There are only three or four things you need to know about a company,” Jerome Dodson tells a dozen students on a crisp September evening, “but, unfortunately, you have to do a lot of looking through the weeds before you find out what those things are.”
A talent for finding gold amid the weeds has helped make Dodson, 75, one of the top investors of his generation. And that has made the class he teaches at New York University a magnet for ambitious M.B.A. candidates eager to emulate his success—plus one Barron’s reporter. But as his students listen to the founder of Parnassus Investments, it becomes evident that Dodson takes far more than three or four things into consideration when deciding whether to buy a stock.
For one thing, Dodson is a giant of sustainable investing. His approach—a combination of virtue and vigilance, bound by guidelines he rarely wavers from—has helped him consistently beat his investment benchmarks along with the vast majority of his peers who don’t take a values-oriented approach. Dodson stepped down from managing the flagship $840 million Parnassus fund (ticker: PARNX) in early 2018; prior to that, he had been just one of a handful of managers to have beaten the S&P 500 index over virtually every time period going back more than 20 years.
Today, Parnassus oversees $28 billion in assets in five funds—Parnassus, Parnassus Core Equity (PRBLX), Parnassus Fixed Income (PRFIX), Parnassus Mid Cap (PARMX), and Parnassus Endeavor (PARWX). Dodson began teaching at NYU in September, but he has been teaching Parnassus interns since he founded the firm, and many of those interns are now managing Parnassus funds—including CEO Ben Allen and CIO Todd Ahlsten.
“He has created a very successful company that has made a lot of money for a lot of people by considering sustainability issues. For him, it’s a complement to the fundamental investing process—treating workers well and the environment well says something good about a company,” says Jon Hale, global head of sustainability research at Morningstar.
Those who take Dodson’s six-week course, “Investment Management: Hands-on Value and Values Investing,” which I began auditing last September, encounter a man who seems deceptively young—spry, cheerful, gregarious, approachable. He’s usually clad in a dress shirt, tan pants, and a tweed jacket that seems like an afterthought.
He’ll wear a version of his outfit throughout the course, as he tries to help students reach the objective described in the downtown Manhattan school’s catalog: “To gain knowledge of how to achieve excellent investment performance by investing in undervalued companies with superior environmental, social, and governance qualities (ESG).” About 40% of the grade comes from an oral report, 40% from a written report, and 20% from class participation.
Value Investing 101
Baron Rothschild is frequently credited with articulating the premise of value investing, famously counseling that “the time to buy is when there’s blood in the streets.” It took Columbia University professor and investor Ben Graham to codify it in his classic book The Intelligent Investor, which we are assigned to read. Graham described how to buy stocks in a disciplined fashion, when they sold at a fraction of their intrinsic value. He called this discount “the margin of safety.” The market is an inefficient place, he argued, filled with players who have wildly divergent agendas. Diversification reduces the risk that our own, massively personal hopes for a company won’t be realized. But not too much diversification—Graham says 10 to 30 companies is enough.
If Graham is Dodson’s great love, the other is Warren Buffett, Graham’s most famous student. Graham was a creature of the 1930s, forever focused on safety. Like Graham, Buffett avoids too much debt. But he also looks for growth, and for a large “moat,” meaning sustainable competitive advantages. He places a high value on intangibles: Coca-Cola, for example, would never appear in a Ben Graham portfolio, because it’s simply too expensive. But Buffett likes its steady growth.
Dodson admires Buffett’s adaptation: “I discovered that the strict valuation criteria kept the Parnassus fund out of a lot of good investments,” he tells the class. Value is a subjective concept, masquerading as immutable and true, he declares: “I don’t believe in the growth and value distinction. Value and growth are joined at the hip.”
In evaluating a company, Dodson looks for four measures of financial health, which indicate an ability to keep paying bills during downturns.
1) A current ratio—current assets divided by current liabilities—of at least 2 to 1.
2) A quick ratio—current assets less inventory, divided by current liabilities—of at least 1.
3) A long-term debt to equity ratio of less than 70%.
4) A ratio of no more than 2 to 1 of debt to earnings before interest, taxes, depreciation, and amortization, known as Ebitda.
To determine value, he uses price/earnings, price-to-sales, and price-to-five-year-high ratios. Some value investors won’t buy stocks with P/Es greater than 12; Dodson is more generous, because “people can miss out on real bargains” if valuations are modest relative to the stock’s history and the market. However, both P/Es and P/Ss should be lower than their five-year average. And a stock should fetch less than 80% of its five-year high.
