Cole Smead is CEO and a portfolio manager at Smead Capital Management, and manages the Smead International Value fund.

Smead Capital Management has long favored value investing and concentrated portfolios, concentrated these days in stocks other than tech. Smead, the firm's CEO and the son of founder Bill Smead, minds the company's international investing business, where he has built a winning portfolio of financial, energy, and industrial stocks.

The $382 million Smead International Value fund (ticker: SVXLX), which he runs, owns about 30 stocks, with a heavy weighting in energy and banks. The fund returned 48.3% over the past year, putting it in the top 1% of international funds, according to Morningstar. Its three-year return of 27.3% beat the S&P 500 index's three-year return of 21%. Smead, who has managed the international portfolio since 2015, established that record without owning a single technology stock.

Barron's spoke with Smead, based in Phoenix, on Aug. 19 about the firm's investing approach, his favorite energy and bank stocks, and the firm's aversion to tech. An edited version of the discussion follows.

Barron's: You use an eight-criteria discipline to pick stocks. Which eight?

Cole Smead: First, we look for simple businesses that address a need in the marketplace. If we can't explain a business simply to our investors, the idea falls apart. We want companies with strong competitive advantages, a long history of profitability, and strong operating metrics. We look at returns on invested capital. Ultimately, you're going to make the returns on capital you have to run the business. If it's an unlevered business, return on equity is a fine metric. In financials, we look at return on equity, as well.

We also want high levels of free cash flow and a strong balance sheet, meaning a balance sheet that either has no debt or more cash than debt, or a company that can pay off debt within two years with free-cash generation. The maximum risk we take on getting a balance sheet back to where it needs to be is five years of debt paid off by free cash.

We like shareholder-friendly management, strong insider ownership, and companies trading at a low price relative to intrinsic value. We need companies to meet seven out of eight criteria to buy the business. If they fail, we move on. If a company doesn't fail our screen, we then ask, "What is my opportunity cost in this investment relative to what I own now?"

We aim to generate returns of 10% to 15% compounded annually, net of fees.

About 38% of the portfolio is in energy. Why such an overweight?

After the "drill, baby, drill" energy capital-spending mania peaked around 2014, there was a downfall [in the stocks]. We wait until manias die, then dig through the dead bodies. We saw a generational low in 2020 in energy equities. Then, everything changed. There is a willingness in the industry to consolidate to drive higher returns to shareholders and return shareholder capital predominantly through buybacks. That wasn't a historical feature of the industry. We like Canadian exploration-and-production companies, primarily the traditional heavy oil-sands businesses. The entire space is still undervalued.

Once an energy company meets your criteria, what metrics help you decide to invest?

We use two factors that anyone can use. One is the reserve life of an energy company. To calculate it, you divide the reserves by the current output of the business in barrels. That determines how many years the company can produce with current reserves.

The second metric is enterprise value per flowing barrel, or debt plus market cap, divided by current production. It's also called enterprise value per daily production, and it measures how much the market values each unit of current production capacity. These two metrics together tell you how long the asset will produce and what price you're paying for those reserves.

People use simple price/earnings multiples to value energy companies, but these businesses aren't really about the current cash flow or earnings. They are about accumulating book value, or cash. Energy producers are underowned and underpriced. They are producing far higher cash returns than during the capex-mania period. They are recycling that cash back to shareholders or into accretive acquisitions to build net asset value for shareholders. That has been underestimated repeatedly.

Which oil-sands companies do you like?

We own several. Strathcona Resources' executive chairman, Adam Waterous, is the best capital allocator in Canada. There are people who can take the tough circumstances of a cyclical industry and despite the odds, produce large wealth for themselves and the people around them. He is one.

The reserve life of Strathcona's proven and probable reserves is 47 years, one of the longest reserve lives in the industry.

