials from
high- to low-cost countries. As revenues
bounced back to an estimated $2.2 billion
last year, we believe operating margins
came in at 10.3%, up from 2.9% the year
before. As revenues continue to grow rap-
idly – which we expect – the lower cost
base should result in margins easily sur-
passing the peak level of 12.3% in 2005.
What’s behind your optimistic revenue
outlook?
EE: Part of it is just an expected rebound
in unit truck production in the U.S. and

well lately. Has it gotten pricey?

Wabco Holdings
(NYSE: WBC) Valuation Metrics
EE: On estimated earnings for the year (@1/28/11):
Business: Develops, manufactures and
ending in July of $2.30 per share, the sells braking, stability, suspension and WBC S&P 500
multiple is around 17x. A recent tender transmission-control systems primarily for Trailing P/E n/a 18.2
offer to buy back 15% of the outstanding commercial trucks. Based in Belgium. Forward P/E Est. 15.2 13.6
shares has helped push up the price. Share Information Largest Institutional Owners
We’ve held on to our shares because (@1/28/11): (@9/30/10):
the company has proven it can deploy Price 57.28 Company % Owned
capital to grow and earn attractive 52-Week Range 24.09 – 63.97 T. Rowe Price 10.6%
returns, which we believe can drive annu- Dividend Yield 0.0% Lord Abbett 9.0%
al EPS growth in the low double digits. Market Cap $3.70 billion Fidelity Mgmt & Research 8.2%
Management runs the business with an Financials (TTM): Vanguard Group 4.4%
owner’s mentality – the founder is still Revenue $2.01 billion Times Square Capital 3.4%
Chairman and his family controls about Operating Profit Margin 8.6% Short Interest (as of 12/31/10):
10% of the stock – and is willing to Net Profit Margin (-12.5%) Shares Short/Float 1.2%
return capital to shareholders as condi-
tions warrant. We would expect to hold WBC PRICE HISTORY
80 80
on to this for a number of years.
70 70
60 60
Why are you so high on prospects for
truck supplier Wabco Holdings [WBC]? 50 50
40 40
EE: Wabco was founded as Westinghouse 30 30
Air Brake Co. 140 years ago and was 20 20
spun off in 2007 from American 10 10
Standard. It is a leading worldwide man- 0 0
ufacturer of technologically advanced 2009 2010 2011
heavy-truck components, including air
disc brakes, electronic braking and stabil- THE BOTTOM LINE
ity control systems, and automatic trans- Eric Ende expects a rebound in truck production in the U.S. and Europe, continued
missions. It’s a global business, headquar- truck-demand growth in emerging markets, and increased penetration of the compa-
tered in Belgium, with major operations ny’s high-end components in all markets to fuel growth in revenues and profits that he
in developed markets in Europe, the U.S. believes will make today’s 16x trailing multiple on the stock appear exceedingly cheap.
and Japan, as well as in rapidly growing Sources: Company reports, other publicly available information
countries like China, India and Brazil.

January 31, 2011 www.valueinvestorinsight.com Value Investor Insight 15

 I N V E S T O R I N S I G H T : First Pacific Advisors

Western Europe, where build rates fell by
two-thirds in the recession and have only
recently started to pick back up as those
economies show signs of life. The compa-
ny has guided to 40% revenue growth in
North America this year and mid-teens
growth in Europe.
Another key factor is that expanding
economies need trucks to transport
goods, making Wabco an excellent vehi-
cle for participating in emerging-market
growth. Unit truck production in China,
India, and Brazil grew probably 40% in
2010 and those countries now account
for about a quarter of the company’s
sales. The recent growth pace won’t con-
tinue, but these markets for Wabco are
anything but mature.
tions on the expectation that the surpris-
es are much more likely to be positive
than negative.
Explain your case today for long-time
holding Graco [GGG].
SG: This is not the Graco that makes
baby strollers and car seats, but a manu-
facturer of industrial equipment that is
used to pump, mix and dispense a wide
variety of fluids and semi-solids. It’s a
classic razor/razor blade type of business,
with the pumps as the razor and the
related hoses and nozzles – which tend to
wear out quickly – as the blades.
INVESTMENT SNAPSHOT
Roughly 50% of total revenues come
from delivering replacement products to
its installed base.
The company is known for the high
quality of its products, for investing in
new-product development, and for strict
manufacturing cost control, all of which
helps produce excellent returns on equity
that are running north of 30%. Total
operating margins are just above 20%,
which most companies would die for, but
which will improve at Graco when over-
all economic conditions more fully recov-
er. We also like very much that their non-
U.S. business generates roughly half of
total sales.