Finally, to gauge growth, he follows a simple rule: Return on equity must be at least 15% on a regular basis.
Could investing success be based on such mundane factors? Turns out, it isn’t. There’s the sustainable part, which the students will learn about later.
Dodson grew up in Oak Park, Ill., outside Chicago. His father managed an insurance agency; his mother cared for him and his two brothers. Dodson studied political science at University of California, Berkeley and graduated in 1965. He became a foreign service officer, serving in Vietnam and Panama.
In 1968, he read The Money Game by Adam Smith, which introduced him to Graham, who also is famed for writing Security Analysis with another Columbia professor, David Dodd. (The term “Graham & Dodd” is synonymous with their careful style of investing.) Then, Dodson read Smith’s Supermoney and learned about Buffett, whose approach intrigued him. “I come from a modest family and was always looking for bargains for myself. It made more sense to me” than the go-go style of investing that prevailed in the 1960s.
After earning an M.B.A. at Harvard University in 1971, he worked in community development in San Francisco, and eventually ran a bank that made loans to underserved areas. On the side, he invested for his own account and bought decrepit three-to-six-unit apartment buildings in Haight-Ashbury, which he renovated, doing the painting himself. Back then, a building might go for $80,000, or about $6 per square foot. Today, it might fetch $1,252 a square foot.
In 1984, Dodson founded Parnassus with $350,000 from friends and family. He named it after his San Francisco neighborhood. He and his Vietnam-born wife, Thao, stuffed envelopes for the fund’s marketing.
One day in class, Dodson fields questions about his career. “What’s your most memorable story?” asks Ishwari, an M.B.A. candidate who works as a trader at
Bank of America
and graduated, not long ago, from California Institute of Technology.
“The time I almost went out of business,” Dodson replies.
It had taken him five years to get to $26 million in assets, close to the $30 million level seen as break-even for a mutual fund. Then came 1990 and Saddam Hussein’s invasion of Kuwait. Assets promptly shriveled to $8 million, hurt by poor results. “All the money I had set aside was gone,” he recalls. He had four young children and feared for their future. “When you are 28 and at Harvard Business School, everyone wants you. Not at age 45.” Yoga proved to be a great stress reliever, helping him look ahead, rather than dwell on his troubles. So did good performance that vaulted Parnassus into the top ranks of growth funds in 1991.
There was also a point, a couple of decades back, when Dodson dabbled in market timing. That fared poorly in the early 2000s, and ultimately he abandoned the practice. “If the market looks fairly valued or overvalued, it can go higher. We fell so far behind,” he recalls.
“How do you avoid a value trap?” asks Janet, an M.B.A. candidate from China.
“I don’t know for sure,” Dodson admits. “I’ve been caught in them.”
Dodson was a long-term holder when news broke that the bank had opened millions of phony accounts. Dodson hung on to the shares, in part because Wells had a good ESG record. But then, more details of malfeasance emerged. Parnassus finally jettisoned its position in 2018. Mistakes are inevitable in investing, Dodson warns. “If you have enough diversification, it saves you.” (For more on how sustainable investors reacted to Wells Fargo, see “Forgive and Forget?”)
Of course, failures are only part of the picture. Among his home runs have been Apple and
which he uses to illustrate the perils of selling too soon. Both were successful investments, but each went much higher than the price targets Dodson originally set for himself, and he sold too soon.
Sustainable Investing 101
Spend any time with Dodson and he will mention a Forbes article from the 1980s that sneered at socially responsible investing, and him in particular, because it implied that it would screen out all kinds of potentially high-return investments.
Well, Dodson likes to point out, every investor screens out investments. For sustainable investors, however, the challenges might be greater because one person’s ethics aren’t necessarily another’s, making it harder to decide which factors to include and which to shun, as the sometimes wildly different ratings for the same funds on Sustainalytics and MSCI Research attest.
A piety of sustainable investing is that good corporate citizens—companies that are environmentally responsible, treat employees as valued colleagues, and aren’t solely focused on revenue and profit—will outperform the market over the long haul. That may be true, but the evidence isn’t overwhelming. Most of the big-cap sustainable stock funds that Morningstar tracks, for example, don’t beat the S&P 500. (See “The Top 200 Sustainable Funds.”)
Dodson’s most important criteria are how companies treat employees and the environment. Ask them if they have accommodations for nursing mothers, he urges us. What do employees think of the company? If employees are happy, there will be less turnover, reducing recruitment and training costs. Happier workers are also more productive, meaning that fewer of them are needed. As for the environment, conserving energy, water, and materials saves money. And avoiding pollution blunts the threat of illnesses, and costly lawsuits and fines. “These savings aren’t theoretical; they are real,” he tells the class.
