How to Buy Stocks With Conviction
Any mutual fund manager can load up a portfolio with hundreds of stocks and say he’s bullish. If the market goes up, he’ll be lifted with it. If the market sinks, he’ll sink with it--but he can always hide behind the boilerplate that “not even a diversified portfolio can escape a bear market.”
Uh-huh.
And how much conviction do such managers have about the individual stocks they own? Usually not a heck of a lot.
If you really want to get a sense of whether there are reasonably priced stocks left to buy in a market that is near record highs--and increasingly volatile, as Tuesday’s 257.36-point Dow Jones surge demonstrated--a good place to start is with managers who run very concentrated portfolios, often owning 50 stocks or fewer.
When every stock has to matter, a manager is likely to be much more thorough in picking. That’s no guarantee of success, of course, but at some point in this bull run--maybe even now--conviction should begin to count more than mere herd-following.
Herewith, four fund managers who pass the conviction test show how they’re applying that discipline today:
* Chuck Bath, Nationwide Fund, Columbus, Ohio (phone: [800] 848-0920): Many Wall Streeters worry that blue-chip drug stocks are overvalued after their spectacular run since 1994. Chuck Bath’s retort: “Compared to what?”
His highly focused fund of about 50 stocks, up nearly 30% year-to-date, is very heavily weighted with two drug stocks: Warner-Lambert and Schering Plough, which together make up about 14% of the $1.35-billion portfolio.
Isn’t it time to sell, with Warner-Lambert priced at 30 times estimated 1998 earnings per share, and Schering at 23 times, versus a price-to-earnings ratio of about 20 for the blue-chip Standard & Poor’s 500 index? “Not when I have so much confidence in their earnings growth,” Bath says of his drug stocks, which he has held for many years. As long as the market overall stays high, he believes that Warner-Lambert and Schering deserve their current prices, and more.
Less pricey among his holdings is Mellon Bank, which sells for a P/E of 15 based on estimated 1998 earnings. Bath loves the franchise and says of Mellon and other high-quality bank stocks: “People are still afraid of the problems the banks had in the 1970s and 1980s [with bad loans], but that’s history. I think these stocks deserve to at least sell for the market’s [P/E].”
* Richard Pender, Sentinel Common Stock fund, Montpelier, Vt. ([800] 282-3863): Pender once felt about Coca-Cola and Gillette the way Bath feels about Warner-Lambert. But in early summer, Pender ejected those stocks from his $1.6-billion fund. Why? “Egregiously overvalued,” he says of them.
To fill their place in the fund, which is up about 20% this year and which limits itself to between 50 and 60 issues, Pender has picked up some stocks that aren’t household names but which fit his definition of undervalued issues that should post strong returns over a three- to five-year period.
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One is Canadian Pacific, which is the trans-Canada railway and a lot more, Pender says. Little-known to many U.S. investors, the company also is the biggest transatlantic shipping firm, owner of major resorts, and an energy company--all for 11 times estimated 1998 earnings.
Pender also likes B.F. Goodrich, which long ago got out of the tire business and has instead built a big business supplying parts to the booming aerospace industry. “They’ve got tremendous growth potential and significantly undervalued assets,” Pender asserts. And at a 1998 estimated P/E of 15, Goodrich is a much cheaper way to play the aerospace boom than Boeing, Pender notes.
* Richard Meagley, Safeco Equity fund, Seattle ([800] 426-6730): Like Pender, Meagley worries about stock valuations in a market that is pushing the edge of the envelope by historical standards.
So he has tried to skew his $1.4-billion fund toward high-quality stocks that are less likely to be dragged down should the market suddenly develop a bad case of acrophobia, he says.
Anheuser-Busch fills that bill, Meagley says. At 17 times estimated 1998 earnings and sporting an above-average 2.4% dividend yield, Anheuser is a good way be “defensive” yet also play for decent growth, he says. Ditto for supermarket chain owner American Stores, which also is a “cost-cutting” story that could yield better earnings growth than the market now expects, Meagley says.
The 48-stock fund, up about 20% year-to-date, also continues to hold such blue-chip favorites as Fannie Mae, the mortgage giant. “I’ve been adding to things like that--companies you really want to own looking out five years,” Meagley says.
* Richard Peterson, SteinRoe Special Venture fund, Chicago ([800] 338-2550): Peterson’s focus is on smaller stocks, which only in the last few months have begun to capture more investors’ attention, after lagging blue chips since 1994.
“I think the undervaluation [in smaller stocks] has been extreme,” Peterson says. If the number of investors who feel the same continues to grow, the small-stock rally is likely to persist for some time to come, he says. “These kinds of [trends] don’t turn off all at once,” Peterson says.
His $220-million fund, up about 14% year-to-date, favors such names as Zytec, a supplier of converters used in computer networking. “All they need is for the networking business to grow”--it doesn’t matter much which of the big networking companies leads the charge, Peterson says.
He also favors a few real-estate-related companies, including property services firm CB Commercial Real Estate and Spieker Properties, a big owner of commercial properties in California. “I figure it’s your turn out there to grow again,” Peterson says of the California market.
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Good Buys?
Here are specifics on some shares favored by fund managers. P/E is stock price-to-earnings ratio based on analysts’ mean estimates of 1998 earnings per share (EPS).
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Stock Tues. close Ticker symbol P/E on ’98 EPS American Stores $24.31 ASC 15 Anheuser-Busch 44.00 BUD 17 BankAmerica 70.31 BAC 14 CB Commercial 31.31 CBCG 20 Canadian Pacific 29.88 CP 11 Exxon 64.00 XON 21 Fannie Mae 45.00 FNM 14 Goodrich (B.F.) 43.50 GR 15 Mellon Bank 49.69 MEL 15 Schering Plough 50.13 SGP 23 Spieker Prop. 37.13 SPK 13 Warner-Lambert 126.88 WLA 30 Zytec 29.00 ZTEC 20
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All stocks trade on NYSE except Zytec and CB Commercial (Nasdaq).
Source: Bloomberg News; IBES (earnings estimates)