The final part of the growth story is

Graco
increased content in each truck produced. (NYSE: GGG) Valuation Metrics
The value of Wabco content on a new (@1/28/11):
Business: Global manufacturer of fluid-
truck varies widely from market to mar- handling equipment used in a wide variety GGG S&P 500
ket, from perhaps $300 in China, to of industrial, processing, construction and Trailing P/E 27.5 18.2
$1,000 in the U.S., to $3,000 in Europe. maintenance applications. Forward P/E Est. 21.3 13.6
All these numbers are very likely to go up Share Information Largest Institutional Owners
as government regulators, manufacturers (@1/28/11): (@9/30/10):
and buyers put increased emphasis on Price 42.15 Company % Owned
safety and improved productivity. 52-Week Range 25.82 – 42.75 Mairs & Power 5.4%
Revised regulations, for example, are in Dividend Yield 2.0% Select Equity Group 4.6%
process to require shorter stopping dis- Market Cap $2.52 billion Vanguard Group 4.6%
tances in the U.S. – requiring more Financials (TTM): Waddell & Reed 3.9%
sophisticated brakes – electronic stability Revenue $693.1 million Franklin Resources 2.6%
control in Europe, and anti-lock braking Operating Profit Margin 20.1% Short Interest (as of 12/31/10):
systems in Brazil. All of this plays to Net Profit Margin 13.4% Shares Short/Float 6.1%
Wabco’s strength as an innovator and
technology leader. GGG PRICE HISTORY
50 50

The story has not gone unnoticed, with

40 40
the shares having more than doubled in
the past year to a recent $57.30.
30 30
EE: The stock has gone up a lot and now
trades for just over 16x estimated 2010 20 20
earnings of $3.50 per share. You could
argue that’s expensive for a cyclical busi- 10 10
ness, but we believe the secular growth 2009 2010 2011
story, enhanced by the operating leverage,
is fairly profound. The company has sug- THE BOTTOM LINE
gested that it can earn operating margins Cyclical rebounds in car, truck and housing markets and secular growth in the usage
in the 25-30% range on incremental rev- of paint-spraying equipment should help drive EPS growth of more than 10% per year,
enues. The question then is how much says Steven Geist. Given the company's strengths, he says, “we're likely to do very
revenues will grow. It’s tough for us to be well from here even if the multiple is a bit higher than a new buyer might like.”
terribly specific about that, but we’ve Sources: Company reports, other publicly available information
made the stock one of our largest posi-

