The Daily Interview: Gabelli Growth's Howard Ward

Give Howard Ward points for calm.

Howard Ward Manager of Gabelli Growth Fund

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Last fall, back when many investors felt as if they were teetering on a precipice, the manager of (GABAX)Gabelli Growth started scooping up downtrodden tech names. He continued to do so through the end of last year. "You have to invest when it's not always sunny out; that's when stocks are on sale," he says, faulting the tendency of Street analysts to be bullish at peaks and bearish at bottoms. "You cannot invest with that kind of mind-set. If that's all you did, you'd constantly be buying high and selling low."

Like many funds, Gabelli Growth closed last year with a loss, in the red by close to 11%. But over a longer period, it boasts a strong performance record. In the past five years -- about the time Ward has managed the fund -- it has averaged annualized returns of 24.5%, beating the S&P 500 by 5.55%.

For today's Daily Interview, we decided to pick Ward's brain on what he likes in the market for 2001. After weathering the last quarter's convulsions, Ward is inclined to be optimistic. "I think that this year the stock market could be a very pleasant surprise," he says. "We're at a point where we should benefit handsomely if the economy does respond to rate easings, the possibility of a tax cut, some regulatory relief and the elimination of goodwill accounting, which should really help M&A activity." Read on to hear Ward get specific about the opportunities in today's market.

TSC: What made you start buying toward the end of last year? What was your strategy at that point?

Ward: In the fourth quarter you had this panic that was probably overdue, which brought prices down on a number of attractive companies. Unless you believe we're going to have a very hard landing -- that Greenspan's not going to do anything -- you have to have the stomach to step up to the plate and buy these stocks when they're being thrown out the window.

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The fourth quarter gave us a very good opportunity to rebuild positions we'd run down early last year in a number of tech and media stocks. For example in the fourth quarter, we were able to go in and scoop up stocks like Dell Computer (DELL), which is now up 60% year-to-date. And AOL Time Warner(AOL) is up about 56% year-to-date.

We've been taking money out of some of our most successful stocks from last year, peeling profits out of drugs and financial services stocks. I make money by buying low and selling high. There are still some values in those stocks for long-term investors, but the easy money -- that first 50%, 60%, 70% -- has been made.

The best values in the market now are in stocks that got beat up last year, unless you don't think we'll have a reasonable economy in the second half of this year.

The notion that people are not going to spend money on tech -- either consumer or business -- is absurd. There is an inventory correction under way, but I don't think much more than that. And if people can look over this one or two quarters of difficult earnings comparisons, then I think there's a lot of money to be made.

TSC: Are you still buying, or have you already finished?

Ward: I never have a high cash position. We've continued to do buying because we have a nice cash flow coming into the fund. So there's no need to sell something to buy something. I have not sold one share of anything so far in calendar year 2001.

TSC: Can you talk a little bit about what you look for in a stock, in terms of the specifics?

Ward: We have minimum growth-rate expectations of about 12% a year. While that was easy to find in recent years, and it still is not a Herculean task, people are much less likely now to believe some of the very high expectations that are out there. Twelve percent is about double the rate of corporate earnings growth in the post-World War II U.S. economy.

For valuing, we use a five-year earnings model. We try to calculate out five years, then discount back and put it in present dollar terms. Also, the companies we favor need to have some kind of competitive advantage. They need some kind of proprietary product or a very dominant brand.

I really view this whole thing as an exercise in compound arithmetic. If you can find a portfolio of earnings with earnings growth of 15% over five years, you end up doubling your base of earnings and your stock price, if there's been no change in the multiples in that time period.

TSC: What are some names you like?

Ward: I'll mention a couple. One is an interesting investment in financial services, which is Stilwell (SV). They own 88% of the Janus fund family, also the Berger funds and Nelson's. But Janus drives the stock's price, and the stock price is selling at a pretty low multiple off earnings because of the obvious [reason]: Janus funds did poorly last year. I think the discount is too great. Stilwell's trading at 16 times what they should be earning this year. That's only half the multiple of Northern Trust (NTRS), for example, and I think Janus could outgrow Northern Trust over the next five years, probably over the next 10 years.

Janus will benefit more than any other fund family from the improving Nasdaq stock market. It has among the best margins in the industry and generates tremendous free cash. I think it has a very attractive brand, which makes it a potential acquisition candidate for financial services.

TSC: What's another stock you like?

Ward: Pfizer (PFE) is my biggest drug holding. It has eight drugs that generate over $1 billion each in revenue. A lot of companies are lucky to have one or two drugs that generate that much money. Pfizer also has a research budget of close to $5 billion. That's a lot of money, but it's a necessary expenditure for long-term growth in the pharma world. If you're not spending, you won't have the drugs in the pipeline to replace other drugs when they go off patent.

They should be able to grow earnings by 20% over the next several years. Remember, you'd be doubling your base of earnings in three-and-a-half years. That's a very high rate of growth, so I think Pfizer should definitely be a core holding in anyone's growth portfolio.

Pfizer last year was up 40% or so. It was not one of the best-performing drug stocks, yet it had the highest or fastest growth in earnings among drug stocks. At 34 times this year's earnings, I think the stock could go a lot higher -- 60% higher, or something like that.

In tech, we like Sun Microsystems(SUNW). We probably sold about 70% of our holdings in the first quarter of last year, and we have been buying it back recently. At its current price of $32, it's selling at about 40 times what earnings should be this year. It went to over 100 times forward earnings at its peak, and now it's back down. We see Sun continuing to grow earnings at a rate in excess of 20%, so it's a pretty good investment down at these levels.

TSC: You mentioned earlier that you'd also bought AOL within the last couple of months. I wanted to ask you about that, because you've gone on the record in the past saying it was wildly overpriced.

Ward: We went back in the third or fourth quarter. It was at about half the price of when I was critical of it a year earlier, when earnings were much less. AOL has become a very powerful and unique company with the Internet risk greatly minimized. Even with the fact that monthly subscriptions will probably be under pricing pressure, [AOL subscriptions] represent less than 30% of the new company's revenues. So now, besides the content and cable at Time Warner, you have the Internet service provider with 28 million subscribers.

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