Click on the company name to jump to Smith's comments on the stock.
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For folks who have found growth investing has been a pretty expensive proposition the past few years, it might be time to look up Robert W. Smith.
The manager of the $3.425 billion (PRGFX) - Get Report T. Rowe Price Growth Stock fund has kept many investors from losing their shirts, in two key ways. First, Smith has taken a more conservative approach to growth than his brethren, which meant trailing his peers during the go-go late '90s.
But he has more than made up for it on the back end, ending 2000 on the upside and posting a modest loss in 2001 while other growth funds were free-falling.
His savvy picking puts the fund in the top 5% of his large-cap growth peers over a three-year period, and top 8% over the past 10 years. Second, because he gives his growth stocks time to grow, his less-frequent turnover has resulted in fund expenses that are half the size of its competitors.
In this week's 10 Questions, the skipper says he has been getting more aggressive lately, buying up "headline risk" stocks like Citigroup (C) - Get Report and Tyco (TYC) , media companies, even adding to big tech holdings like Cisco (CSCO) - Get Report. He also talks about some of the sectors he's avoiding, as well as where he's sees the market and the economy.
Looking for growth that won't cost you your shirt? Read on.
1. What is your philosophy on growth investing and how has it led you beat your peers while keeping expenses low?
We try to find companies with sustainable, double-digit growth over a business cycle -- so that doesn't mean it can't have a period of down earnings. We want companies that are growing much faster than the market that are high-return businesses that generate good cash flow, have a decent history of investment at a high rate. Over time, if we don't pay too high of a price for those companies, then we'll offer much better than market returns. It's pretty simple.
We prefer to have lower turnover over high. We think that a growth fund run at a fundamental basis should have a lower turnover. A low turnover means that you bought the right stocks and they're doing what you think they should be do. That helps keep expenses down.
In periods when we think the economy is going to get better, we'll tilt the portfolio toward faster economic growth. In periods where the economy is slow, we'll tilt it away from economic growth. In periods where the market is what I'd say a buying risk, we'll sell it. In periods where the market is selling risk, we'll buy it. Risk is not always economic risk. While much of risk is economic risk, there's also corporate risk.
2. Where are the market and economy heading and how are you positioning your portfolio to take advantage of those changes?
Tenure: Managed Fund Since March 1, 1997
Assets: $3.425 billion
Top Three Holdings: Citigroup, UnitedHealth Group, Freddie Mac
Expenses: 0.77% (Category Average: 1.51%)
Source: T. Rowe Price, Morningstar
Good question. There are periods where we have more economic growth and periods where we take on more just general risk. And we're sort of in both those periods now, even though I wouldn't say we're aggressively in both.
We do think the economy is going to show improvement -- cutting rates and more monetary liquidity will be good things. We think the consumer will hold together. We think that by the end of next year, capital spending will get better. If we put ourselves forward six or 12 months, we think people will feel better about the economy both here and overseas. I think Europe will cut rates eventually and that that will begin to stimulate their economy.
If we project forward, we don't see a huge amount of inflation, but we don't believe in the deflation spiral that could occur.
So, with that economic outlook, what have we done?
We bought slowly into some media where we have decent positions in
. In general, Internet content is an area we've nibbled up recently.
We own some of the better retailers:
. We own
, which has been disappointing but we think it will hold together. It's not quite the market-share mess that the market perceives it to be at the moment, but it's got its own issues.
We've been buying
, which we think is a good play on a consolidating industry. So, we tilted the portfolio toward more economic sensitivity. Over time, our portfolio doesn't change a lot if you ever see how it's characterized in terms of growth and cap, it hasn't changed a ton.
3. What do you make of some of the headline risk companies? Citigroup, your biggest holding, certainly falls into this category.
I think every company we own has headline risk. (Laughs)
In September, everyone was selling risk. We were buying across the board names that we thought that people were unduly punishing, including Citigroup. We added names to our
position, we added some to our Tyco position.
These are what I would call our pseudo-troubled names. I still think that those companies have a way to go back. There's a huge number of companies that are trading at really low multiples and they have issues, but over the next 12 months people will realize the cash flow is real.
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While they're not super-growth companies, they have moderate growth. But they're very cheap, that we'll see valuations rise in those companies, like Citigroup, Tyco and Cendant.
In general, the implications of
just decimated the looseness of which some of the companies were run. So we'll leave the year with tighter-run companies, tighter, less profitable companies. (Laughs) But that's a good thing going forward for investors. The risk premium will narrow for those companies -- they'll have to earn it, but it will happen.
There's a lot of short-term mispricing going on. The reality is that the market is also a leading indicator. The market sent Tyco down before Tyco had issues. And so I was wrong to hold it and the market was right to sell it. So, it's not always advantageous to go against what the market says. But I do think we're in a period where there is a lot of short-term opportunity.
With Citigroup I think they just need to get the Grubman issue behind them. It's a company that has taken market share, shown good growth, and is well-positioned for an economic rebound around the world. Citigroup is at 11, 12 times earnings, and it has done well both from a return point of view. It trades from a very big discount -- I know part of it's because it's a financial, but a diversified financial poses much less real risk than a mono-line financial. Over time, the market will afford it a slightly higher multiple.
I do think they'll be a settlement, some one-off charges.
This interview was conducted Friday morning, before reports of a possible settlement.