January 31, 2011 www.valueinvestorinsight.com Value Investor Insight 16


So is the basic bet on recovering econom-
ic conditions?
SG: We see a few levers to the upside. The
Industrial business segment, which
accounts for around 55% of revenues,
serves original-equipment manufacturers
in markets, like cars and trucks, that fell
off a cliff in the downturn. As that pro-
duction ramps back up – and, as Eric
mentioned, there are early signs of life –
Graco will benefit.
The Contractor business unit, which
generates around 35% of sales and sells
things like paint sprayers to painters and
striping equipment for highways and
parking lots, has both cyclical and secular
upside. The decline in the housing market
has hurt both revenues and profits in this
business, where operating margins are
running at roughly half the more typical
levels of 25% or more. No one is count-
ing on a imminent turnaround, but any
reasonably good news on housing would
clearly have a positive impact on the com-
pany’s results.
The secular trend working in Graco’s
favor is increased usage of spraying
equipment by painters in international
markets. The U.S. has been well ahead of
the world in replacing brushes and
rollers, but that is changing over time as
penetration levels steadily increase in
both Europe and Asia.
With the shares trading at around $42,
isn’t the valuation – more than 20x con-
sensus 2011 EPS estimates – a bit on the
high side?
SG: Yes, which you’d expect to an extent
for a company coming off depressed earn-
ings. Our feeling is that over time the
recovery and expansion of the revenue
base will drive annual growth rates in
earnings per share in the low double dig-
its. If we can own a market leader in good
industries, with a great balance sheet, high
returns on capital and that kind of long-
term profit growth, we’re likely to do very
well from here even if the multiple is a bit
higher than a new buyer might like.
Have you held this for a long time?
January 31, 2011
I N V E S T O R I N S I G H T : First Pacific Advisors
SG: In fact, we first bought shares in
1996 at a split-adjusted $4 per share. So
at today’s price, before dividends, we’ve
earned a 16% annualized return.
Are any macroeconomic views particular-
ly influencing the makeup of your portfo-
lio today?
GH: One that is certainly not unique to
us and that we’ve been talking about for
some time is our expectation that the U.S.
dollar will weaken over time. That con-
tinues to result in our gravitating toward
businesses with significant geographic
diversification in their operations. Those
to-date have been listed almost exclusive-
ly in the U.S., but we’re making a concert-
ed effort to look at non-U.S. equity mar-
kets as well.
SG: We’re also quite aware of the debt
overhang that still exists for U.S. con-
sumers, which is tempering our outlooks
for retail and other consumer-discre-
tionary companies. For such companies
we’re not counting on a return to histor-
ical volume levels or rates of growth for
some time. To the extent we own a con-
sumer-focused business, it’s likely to be
like O’Reilly, where the spending is less
discretionary because people need to
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keep their cars working. Something like a
high-end clothing retailer we’d be quite
leery of today.
How are your views on the economy’s
prospects informed by ongoing conversa-
tions with the management of companies
you own?
GH: Particularly in more industrial and
cyclical businesses, the attitude is much
more positive today than it was two years
ago. I wouldn’t say we put a lot of stock
in that, however, given that these same
businesses showed little or no ability to
foresee the latest downturn. Our conver-
sations with management are much more
focused on understanding the business
dynamics than on trying to get a sense of
what their economic outlook is for the
next year.
EE: We have been surprised by how well
companies in general responded to the
demand shock of the crisis, and by how
well they’ve enhanced profitability as rev-
enues have come back in the last quarter
or two. I’d say we’re undecided on
whether that gives us confidence in the
future, or if it’s just an endorsement of the
companies we were fortunate enough to
buy and own a couple years ago. VII
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Value Investor Insight 17

Delayed Gratification
It's typical for value investors to favor market leaders pressing their competitive advantage when times are
tough, since such companies can do particularly well as times improve. Sometimes that can involve a wait.
Smart companies typically use adverse
market cycles not only as an impetus to
tighten their belts, but also to make
strategic investments that will enhance
their competitive advantage when overall
conditions improve. At a time when the
worst of the economic crisis was only ten-
tatively past, W.P. Stewart's James
Tierney saw Staples doing just that 14
months ago (VII, November 30, 2009).
The #1 office-supply retailer had signifi-
cantly expanded its direct-delivery busi-
ness through the purchase of a leader in
the segment, Corporate Express. It was
opening new stores while its floundering
competitors Office Depot and OfficeMax
were cutting back. It continued to under-
cut competitors on price, all the while
maintaining industry-leading operating
margins. As the economy healed, Tierney
argued, Staples' enhanced competitive
strength would drive earnings – and the
stock price – much higher.
While Staples has executed well –
2010 earnings per share increased an esti-
mated 12%, to $1.28 – the share price,
recently at $22.30, has gone nowhere in
the past 14 months. The primary reason
is that one key aspect of Tierney's thesis
has yet to arrive: “There's been no eco-
nomic tailwind to speak of,” he says.
That's particularly true in office-supply
retail, where fortunes are most closely
tied to employment numbers, which
remain anemic in the U.S.
Tierney argues that despite the econo-
my's sluggishness, the investment case for
Staples is stronger than ever. Even assum-
ing a modest 2-3% rise in annual compa-
rable-store sales – which would be higher
if economic growth accelerated – he
believes the company can generate 15-
20% EPS growth over the next few years.
That's fed by a wide variety of factors,
including new-store openings, improved
international margins, continued syner-
gies from the Corporate Express acquisi-
tion, an ongoing mix shift to higher-mar-
January 31, 2011
A F R E S H L O O K : Staples
gined Staples-brand products, and the use against what those three are trying to do.
of free cash flow to buy back shares and I can think of plenty of other areas they'd
pay off debt. Prior to paying its dividend, pursue first before expanding here in a
he says the company generated an esti- big way.” In fact, he says, Wal-Mart has
mated $1.4 billion in free cash flow in been taking floor space away from office
2010, or nearly $2 per share. supplies.
While this could be said of almost any What's Staples worth? Assuming a
large retailer, one oft-cited fear among more-conservative-than-before 15x mul-
analysts is that Staples over time faces tiple, $2.85 in 2016 EPS, $4.16 in cumu-
increased competition from low-price lative dividends and a discount rate of
retail behemoths such as Wal-Mart, 9.5%, Tierney pegs the company's fair
Costco and Amazon.com. Tierney consid- value today at $30 per share. He refuses
ers such fears overdone: “The nature of to count on meaningful improvement in
the category is to sell things that are rela- the employment picture, but if it happens,
tively low-priced and bulky, which works he says, “this stock will just kill it.” VII
INVESTMENT SNAPSHOT
Staples
(Nasdaq: SPLS)
SPLS PRICE HISTORY
30 30
25  25
20 20
15 15
10
2009 2010 2011
10
VII, November 30, 2009
Share Information (@1/28/11): Valuation Metrics (@1/28/11):
Price $22.32 SPLS NASDAQ
52-Week Range $17.45 – $26.00 Trailing P/E 19.4 12.8
Forward P/E Est. 14.3 16.1
ORIGINAL BOTTOM LINE – NOVEMBER 30, 2009
The company is pressing its advantage over weak competitors, says James Tierney,
through aggressive pricing, store growth and an expanded delivery business. Assuming
14% annual EPS growth through 2015, he puts the shares’ fair value today at $32.
NEW BOTTOM LINE
While the company’s execution has been excellent, one key aspect of James Tierney’s
investment thesis has yet to manifest itself: an overall economic tailwind. Even after taking
down his out-year multiple expectation, he puts the fair value of the shares today at $30.
Sources: Company reports, other publicly available information
www.valueinvestorinsight.com Value Investor Insight 18

