The Daily Interview: Finding Value in Today's Market

With value one of the few bright spots in equity investing, the Daily Interview turned to a leading value manager to ask him how he's been able to keep such a steady and profitable hand during the continued market turmoil.

Peter I. Higgins Portfolio Manager, Dreyfus Midcap Value Fund and Dreyfus Small Company Value Fund

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Peter I. Higgins is manager of the (DSCVX Quote)Dreyfus Small Company Value fund, which is up 25.1% so far this year after delivering a 5.4% return in 2000. The second fund he manages, the (DMCVX Quote)Dreyfus Mid Cap Value, is up 17.92% this year after delivering 27.5% in 2000. Here Higgins explains how he's been able to achieve these impressive returns.

TSC: You call yourself a contrarian investor and say you don't pay much attention to Wall Street. How difficult is it for you to make these judgment calls and ignore what is happening in the broader markets?

Higgins: We don't totally ignore what's going on in the market or what Wall Street is saying. My point is we're not sitting by the phone for someone from Wall Street to call us up and tell us what the next good idea is. We are doing our own fundamental research and buying stocks that we think are compelling. We might see a catalyst for improvement before it's broadly known.

Oftentimes, we are accumulating positions in stocks that a fair amount of people on Wall Street are neutral or negative on, and oftentimes even selling stocks when they are warming up to them. We're contrarian investors, and we think that as a good contrarian value investor, you have to be willing to think differently than the mainstream to be able to win, and if you are relying on Wall Street, then you are thinking in the mainstream.

TSC: What are some examples of stocks you hold where the consensus is that they are not poised for improvement anytime soon?

Higgins: Arch Coal(ACI Quote) is a good example of that. Now some of the sell-side firms have embraced it. Since we started buying it, the stock is up from $13 to $33. Clearly, there were business trends going on beneath the surface at Arch Coal that were going to be very, very favorable to an increase in the price of coal.

There are going to be cases where there's value and tangible short-term drivers of the stock. But there are other situations where you buy a stock because it's an extraordinarily high-quality company that's just down on its luck because it just got hit way too hard by selling. Even though there might be some short-term challenges in the business, you are getting it at such a compelling price that it makes sense to buy it despite short-term negative news.

TSC: How difficult is it to find a catalyst for specific stocks when the entire broader market is suffering?

Higgins: We are not deep value, which would mean buying a stock purely on valuation and you don't have any idea when the company is going to turn. While we do this from time to time, we typically buy higher quality, higher growth companies that have temporarily stumbled.

In the last six to nine months, I have bought a number of tech names as technology was selling off -- companies that we thought were leaders in their industry that the market was treating very harshly because, granted, business was poor. Interestingly enough, some of these stocks have done extraordinarily well on a year-to-date basis.

Network Associates(NETA Quote) is an anti-virus software company that is up 156% year to date. In part, it is up so much because it was hit so hard at the end of last year and reached historic lows where it was priced like it was going out of business. That was compounded by tax-loss selling and horrible news of revenue decline in the fourth quarter. Our opinion was the company would be able to work off too much inventory and resume growth. We didn't believe that it was going out of business at all.

Key Energy(KEG Quote), which is one of the biggest holdings in the small-cap portfolio, is an energy services company. They have what they call work-over rigs and recompletion rigs. They provide peripheral services for the drillers. The stock is trading at $13.5 and we started buying it at $6.

Oil prices and gas prices are up a lot, and Key has been a direct beneficiary, because their products play right into that.

Apple Computer(AAPL Quote) is one of our biggest holdings in the mid-cap portfolio. In the fall, it fell below $14 a share. But Apple has, on its balance sheet, over $12 a share in net cash. So, the business was almost trading at zero, or close to zero. Did they have problems? Yes, they did. Could they work through these problems? It was our opinion that they could, and as it turns out, they are in the process of doing that.

Apple just posted a positive earnings surprise the other day, and the stock is up 63% year-to-date. So, here you have another example of another technology stock that has done very well, but again, we bought it because the valuation was extremely favorable.

TSC: While you say you are not a sector investor but a bottoms-up investor, both of your portfolios contain quite a number of technology and energy stocks. Are you seeing any trends in those areas?

Higgins: As a bottoms-up investor, we try to pick stocks on a stock-by-stock basis. Having said that, we can build up pretty concentrated positions in an individual sector. A top-down approach would be one where we would say, "We want to own technology," or "We want to own energy." And then you go and find the names. Instead, we are finding the names and building up from the bottom.

However, we do see trends. Within energy, clearly things are good. The price of gas is up a lot. The price of oil is up a lot. The demand for energy services is up phenomenally over the last several years. We began taking a position in energy back before this started happening, when oil was $10 a barrel, when gas was at $2 per MCF [thousand cubic feet]. We were doing it when it wasn't fashionable to do it because we thought the valuations were extraordinarily favorable.

We also believed that OPEC would act more rationally and cut back production and help the price, and that the demand for natural gas, particularly from utilities, would drive up that price.

In the case of technology, this wasn't a bet that this is the place to be, but, rather, the realization that we have been able to buy some really high-quality technology companies that are on sale and are having short-term challenges that we don't think are going to be insurmountable. But the way we approach technology companies is first from valuation.