The New, the Tried-and-True
After a year in which their funds went from leading the bull market to trailing badly behind it, two high-profile growth-stock managers say they’ve changed the way they pick stocks because their former strategies no longer work.
Garrett Van Wagoner and Louis Navellier, two small-cap managers who gained fame by paying hefty prices for rapidly growing companies, say they now look far more carefully at valuations. The two men still buy stocks other managers see as expensive. But both say they shy away from the priciest issues because those have fallen so deeply out of favor with the market.
“Today, earnings momentum as a strategy does not work,” Navellier, Reno-based fund manager and editor of the widely followed MPT Review newsletter, said at The Times’ Investment Strategies Conference on Sunday. “Right now, you have to get growth at the right price, and that is my main obsession.”
The revelation was one of many insights about stock-picking that came out of the two-day conference that saw an attendance of 14,000 at the Los Angeles Convention Center.
Managers shared tips designed to help investors dig deep into companies and get a truer picture of how their shares might do in the future. Managers also elaborated on topics ranging from the volatility of technology stocks to the importance of profit margins, and they offered recommendations on several specific stocks to buy.
At a panel on investing in tech stocks, for example, four noted stock pickers stressed that investors must be cautious because statistics show the volatile sector has become even riskier in recent years. Techs have rallied for the last month, but they got hammered when the Asian crisis hit the U.S. stock market in the fourth quarter.
Here’s a sampling of insights from pros at panels on tech stocks, growth investing and advanced stock selection:
* P/E Ratios Matter After All. The most notable news was the altered thinking of Navellier and Van Wagoner, former high-fliers who got a lot of media attention and cash from investors when they notched outsize returns in the mid-1990s. But they and other growth managers fell on hard times last year even as the Standard & Poor’s 500 index surged 31%. For example, Van Wagoner, San Francisco-based president and portfolio manager of the Van Wagoner Funds, saw his emerging growth and micro-cap funds each lose 20% last year, according to Lipper Analytical Services. Several Navellier funds made money last year but still trailed the S&P.;
In 1995 and part of 1996, growth managers turned in strong gains by pursuing what Navellier termed an “earnings momentum” strategy that called for buying stocks of companies with rising profit growth rates without looking at their valuations.
But Van Wagoner said he pays more attention to price-to-earnings ratios these days, after barely considering them a couple of years ago. Today, he won’t buy a stock with a P/E that exceeds the market average by more than 30%. In 1994 through 1996, he would often go with premiums as high as 60%, he said.
* Watch the Analysts. Navellier also recommended that investors pay attention to brokerage house recommendations, particularly when analysts downgrade companies. In this market especially, even a good stock will have trouble gaining if one or two analysts sour on it, he said.
“We only buy stocks that analysts like,” he said.
If an increasing number of analysts start coverage of a stock, that’s a positive sign, Navellier said.
* Watch Earnings Growth. As for the characteristics he likes, Navellier recommended that investors look for earnings that are growing at a faster rate than sales. That shows a company is becoming more efficient and that its profit margins are growing. In contrast, if profit margins narrow, watch out.
* The Venture Capitalist Indicator. Many young companies have members of venture capital firms on their boards. These firms supply companies with start-up money in return for large blocks of stock and are helpful because they advise new chief executives.
But investors should beware when a venture capitalist leaves a board, Van Wagoner said. On top of losing that guidance, a venture capitalist’s leaving a board is usually a sign that his or her firm will cash out to reinvest in new up-and-comers.
A decision to cash out is not necessarily a sign the company is in trouble. By their nature, venture firms often sell shortly after companies go public because they don’t hold ongoing stakes in companies once they’re on their own.
But when a venture firm sells stock, that often means the market will be flooded with shares, which can depress a price at least temporarily, Van Wagoner said. So investors mulling a purchase should perhaps hold off in such a situation.
* Tech Comeback in Store? Although tech stocks have become riskier, the good news is those issues tend to make dramatic recoveries from severe sell-offs. Since 1987, tech stocks have jumped an average of 42% in recovery rallies, said Ron Elijah, a fund manager at Robertson Stephens Investment Management.
The bad news is that the rallies only last about six months, he said. That makes it hard for a mutual fund to notch a full year of stellar performance, which is the number fund owners most look at when assessing performance.
Several managers said small investors should be wary of the current tech rally. The prices of some issues have surged, and they’re worried the stocks have gotten ahead of themselves, given the worries about Asia hurting U.S. corporate profits.
Van Wagoner said he’s been “trimming those pretty aggressively” after loading up on techs in December and early January.
