10 Questions With Growth Maven Jeff Van Harte and Value Guru Bill Nygren

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Many of us have seen stock market declines, but nothing like this.

The average bond fund has trounced the S&P 500 over the past three years. Meanwhile, 14 of 18 U.S. stock fund categories are under water this year.

How to play it? Well, one answer is to huddle with the brainiacs from the fund industry's warring tribes: the bargain-hunting value club and the price-indifferent growth faction. Usually we ask one manager 10 questions, but this week we're asking two pros five questions.

For the growth perspective, we turn to Jeff Van Harte, manager of the (TEQUX Quote)Transamerica Premier Equity fund, among others. Jeff matched his peers in 1999's heady days, while incurring significantly less damage since the tech sector collapsed last year. Much is rightly made of Bill Miller's 10-year streak of beating the S&P 500, but Van Harte quietly did the same before falling off the pace last year.

For our value viewpoint, we have Bill Nygren, who survived the dry season of 1998 and 1999 and has thrived since. His (OAKLX Quote)Oakmark Select fund recently closed due to steep inflows, and the (OAKMX Quote)Oakmark fund has flourished since he took the reins last year.

Where do these guys think the market is headed? Are tech stocks cheap? What are they buying now? Read on.

Talking With: Jeff Van Harte

Fund: (TEQUX Quote)Transamerica Premier Equity

Assets: $175 million

Managed Since: May 22, 1998

1-Year Return: -28.8%/Beats 67% of Peers

3-Year Return: 2.6%/Beats 56% of Peers

Expenses: No-Load/1.3% annual expenses

Top-Three Holdings: First Data(FDC Quote) Northern Trust(NTRS Quote) Rite Aid(RAD Quote)

Sources: Transamerica, Morningstar. Returns through July 26.

1.The S&P 500 is on track to lose ground for the second year in a row and the Wilshire 5000 is down about 25% from its peak. How did we get here, and where do you think we're going?

Van Harte: These losses are abnormal, but the five years ending with 1999 were the five best years in the history of the stock market. You've got to have some adjustments in terms of valuations and also expectations.

But lately, you're seeing huge write-offs [and cost cuts] from all kinds of companies, and that's healthy. So there's reason to be optimistic that we're addressing our problems. The economy is clearly worse than anticipated, but I think it's going to show signs of turning around in the second half of 2002.

We're not going to have a '90s-type environment with lots of multiple expansion and blowout earnings growth. I think we're going to have a market that will maintain relatively high multiples to the past because of low inflation and interest rates. That means you're probably going to earn a stock market return that's more in line with your earnings growth.

Nygren: Cap-weighted indices have given you a very different picture than what was going on at most companies. In 1998 and 1999, as the cap-weighted indices were going up 25% a year, the average stock was flattish. In 2000 and this year, the average stock is up.

That's been the tremendous opportunity that a lot of value managers have benefited from: picking companies that were priced very differently than the market averages a year ago. I think the most likely course from here is a continuation of the direction we've been in since March 2000. The technology sector and the biggest-cap names, to me, still look to be priced at undeserved premiums to average companies.

Talking With: Bill Nygren

Fund: (OAKMX Quote)Oakmark

Assets: $3.1 billion

Managed Since: March 21, 2000

1-Year Return: 38.4%/Beats 95% of Peers

Expenses: No-Load/1.2% annual expenses

Top-Three Holdings: Washington Mutual(WM Quote) Fortune Brands(FO Quote) J.C. Penney(JCP Quote)

Sources: Oakmark, Morningstar.

2. Where are you investing your shareholders' money today?

Nygren: Well, where we can find industry leaders selling at two-thirds of the S&P 500's [price-to-earnings ] multiple or less, we're happy to buy those.

A new name for us is Guidant (GDT Quote), a medical-device company that traded as high as 72 last year. Medtronic (MDT Quote) and St. Jude (STJ Quote), their main competition, have had a little better new product flow in the last year, and three weeks ago the FDA advisory panel turned down Guidant's new congestive heart failure device. That stock hit 28 after that was announced. It's come back now to 32.

At that price, it's selling at around 14 times next year's expected cash earnings. We believe it will go back to growing faster than the S&P 500, and it's selling at about two-thirds of the S&P 500 multiple.

I also like Kroger (KR Quote), a large holding of ours. The grocery business is relatively mundane, but they've been cranking out 15%-20% growth for quite some time. They expect they can continue growing at 15% a year, and yet here's a stock that's selling at about 12 or 13 times next year's expected cash earnings.

