The Daily Interview: Values, Values, Values!

The markets are looking uglier and bleaker than the XFL these days. But one man is very excited.

Hugh H. Mullin Senior Portfolio Manager Putnam Investments

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For today's Daily Interview, we talked with Hugh H. Mullin, a senior vice president with Putnam Investments and senior portfolio manager of the $31.7 billion (PGRWX)Putnam Fund for Growth and Income. As a value guy, Mullin suffered through late 1999 and early 2000 in a market where nothing looked cheap. He says this market has made his job a lot easier.

Today, Mullin says some of "the world's greatest companies" -- Citigroup(C) and ExxonMobil(XOM) among them -- look downright inexpensive. He also has been judiciously adding to his tech basket, pointing to favorites such as IBM(IBM) and even Motorola(MOT).

TSC: Have the criteria you use to select value stocks changed at all in today's market?

Mullin: The criteria we use for running most of our value funds are still the same. We are looking at good relative value, and we use a number of metrics to define that, including price to earnings, dividend yield, price to sales, price to book value, price to cash flow. However, all of those are relative, so that when the market moves up and down in its valuation, our valuation screens move in tandem.

We obviously are also looking for companies that we believe are fundamentally sound and improving. It's not enough to have a stock that's cheap; besides the valuations, we also want to have a view of what the fundamental outlook for the company looks like over the next several years, and hopefully that's an improving one.

TSC: How difficult is it to find profitable companies in today's market?

Mullin: My job is easier by far than it was in 1999, certainly, when valuation was irrelevant. That was a very frustrating year. But what it set up was a market that offers value in almost every sector except technology. In 2000, a lot of the stocks and sectors that we invested in rebounded very strongly from what we believed, and still believe in many instances, were very attractive levels. Because of what happened in 1999, we were set up for very strong performance over the past year. It's been a year that value has been outperforming the markets and the fund has been doing pretty well in that environment, returning 7.9% in 2000, given today's volatility.

Surprisingly, today's volatile market gives me many more opportunities to buy a number of companies at very attractive levels for long-term investors. And we don't believe that this difficult macro environment is going to last forever, and as we get out of it, the companies in our portfolio are going to be pretty well-positioned.

TSC: You have shied away from technology at a time when other value managers are moving into it. Do you have any interest at all in buying into that sector?

Mullin: I wouldn't say that we have shied completely away from technology. We have actually used technology through the years in this fund at different levels. In some instances, it's been a fairly major investment. We didn't own technology in the latter half of 1999 or in 2000, and that was a combination of our belief that the stocks were very highly valued and also a concern that the growth rates that these companies were posting at the time were unsustainable. In fact, that turned out to be true.

While the valuations on some technology stocks have become lower, we have been very cautiously adding technology stocks. But at 7%, it's still a relatively small portion of the portfolio as opposed to 19% of the S&P, because while the valuations have come down a lot, these stocks still don't look all that undervalued under the metrics we use to evaluate stocks. This surprises a lot of people, but what happened to many of these stocks is that they reached such unbelievably high levels that even though they are down, many are still very expensive vs. the broad market.

There just aren't a lot of technology stocks today that we think are that attractive.

TSC: Can you tell us, then, why you have chosen the few technology stocks that you own?

Mullin: First, we have to believe that the stocks are undervalued relative to their long-term earnings and cash-flow potential. Second, we have to believe that the companies are competitively well-positioned for the long-term.

IBM is our largest technology holding. We think the company has done a very fine job of repositioning to become more oriented to software rather than hardware. As a result, IBM is much less cyclical and is delivering much higher returns and profits. And we don't think the stock adequately reflects that, so that's obviously why we own the stock.

We also own Compaq(CPQ). It's a little different, but for a long-term investor, it appears to be quite undervalued, and the company is in the process of restructuring itself, trying to improve its cost competitiveness in a very difficult macro environment.

Motorola is also a holding in the portfolio. We think it's come down to pretty attractive levels. A lot of issues at Motorola, namely a need to improve its handset competitiveness relative to Nokia(NOK). Motorola has been slower to develop handsets and has lost a fair amount of market share to Nokia. The company also seems to be a little bit too diversified. They also are obviously being impacted by the slowdown in the semiconductor business.

TSC: What are some of your other favorite holdings in other industries?

Mullin: If you look at the types of stocks that we own, it makes the point about how attractive and broad the value market is in general. We own a lot of what I consider to be the world's greatest companies, which are available today as value stocks. This is quite unusual for value investing.

Citigroup is our largest holding. It's extremely well-positioned on a global basis. In fact, I would argue that it's the world's pre-eminent financial services company. It's extremely well-run, with adequate focus both on growth and risk control. Yet the company has come down 15% from the high, and we think it's particularly attractive here.

ExxonMobil is our second-largest holding. It's obviously an extremely well-known, broad-based energy company benefiting clearly from the very high oil and natural gas prices that we are seeing today. But more importantly in the case of ExxonMobil, we think these guys are extremely good stewards of capital. They have created large value for their shareholders over the last 15 years in what is a very difficult pricing environment because of the swings in commodity prices. They generated a tremendous amount of cash flow, which they have used either for acquisitions or share repurchases.

A name like Johnson & Johnson(JNJ) again speaks to the point that here is a company that you normally wouldn't associate with a value portfolio, but the stock got down to levels where we were able to purchase it. It's an extremely consistent growth company that through the years has generated strong and solid top-line sales growth as well as earnings growth. Merck(MRK) would follow along the same lines. We like the company because it has delivered a consistent growth record, and fortunately, it's now at a relative value.

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