In response to a question from an audience member seeking the “next Microsoft” (ticker symbol: MSFT), several tech managers said investors should make sure they own industry leaders.
“I don’t need to find the next Microsoft,” Elijah said. “I own the current Microsoft, and I own the current Compaq [CPQ] and Applied Materials [AMAT]. These are great long-term investments for all of us.”
Small-company stocks may also be due for a comeback, several managers said. These issues have generally lagged the market for several years and are doing so again in 1998. But in the past, when they’ve reached low valuations compared with larger stocks, small stocks have outperformed.
* The Reinvestment Factor. Douglas Ramos, who manages four funds for Dreyfus Corp., looks for companies that have above-average returns on equity, or ROE, and below-average dividend payout ratios. ROE measures how profitably a company is using the capital it gets from shareholders. The payout ratio is the percentage of a company’s profit that it pays out to shareholders as dividends. Ramos favors this combination because it lets him zero in on profitable companies that are reinvesting in their businesses.
* Watch Cash Flow. David Decker, who runs the Janus Special Situations fund, said he looks more at cash flow than at earnings when choosing a stock. Companies can fudge their earnings to make themselves look more profitable than they truly are. But cash flow shows how much a company has left over after paying expenses to reinvest in its growth, he said.
“For me, cash flow is something I can really get my hands around,” he said.
* Cut Your Losses. Ramos and Decker said one of the best lessons you can learn is to cut your losses when stocks fall. Many people hang on, figuring they’ll recoup their investments, only to watch the stocks sag further.
Said Ramos: “That’s one of the most difficult things to do with a stock, to say, ‘I was wrong.’ ”
Added Decker: “Accept the fact that you made a mistake and go on to something else.”
Ramos also warned against buying a stock just because its price has fallen and it looks cheap. Stocks often fall before bad news actually hits because institutional investors are paid to anticipate problems before they occur, he said.
“Generally, the price goes down before the earnings estimates, so the stock looks cheap,” he said.
Investors must do their homework in these cases to make sure there are no negative forces that will soon tug down earnings estimates, he said.
* Stock Picks. David Schafer, president of Schafer Capital Management, likes Fabric Centers of America (FCA/A). The Hudson, Ohio-based retailer of fashion and decorator fabrics is opening a series of super-center stores that do considerably more sales per square foot than its roughly 1,000 traditional stores, Schafer said. He thinks earnings can improve 15% to 20% annually.
Schafer also likes Borg-Warner Automotive (BWA), which makes transmissions and other parts for cars. The company has been helped by a trend in which auto companies are increasingly contracting work out to smaller companies. Borg-Warner sells for about 11 times estimated 1998 earnings.
“It’s just a cheap stock that’s misunderstood,” he said.
Navellier likes two regional airlines: Alaska Air Group (ALK), parent of Alaska Airlines, and SkyWest (SKYW), holding company for SkyWest Airlines. In the same broad sector, he recommends Airborne Freight (ABF), whose stock has almost tripled in the last 12 months and hit a new closing high Monday. The express delivery company gained a lot of business from the strike last year at rival United Parcel Service, Navellier said.
Among other sectors, Navellier likes Osteotech (OSTE), a biotech company, and General Nutrition (GNCI), whose retail stores sell vitamins and other health-related products. Its sales have been helped by the health worries over the Fen-Phen diet drug because people have bought more of its herbal diet products, he said.
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Walter Hamilton can be reached at walter.hamilton@latimes.com
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Los Angeles Times Investment Strategies Conference: How to Get More on the Conference
Attendance at The Times’ second annual Investment Strategies Conference at the Los Angeles Convention Center last weekend topped 14,000 over the two days. Southland investors heard four nationally known keynote speakers and had their choice of attending any of 36 panels on topics including blue-chip stocks, retirement and estate planning, real estate investing, and options and futures strategies. For more on the conference:
* Online
Visit https://www.latimes.com/HOME/BUSINESS/INVSTRAT to watch video or listen to audio clips of featured speakers Charles Schwab and John Bogle. Read stories from the special conference program published Feb. 3. Join our interactive discussion about the conference.
* Audiotapes
Cassettes of each panel, and of the keynote speeches, are available for $10 each. To order, or to receive a list of the panels, call (800) 367-9286.
* Television
Selected panels, including “Investment Strategies for Early Retirement,” “Investing in Tech Stocks” and “Advanced Stock Selection,” will be broadcast on CNBC throughout the day on Monday, Feb. 16.