Van Harte: Companies tied to the PC upgrade cycle will be big in a recovery. We're going to have an unexpectedly strong [upgrade] cycle with the combination of new Pentium 4 processors and Windows XT.

So I like Microsoft (MSFT Quote), Dell (DELL Quote) and Intel (INTC Quote). I think those companies, especially Dell and Intel, have reduced costs to where you're going to see some really nice earnings. Those are my best recovery ideas.

A Valuable Approach Nygren's Oakmark Select fund has trounced its peers over the past three years

Source: Morningstar. Returns through July 26.

3. What are investors overlooking today?

Nygren: A mistake that's likely today is to look back to where we were a year or two years ago and think that was normal. I think it's probably optimistic to think that within the decade we could get back to Nasdaq 5000. As investors, we've been trained to think if something falls 50%, 60%, by definition it must be a value. Instead, look at what am I paying now for earnings that are expected in the future?

The market presents me with the choice of owning something like a Kroger, or pay three to four times the multiple to get a technology leader. Even though that tech stock might be down a lot over the last year or two, I don't see any element of value to it at all.

Van Harte: I hope one lesson that a lot of people have learned is that it does pay for most people to be diversified. If you're going to be 100% in equities, have some value and some growth. Over the long term I obviously favor growth, but I personally own our Transamerica Premier Value fund. I also have some money in bonds and cash.

Weathering the Storm Van Harte has taken his lumps but has beaten his peers, too

Source: Morningstar. Returns through July 26.

4. Tech stocks' valuations obviously got too high. Are you seeing any value there now?

Van Harte: The problem with technology is that psychology disconnects from the fundamentals.

Right now the psychology is negative, but if you talk to the companies like Qualcomm (QCOM Quote) and Intel, they're moving ahead very quickly with improving their products and their competitive situation. I think in those kinds of companies there's a real opportunity.

Value's Turn Value is back in favor after 1998 and 1999's tech-fest

Source: Morningstar. Returns through July 26.

Nygren: We continue to spend more research time in technology than we had been because so many of the stocks are down so much. But I would say our hit rate from ideas we look at, if you compare ideas we actually buy to the number of ideas we started out looking at, is still significantly below what it is in more traditional companies.

We really haven't added new technology names in a quarter or two. We bought Motorola (MOT Quote) and Teradyne (TER Quote) months ago.

Still own them?

Still own them. Still like them. But I think that's kind of the flavor of the names that you might make the value argument for, the very out-of-favor like Motorola because of the way they screwed up their cell-phone business, or Teradyne because of how cyclically negative the semiconductor cycle is right now.

10 Questions Archive

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5. Given their products, management and current valuation, what three companies would you buy today and hold for five years?

Van Harte: I have to say First Data (FDC Quote). They touch about one in every two credit-card transactions in the U.S. Electronic transactions comprise about 30% of total transactions in the economy, and that should grow to 40% in five years and roughly 50% in 10 years. So you've got a company that is in a hugely competitively advanced situation and riding a nice growth wave. I feel that's rock solid.

Second, I'd say Rite Aid (RAD Quote). The best thing I can do as a growth investor is find a growth company when it's perceived as a value company. We love the [drugstore] industry in terms of the demographics and the pharmaceutical pipelines that are basically set and ready to run for years. We know the new management and feel that they've got a handle on the company's problems. You've got nice growth, profits and cash flow. You'll have some debt repayment and some working capital improvement, which we think will help double the stock in roughly three years.

The last one that I would highlight is Qualcomm, which I think is basically a combination of Intel and Microsoft for the wireless world. They control CDMA [code-division multiple access], the wireless industry's technological standard. They're going to be paid for it in the form of licensing and royalty fees. Qualcomm's share of chip sets is still very high, like 80%-90%, because nobody can figure out how to make this CDMA stuff work right in an integrated circuit. I think having access to mobile data services is a big deal for a lot of business people. Qualcomm is just, is going to be, a huge winner.

Nygren: Washington Mutual (WM Quote) would be at the top of the list. It's growing earnings at more than 15% a year, and we think it's likely to continue doing so, but it's selling at about half the S&P 500's multiple.

A second name I'd certainly add on that list is Kroger. In the grocery store industry you probably don't see much top-line growth for above 4%-5%, but we believe Kroger can continue growing 15% a year for a very significant period of time, certainly for our five-year time horizon.

The third name that I'd have to put on this list would be Guidant, and we've talked about them.

Kroger had an above-market P/E just a few years ago and was a favorite of growth managers. Guidant as recently as last year was a growth stock. That's kind of the transition I'm looking for: Better-quality companies being available at prices that appear to be quite attractive relative to the market.