What Are You Waiting For?
People delay difficult decisions for any number of good reasons. But the choice to put off a tough call isn’t
always a neutral act, and can in fact alter decisions in predictable and not-always-benign ways.
It's hard to argue with the time-tested
advice to “sleep on” difficult decisions.
The perspective gained by not acting in
the heat of the moment or just letting time
pass as you grapple with an uncertain or
unpleasant choice generally leads to a
more rational decision. Time for reflec-
tion can also allow time for more digging.
As investment strategist and author Peter
Bernstein once put it: “Once we act, we
forfeit the option of waiting until new
information comes along. As a result, not
acting has value. The more uncertain the
outcome, the greater may be the value of
procrastination.”
For all the benefits, however, there are
potential pitfalls in delaying the tough
calls. One of which to be aware is that the
act of choosing to delay a decision can
actually influence the ultimate decision
made. Thomas Gilovich of Cornell
University and Niels van de Ven of
Holland's Tilburg University asked
research subjects to imagine they had just
received an inheritance and that a finan-
cial advisor had recommended investing
it in a particular stock. In case they didn't
like the recommendation, the advisor
offered an alternative, which based on the
information provided was meant by the
researchers to offer an almost indistin-
guishable choice. Half of the subjects
were asked to make an immediate deci-
sion, while the other half were allowed to
delay it.
What happened? An overwhelming
majority of the immediate-choice group
opted to go with the financial advisor's
recommendation, while only 56% of
those who chose to delay did so. “We at
times infer our attitudes from our behav-
ior,” says Cornell's Gilovich. “Delaying a
choice that could have been made earlier
can be seen as a cue that we aren’t confi-
dent of which alternative is best. That
lack of confidence makes people less like-
ly to choose the normative or intuitive
option,” which in this case was to go
January 31, 2011
along with the advisor's suggestion. On
its face this is neither good nor bad – the
“normative” option can be a better or
worse choice – but it highlights that the
choice to delay a decision isn't a neutral
act and can alter decisions in a pre-
dictable way.
Another potential mistake is ascribing
excess import to new-found information.
In a study titled, “On the Pursuit and
Misuse of Useless Information,” academ-
ic researchers Anthony Bastardi and
Eldar Shafir found that people often
arrive at a decision point, “not with well-
established and clearly ranked prefer-
ences, but rather with the need to deter-
mine their preference as a result of having
to decide, and they often look for addi-
tional information in hopes that it may
facilitate the choice.” The problem, they
found, is that people often treat such new
information – which would have had no
impact on the decision had it been avail-
able earlier – as instrumental to the deci-
sion after it has been pursued. “It's hard
to imagine that giving greater prominence
to input just because you've waited for it
will result in a better decision,” says
Gilovich.
www.valueinvestorinsight.com
OF SOUND MIND
The more conspicuous the new infor-
mation, the more likely it is to exert
undue influence on a decision. Economist
George Akerlof cites as a thought experi-
ment the example of a new-car purchaser,
who after doing research that includes
poring over Consumer Reports' safety
and reliability ratings decides to buy a
Volvo. But when someone at a cocktail
party says his brother-in-law owned a
Volvo that was a lemon, the prospective
buyer is likely to abandon his choice post-
haste, even though, as Akerlof points out,
“the status of this additional information
is only to increase the Consumer Reports
sample by one. Mean repair records are
likely to remain almost unchanged.”
In an investment context, delaying
decisions to buy or to sell would appear
to have somewhat different opportunity
costs. To the extent that an inability to
pull the trigger on a buy decision reflects
discomfort with one's analysis or the risk
and uncertainty involved, the downside
of waiting is quite low. As Baupost
Group's Seth Klarman puts it: “As
Graham, Dodd and Buffett have all said,
you should always remember that you
don't have to swing at every pitch. You
can wait for opportunities that fit your
criteria and if you don't find them,
patiently wait. Deciding not to act is still
a decision.”
Potentially more problematic is dither-
ing over selling decisions, especially when
it reflects an unwillingness to acknowl-
edge a mistake or hubris in parting with a
winner. In either case, investors can con-
coct new reasons to hang on in the face of
objective evidence that it's time to go,
which is unlikely a recipe for success.
“'Should I delay a decision?' is only the
first question,” says Gilovich, “followed
quickly by, 'What do I gain by doing so?'
For a decision that needs to be made, you
should have concrete reasons why it's bet-
ter to wait. If you don't, you're generally
better off making it now.” VII
Value Investor Insight 19
 EDITORS’ LETTER

