My Conversation With Jerry Dodson, Founder of Parnassus Funds

Rod MacIver Blog, Interviews 2 Comments

Wednesday, March 1, in New York City, I interviewed Master Investor Jerome Dodson, CEO and founder of The Parnassus Funds. The Parnassus Funds under the leadership of Jerry Dodson have built one of the most impressive performance records in the investment business, generating superior returns over the last one, three, five, ten and twenty-five years. According to Barron’s, the Parnassus Endeavor Fund is one of only four domestic stock funds to accomplish superior returns with such consistency. The fund has a five-year annual return of 17.8% versus 14.1% for the S&P 500.

The Parnassus funds have accomplished these returns following simple investment principles: invest in companies with exceptional long term profitability during periods of temporary adversity, or when the market is negative about the prospects of an entire sector, and focus on companies that are socially responsible, in particular that are good places to work, that treat their employees well. In part, this approach evolved out of studies of the investment performance of Fortune’s list of the best 100 companies in the country to work for — they outperformed the market by one to two percent, on average, consistently, over long periods. In our interview, I explored the investment principles behind the Endeavor Fund, as well as the individual holdings in the fund — what positions Jerry feels best about, and which ones concern him.

Rod MacIver:             What do you look for in potential investments?

Jerry Dodson:            There are two crucial considerations. One, we look for companies that are out of favor, that are selling at low prices compared to their five-year historic average price to earnings, price to sales, price to cash flow, price to book value. The second thing we look for are companies that are good corporate citizens and that have good environmental policies. We look at charitable contributions. Most importantly, we look at how a company treats its employees. We try to invest in undervalued companies that we think are good citizens and that are socially responsible.

Rod MacIver:             Average price earnings, price sale, price book over the last, what period of time?

Jerry Dodson:            Five years. If the average five-year PE ratio is 15, and now the stock is selling at 14 or below, it’s a candidate. If the average PE is 21, and now it is trading at 19, it is cheap on a relative basis.

Rod MacIver:             I see. If it falls further … let’s say it falls 50% from where you buy it. You have been investing long enough that that must have happened at least a few times.

Jerry Dodson:            Unfortunately, it has. Just because it is out-of-favor and trading at five year lows, doesn’t mean it can’t go lower. We look at it again to see if the fundamentals are still intact. We look at the qualitative; what Warren Buffett calls “moat”. Of course, we exclude certain areas: tobacco, alcohol, gambling, and, in my fund, fossil fuels.

Rod MacIver:             How about military suppliers?

Jerry Dodson:            There’s a good question. Because we don’t want to give the idea that we’re anti-military. The military keeps America …

Rod MacIver:             You like living in America.

Jerry Dodson:            Exactly! Safe and free! We don’t want to invest in weapons manufacturers, which have a lot of different problems. If they’re making, say, uniforms for the military, or they’re selling canned foods or something like that, that’s fine.

Rod MacIver:             Yes. Okay, so if it falls, you look at it again, review it, and if the fundamentals appear reasonable and it’s now down 50%, you buy more, and if it’s not, you sell it, and move onto the next thing.

Jerry Dodson:            Exactly.

Rod MacIver:             Holding period, on average?

Jerry Dodson:            The average is about three years, but of course it varies from time to time. Sometimes, it’ll go up in a year and we sell it. Sometimes, we should have sold sooner and we didn’t. For instance, Whole Foods. We bought in the low $30s. It promptly went to $60, but we’d held it less than a year so to take a capital gains tax, not an ordinary tax, we held on. Was that a mistake. It promptly plunged back, below where we originally bought it. That was within a year. Typically, you don’t have that happen.

Rod MacIver:             Would you ever hold a stock for decades?

Jerry Dodson:            Not that long. We sell when a stock reaches what we calculate as intrinsic value. It’s rare that we hold more than three or four years.

Rod MacIver:             Yes, and it appears from what you’ve said, that you won’t pay a premium for growth unless it’s reflected in the historic five-year average PE, price book, price to sales, etc. Right? You wouldn’t for instance, apply the Benjamin Graham valuation formula for growth stocks as outlined in the 1962 edition of Security Analysis, which proposes appropriate PE ratios for companies based on historic growth rates. They range from nine to 48.4 basically. He’s looking at historic growth rates, but not looking at historic PE ratios. Your approach is fascinating to me. That’s why I’m re-exploring it. Of course, the most standard, widely used, difficult to use well ratio, is the PEG ratio. Price earnings to growth, so if a company is growing at 10%, the PEG ratio is ten times. If it’s growing at 50%, then the appropriate PE ratio is 50, according to the theory. That doesn’t enter into your analysis, correct?

You can read the entire interview [HERE].

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About the MicroCap Expert Author

Rod MacIver

Rod MacIver is an investor and writer living in the Adirondacks, Florida and Vermont. He focuses on companies with a sustainable competitive advantage or “moat” as reflected in extraordinary profitability, little or no debt and minimal capital expenditure requirement. He publishes the Quality Company Analysis report, which offers in-depth research into the highest-quality companies trading on U.S exchanges.

Comments 2

  1. Rod, thank you for posting your interview with Jerry Dodson. I also noticed his Morningstar five star Endeavor Fund is ranked #1 in its category (out of 1,000 funds) for one, three, five, and ten year periods. It is quite impressive.

    It’s fascinating, yet not surprising, how he looks at Fortune’s 100 Best Companies to look for list. I’m sure it’s a good sign of a great culture. Happy employees tend to make happy customers.

  2. Thanks Ian, and thanks for publishing the interview. I was surprised too.

    Dodson’s investment philosophy brought to mind a life philosophy that I’ve long been fascinated by, and tried to incorporate into my own life with varying success over the years: “Quality in all things.” I printed something out years ago that I keep above my desk:

    Quality
    In all things:
    Friendships, your relationship with time,
    with yourself (time in nature, music, books)
    Strive for harmony, equilibrium.

    “Tell me, what is it you plan to do
    with your one wild and precious life?”
    – Mary Oliver, “Summer Day”

    And in investing 
    Invest with quality people
    in quality companies when they are unpopular

    It is easy in concept, difficult in execution. There are many different definitions of what quality is because as people we are each different, but it is a good way to go through life. Back in the days of Tom Landry, the Dallas Cowboys locker room had a banner:

    “The quality of a man’s life is directly related to his commitment to excellence.”

    It is a completely different philosophy than trying to get the most for the least, just as in investing, paying a premium for quality is different than value investing, not that the two can’t work together in a kind of harmony. But anyway, I think you know all this because the MicroCapClub shows your commitment to excellence and quality.

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