In general, the cost to build new production is between 30,000 and 35,000 Canadian dollars [$21,700 to $25,400] per flowing barrel. The market currently values Strathcona at $66,400 a barrel on production of 125,000 barrels of equivalent oil. The company gains roughly $30,000 a barrel in enterprise value when it adds production. Company guidance suggests production will rise to 145,000 barrels in 2027.

Leaving the enterprise value-per-barrel metric where it is now, this means it could add 16% in enterprise value to the end of 2027 from production. This equals $1.3 billion of market-cap value if no debt is employed. We believe this is a conservative estimate, as it implies no uptick in the valuation or any benefits from capital allocation.

If the market cap comes down as production comes on-line, management may buy back stock with the same cash. Why? Because the barrels the company already has are cheaper than the barrels that new production would cost to bring on-line.

This is also the case for Cenovus Energy, another oil-sands producer. The CEO, Jonathan Mackenzie, is the best capital allocator among larger oil-sands company managers. Cenovus has a reserve life of 28 years. Production is estimated at 970,000 barrels in 2026, and we estimate enterprise value per flowing barrel at $69,154. In 2027, company guidance has production rising to 1.01 million barrels, and we estimate the enterprise value at roughly $65,000 at current prices. We believe buybacks and cash generation could take this to $75,000 a barrel.

Where do oil prices need to be for your outlook to work?

A minimum of $70 is great. Anything above that is beautiful.

Financial services stocks account for 32% of your fund's portfolio, and you own a lot of European names. What do you like about that sector?

Historically, cross-border mergers were a swear word in Europe. But a catalyst for such mergers was [former European Central Bank President] Mario Draghi's 2024 report on European Union competitiveness. Draghi identified two industries for an overhaul: telecom and banking. The individual countries aren't adapting, but the companies are. We expect a wave of European mergers among financials. [Austria's] Bawag Group and [Italy's] UniCredit are good examples of what we are going to see in Europe.

Bawag has been acquiring banks or other assets in markets where it can gain scale. Most recently, it announced an all-cash purchase of Permanent TSB Group Holdings, the third-largest Irish bank. [The transaction is expected to be completed in late 2026 or 2027.] It isn't common for a bank to do an all-cash deal, but it is accretive and Bawag is adding a lot of value for shareholders. Bawag's current return on equity is about 20%, and the purchase of Permanent TSB could push it up to the low-20% range once it cuts costs related to the acquisition.

Bawag trades for 3.2 times book value. We don't have a forecast for the postmerger price/book ratio, but the purchase of Permanent TSB will durably increase return on equity, so it is reasonable to expect upward pressure on the price/book value ratio.

What makes UniCredit noteworthy?

UniCredit is leading the hallelujah chorus on consolidation and competitiveness. It is getting ready to take over Commerzbank. Why is this important for banking? Historically, access to capital has been poor. People are underestimating that with more scaled, stronger banking franchises, there will be better economic growth in Europe because of access to capital. This is the old roll-up playbook: Buy a business, cut unnecessary costs.

UniCredit is the bigger story because this is the first cross-border merger of size that no one expected. We are going to see cross-border mergers pick up because effectively [UniCredit CEO Andrea] Orcel just jumped into the hot tub and said, "Hey, everybody, the water's warm." We are going to see active competition for mergers that hasn't been present previously because the policy and environment were never this ripe. That is probably going to cause multiples to go up.

UniCredit is trading for around 1.6 times book value. It is generating an accelerating 17% return on equity, and the multiple should tend toward two times book value over time.

Which bank is flying under the radar?

[Spain's] Bankinter. It generates just under a 22% return on equity, and currently trades at 2.25 times book. Unlike Bawag and UniCredit, however, Bankinter doesn't buy back its stock. It could have saved a lot of capital in taxation by buying back shares rather than paying dividends. Even if the stock returns to one times book value, it would be priced to compound at a low-teens rate.

You bought shares in the United Kingdom-based used-car website Autotrader Group earlier this year. What was the attraction?