He tells us to ask about charitable behavior, on the notion that it sheds light on a company’s approach to sustainability: More charitable companies are more likely to think about the effects of their behavior. He notes that giving 1% of profits “is a substantial commitment.” Indeed, 63 of the largest 300 companies in the U.S. that provide data on donating contribute about 1% of pre-tax profits to charity, according to the Chronicle of Philanthropy.
All of these are signposts about a company’s quality.
Back to the Classroom
The questions keep on coming.
Ila, a former family-office analyst from India, asks whether her written report can be about a biotech with no earnings. “No,” Dodson replies decisively. “I have no way of evaluating whether you know what you’re talking about. And please don’t research a marijuana company. I don’t like the idea of people sitting around and getting stoned.”
Carl, who’s pursuing an executive M.B.A. and does business development for sustainable companies, notes that ESG is “an extraordinarily wide concept; do our investments” have to meet all three of its tenets: environmental protection, social responsibility, and good corporate governance?
No, Dodson says. He’s most interested in corporate environmental and employee practices. And he reminds the class that idealism must be tempered by realism. He cites Control Data, a conglomerate that once owned Ticketron, Gulf Insurance, Commercial Credit, and a big disk-drive operation. Decades ago, socially responsible funds liked it because it built factories in slums and prisons, developed wind power, and leased cars to ex-offenders. Ultimately, however, Control Data defaulted on its loans. “No. 1, it’s got to be a good business,” he says of any potential investment.
In the next few weeks, we’ll start on our presentations. We’ll look at annual reports, 10-Ks, news articles, and reviews of the company’s products and services. We’ll visit companies, in person, if possible.
Then there’s the social profile; companies should have a decent rating from either MSCI or Sustainalytics.
To gauge growth potential, Dodson urges us to pay close attention to the moat, which might include a unique marketing concept, a famed brand, or a tough-to-duplicate manufacturing process. Lacking a moat, a product, and its maker, are commodities, he cautions.
Finally, identify intrinsic value. Then, knock off a third to provide Graham’s margin of safety.
Suddenly, it’s November and time for presentations.
Dodson sets great store on preparation, communication, and presentation. Write clearly. Don’t exceed 30 minutes; otherwise, you’ll lose your audience. Look at people when you’re speaking. And practice, practice, practice.
When Janet admits that she hasn’t read all of Graham, Dodson exclaims, “Be more confident! Never let people know you haven’t read the whole thing.”
Sometimes, it isn’t clear whether Dodson is talking about investing or about life.
The companies we decide to report on are a diverse lot.
Ishwari is plugging Bank of America, where she works, and recounts its march to sustainability after the financial crisis.
Ila has a complicated sum-of-the-parts thesis for Macquarie Infrastructure, which she researched for an investment management internship the previous summer, and which has cut its dividend.
Greg, a former proxy analyst for Glass Lewis, is pitching
whose shares have collapsed. He’s betting that it will find its feet after a merger. Enthusiastic, he has purchased 10 shares.
Colleen, who already has a post-graduation job lined up in corporate social responsibility, pitches biotech giant
off sharply from its high. Carl favors chip maker
Janet talks about home builder Lennar, and has unearthed interesting data about its charitable giving.
I’d come up with
the semiconductor equipment manufacturer. It was trading at a low, and what I dubbed the Graham & Dodson ratios were compelling. The market was collapsing, meaning the stock looked even more attractive. It had appeared on a ranking of most sustainable U.S. companies that Barron’s published, and had a good score from Sustainalytics. In fact, it was too good to write up only for Dodson. I pitched it to my editor. I talked to investors, analysts, and the CEO. Then, my favorable verdict appeared in Barron’s.
Unfortunately, writing on deadline, I neglected my class presentation, which didn’t go very well.
Dodson’s critique: “You sounded harried. You didn’t get home what you could have done. It could have been very good if you’d taken the time.” I hadn’t talked about the company’s marketing. My slides were inconsistent. The thesis and analysis were good, but my price target of $44 was too conservative with the shares at $34. On the other hand, he added, I was articulate and had a “warm personality.”
Just the kind of thing they tell the losers on Shark Tank. But I didn’t care: I might not have gotten an A in presentation, but I’d become rather fluent in Graham & Dodson. That could come in handy down the line.
Write to Leslie P. Norton at firstname.lastname@example.org