The Saving Grace of Value

Starting in earnest a few years ago,
GMO asset-allocator extraordinaire
Jeremy Grantham has been pounding the
table for high-quality blue-chips, arguing
that they are significantly undervalued
relative to smaller, less financially secure
and less competitively blessed rivals. As
he told us in an interview (VII, January
30, 2009): “A year ago, high-quality
stocks were as cheap on a relative basis as
they have ever been against low-quality
ones.” This sentiment has been a com-
mon one among many investors we've
interviewed, and we'll admit to express-
ing it ourselves with some regularity.
It's also been a trade that has thus far
been wrong. The market's re-embrace of
risk, accelerating over the past three or
four months, has left blue-chips lagging
well behind their higher-octane brethren.
In his latest market commentary,
Grantham takes stock of his “quality”
call with his usual wisdom and wit:
[I]t would have been reasonable to have
shifted to at least an increased percentage of
risky investments after March 2009,
because some of them, notably emerging-
market equities, did have estimates almost
as high as quality. [But] quality stocks were
not only the least expensive, they were also
the least risky, often a formidable combina-
tion. But even if we had made such a move
at the lows, more extreme value discrepan-
cies by early 2010 would have compelled us
to move back to our present position –
heavily overweight quality stocks – that we
have carried for years.
Our pain in 2010 was more “business as
usual,” waiting for the virtues of value to be
revealed. The saving grace is that, although
value is a weak force in any single year, it
becomes a monster over several years. Like
gravity, it slowly wears down the opposition.
“As I said before . . . ”
In its newly launched S&P 500
Earnings Behavioral Snapshot, Business
Intelligence Advisors analyzes earnings
calls for subtle and not-so-subtle indica-
tors that management is being evasive or
is otherwise uncomfortable in describing
its company's business. BIA's latest report
highlights what it calls a common tactic
of which investors should be wary: man-
agement's continued reference to previ-
ous statements in explaining potentially
negative trends. As an example, in
Nuance Communications' Q3 2010 earn-
ings call, management addresses ques-
tions over deteriorating enterprise sales of
its speech-based technologies by repeat-
edly citing earlier warnings that such
weakness would be a natural conse-
quence of a shift to a hosted, “on-
demand” business model. The danger
with such a tactic, BIA warns, is that by
re-casting shortfalls as business-as-usual,
“management is able to gloss over the
extent to which revenue declines sur-
passed original expectations … steering
the discussion away from the possibility
that any additional factors contributed to
weaker segment performance.” In such
cases BIA counsels persistence, asking
“presumptively worded” questions such
as, “To what extent did revenue declines
exceed your previous expectations?”
Direct questions call for direct answers.
You may not get them, but that’s worth
knowing as well. VII
John Heins Whitney Tilson
Co-Editor-in-Chief Co-Editor-in-Chief

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