10 Questions With Legg Mason Focus Trust's Robert Hagstrom

Click on the company name to jump to Hagstrom's comments on the stock.

AOL Time Warner

General Electric

Home Depot

Honeywell

Liberty Media

Lucent

Merck

Microsoft

3M

Nextel

Nokia

Nortel

Tyco

USA Interactive

Vodafone

Wal-Mart

"Put all your eggs in one basket and -- watch that basket."

That morsel is doubly apt for this week's 10 Questions. For starters, fund manager Robert Hagstrom puts that idiom to work every day at his (FOCTX)Legg Mason Focus Trust fund, which holds a mere 18 eggs, er, stocks. Second, the quote comes from Samuel Clemens' legal sleuth Pudd'n'head Wilson, and Hagstrom -- a prolific author in his down time -- has a hot-off-the-presses book, "The Detective and the Investor". The purpose of the book: Instructing investors how to apply the methods of great fictional detectives to make better stock-picking decisions. It couldn't be timelier: If Sherlock Holmes had been around to sniff into WorldCom, Tyco and Enron's books, perhaps Wall Street would have avoided those massacres.

Hagstrom has played stock-market sleuth for years -- at the helm of the focus fund since its April 1995 inception. While concentrated funds' returns often provide as many twists and turns as a Poe mystery -- Legg Mason Focus is no exception, having had a rough 2000 -- Hagstrom's performance handily beats his peers and the broader market over the long haul. His five-year average annual return of 4.33% places him in the top 6% of the large-cap blend category, according to Morningstar.

It seems fitting that among Hagstrom's 18 stocks are three companies with such labyrinthine structures that much of Wall Street has shied away: AOL Time Warner, General Electric and Tyco. But Hagstrom thinks he has cracked all three cases and in the following pages, he lays out the compelling evidence. He also weighs in on other subjects, including Microsoft, winners and losers in the telecom sector, stocks he has sold, interest rate cuts, deflation risks and, of course, his new books.

The interview, like most worthy yarns, is stuffed with juicy information and, like all good authors, Hagstrom ties it all together in the end. We think investors will find it a most enriching read.

1. You have carved out an unusual niche for yourself in the literary-business marketplace, taking a liberal arts approach to investing -- first in "Latticework" (renamed "Investing -- the Last Liberal Art" for the paperback), now in "The Detective and the Investor." Whenever I recommend these books, people say, "Sounds interesting, but I don't see how it applies to real-world investing." Would you explain how you want readers to apply the lessons of these books to investing?

My books on Warren Buffett ["The Warren Buffett Way," "The Essential Buffett" and "The Warren Buffett Portfolio"] are highly practical books, with highly practical solutions -- how-tos on solving investment problems. The two "liberal arts" books -- "Latticework" and "The Detective and the Investor" -- aim to teach investors how to broaden the way they think about investing, with the hope of becoming a more intuitive, crafty investor.

Robert G. Hagstrom, Jr.

Fund: Legg Mason Focus Trust, manager since April 1995 inception

Assets Under Management: $86.2 million

One-Year Return: -1.73% (Top 3% of category)

Five-Year Return: 4.33% (Top 6%)

Top Three Holdings: Nextel(NXTL), Amazon.com(AMZN), Citigroup(C).

Expenses: 1.9%, no-load

Contact: Legg Mason Focus Web site Phone: [phone]

Source: Morningstar, Legg Mason Returns through Nov. 8

These books take up Charlie Munger's challenge to think of mental models. This was a highly theoretical notion to me until I started working with Bill Miller [manager of Legg Mason Value fund, which has topped the S&P 500 for 12 years running], who was a walking edifice of mental models. He was a philosophy major in graduate school, and now he eats and breathes multidiscipline investing -- using biology, philosophy, psychology and other disciplines to examine an investing problem. What I began to recognize was that there are intuitive insights one can gain if you invest with a multidiscipline approach.

People try to reduce investing to a few fast-and-true metrics. But the markets have gotten smarter, the participants have gotten smarter. We all know and use the same data that by and large is being used by the rest of the market as well. When you're trying to figure out if markets misprice securities, you have to get past the obvious. Applying other disciplines can help you get an advantage over the rest of the market.

Regarding "The Detective and the Investor," I found that detective books are gifts to investors. What we've learned the past decade is that we can teach people about investing principles -- we can tell people how to be a Buffett investor, and they basically get it. Where we seem to lose people is in their behavior.

"The Detective and the Investor" is meant to help investors align their behavior to be consistent with optimal results. In the past decade, very smart people have behaved badly. They have taken short cuts; they have jumped to conclusions. Oftentimes, they take the first set of evidence -- akin to the chief of police in those detective books who always collars the wrong person based on limited evidence, and then gets corrected by the detective who does more probing analysis.