BILL PRIEST IS A MAN ON A MISSION, determined to educate individual and institutional investors about a new paradigm for picking stocks.
In four-plus decades on Wall Street, Priest learned that there's more than one way to generate returns on equities. In 2004, he and co-chief investment officer David Pearl established Epoch Investment Partners -- a specialized money-management firm that oversees some $12 billion in assets -- to help institutions increase risk-adjusted returns.
Their methodology involves identifying companies that intelligently allocate free cash flow. Among the ten strategies they've crafted, five have track records of at least five years, and each of these has surpassed their relevant benchmarks as of Dec. 31. Epoch's largest strategy by assets, Epoch U.S. Value, with $3.1 billion, has a five-year annual return of 3.2% (net of fees), versus the Standard & Poor's 500's 0.4%.
Epoch's assets since founding have grown an average 50% annually, while the publicly traded asset manager's common shares (Epoch Holding; EPHC) have skyrocketed from $2.65 to above $11 since November 2004.
Last June, Epoch was hired to subadvise several MainStay funds. In November, MainStay, which has $36.6 billion in assets under management and is owned by New York Life ($245 billion AUM), and Epoch completed a fund-adoption plan -- meaning that NYL is distributing/marketing the Epoch funds under its banner. In 2009, the MainStay Epoch Global Equity Yield Fund (EPSYX) was awarded the Lipper "Best Fund Over 3 Years" in the Global Multi-Cap Value Funds category.
Barron's caught up recently with Priest at Epoch's mid-town Manhattan offices.
Barron's: Congratulations on your new partnership with MainStay. What's the main advantage for Epoch?
Priest: It adds a volume-based retail strategy to our traditional institutional-client focus. It gives us access to a vast and growing distribution network. In five years, gross sales through MainStay's outside broker-dealer channel have almost quadrupled. Today, MainStay ranks 26th based on net flows among intermediary-sold mutual funds in the U.S.
In your '07 book, Free Cash Flow and Shareholder Yield, you express skepticism about the usefulness of corporate earnings as indicators of a company's financial health. You take issue with standard valuation metrics like price/earnings ratios as a tool to determine a stock's true value. Why?
The P/E ratio is no longer the keystone metric that many investors continue to believe it is. The weakening of GAAP [generally accepted accounting principles] standards over the past 20 years has led to earnings becoming less informative about the true financial health of a business. In fact, GAAP standards have grown so intricate and complex that their utilization is fraught with serious pitfalls for both management and investors.
You don't think they are reliable or useful?
No I don't. Any methodology subject to so much variation, imprecision and even manipulation should not form the basis for equity valuations. Yet historically, to question conventional accounting practices was considered heresy. It's time we thought differently.
There is an excellent book by George Christy, Free Cash Flow: Seeing Through the Accounting Fog Machine to Find Great Stocks. The accounting is a fog machine. It hides financial reality. Recently, we won a mandate from a large health-care institution, following a meeting with the selection committee. The committee chairs were former partners of a Big Four accounting firm. As David Pearl and I were explaining our methodology for free-cash-flow investing, they stopped us, and one said, 'The only thing we accountants can't hide is cash.'
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