4. Your portfolio is still underweight technology. What are your concerns about the sector's ability to recover?
We've been wary on economic risk, especially regarding technology. We're probably more back into a neutral position, even selling into the rallies. I think semiconductors are pretty stretched. I'm not a big believer in that space. I own some names. I think we could have a liquidity squeeze -- we could have people kind of panic buy toward the end of the year.
If you look at a two- or three-year time frame, I don't think that we're going to have returns way outside the norm in either direction. We could have a little bit of a snapback. Economic growth is going to be a little bit below trend; that will probably lead to more modest earnings growth. If you look at the type of companies we own, if you go two or three years down the road it's more likely people will realize that 12% to 13% growth is really good growth. And they're more likely to pay a higher price than they do today because few companies will be able to do it, so that's what we're trying to focus on.
The fourth quarter tends to be a good one for technology. And while I'm not bullish on the sector, I stopped being totally bearish. Demand should begin to improve. You'll have a seasonally down first quarter, and then you ask, "Who do I want to own?" I think you really want to own the leaders.
and some of the bigger names, but technology growth in the next economic cycle won't be much better than regular economic growth. It's not going to be a huge jump. Valuation is still relatively extreme.
5. You have been adding Cisco. If there's no promise of near-term growth for the company, why is now a better time to buy than later?
Good question. First, the hard part with the market is knowing when it's going to discount a stock, and when it's going to close the gap. Two things led me to be a Cisco buyer at this time: It looked to me like they ran their business exceedingly well in the downturn. Second, they created an earnings floor on the downside that supported the price at current levels.
Whenever you look at most companies, a lot of it is decision tree analysis. You look through and say, "X could happen, Y could happen, Z could happen. What are the probabilities and what does it give me?" The bottom end, you have Armageddon, of course. But in terms of the floor underneath Cisco, the earnings went up a lot. In a sense, the downside was limited.
Why buy it today? Because, as we discussed with Tyco, the market is an anticipator. The market will anticipate the turn before Cisco turns.
So my view is that Cisco, which is now in the $12-$13 range, has the ability to earn 70-80 cents a share a couple years out. It's a company that should be able to do low double-digit growth, great free cash flow. It has $20 billion cash on the balance sheet. I think the stock can get back up to the $17-$18 range. It could over the course of months, but it also can all happen over the course of a week. That's a lot of upside.
Another thing with Cisco: If you have a portfolio, it's a bit like having a baseball team. You want to have different talents. You have stocks that you feel comfortable on the short term, and some that will work on the long term. You have a mix. The ones that are short term might already be discounted; you just don't always know. And the ones that are long term, you don't know when it's going to be put in the price. Very few people are good at figuring the timing of when everything works.
6. Yahoo! (YHOO) is a recent addition to your fund. Why are you buying it now, and are you afraid you missed the run-up?
We've made recent purchases in Yahoo!. I think that in general Internet content is a name we've nibbled up more recently.
There are a few reasons we like Yahoo! -- and the first one is a thematic reason. The Internet bubble burst, competition knocked out many players. But reality is that the whole time, the demand for the Internet continued to grow. The key was: Who could really monetize their assets?
What they've done with
Yahoo! has an affiliation with the pay-per-view Internet search engine is a good thing. They've found a way to monetize the search.
They've brought in new management that is more focused on profitability. They generate better cash. And they've begun to grow outside of advertising. So they have some good growth drivers that aren't ad-driven.
I think the advertising market has bottomed. For
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it will take longer, because AOL had a lot of bigger deals to unwind. But the Internet's real. The search is a real service that they monetize over time.
If I try to model through where they can take cash flow levels, I think in several years, they can have $400 million to $500 million in free cash flow. I think that's a reasonable price to pay for assuming that they can do it.
I feel comfortable that the business model is growing. I feel comfortable that the space will be more profitable. The biggest risk is probably competition with Google. They've lost a little bit in market share. I feel a little bit better about the market. This is the type of the stock that people look to for growth over the next five years, as opposed to the previous five years.
Have we missed some of the run-up from the bottom? Yes, it's up 60% from the bottom. But it's also down 90% from the top.
7. Freddie Mac (FRE) is your number-three holding, and it's one you have lightened up on. Are you as concerned about the impact of Republican-controlled Congress, which is expected to be less enamored of the government-secured entities, or perhaps the slowdown in the refinancing boom? What else concerns you?
I feel less-concerned than the darn market is! (Laughs) Rodney Dangerfield had more respect than Freddie Mac has.
Here's a company that has posted 18% earnings growth over 10 years, and the multiple goes down every year. It trades at nine, 10 times next year's earnings. I don't see it getting slammed. You could argue that it's incrementally worse, and I'm sure that's creating some of the liquidations of this position.
I still think they are a solid, double-digit grower. The risk you face is that Freddie Mac has been growing above trend; so, does that mean they grow below trend -- maybe 10% for a few years? I think that's possible.
But I do think they are driven by growth of debt outstanding. Even if you don't have this huge refi boom anymore, the debt outstanding balance will be driven by housing prices. While we have pockets of housing bubble, remember, Freddie Mac can't do jumbos. So I don't think, in their space, we have a housing bubble.
So over time, if it grows low double-digits and you're paying nine, 10 times earnings.
Are you still lightening up?
No. I've stopped.
8. You traditionally sock about 10%-15% of your fund into foreign equities. According to Morningstar, you have about 7.3% in foreign stocks right now. Why the smaller stake? Is this a bigger statement about U.S. vs. foreign equities right now?
I'm at the low end of that the range; maybe 8%. It's lower than normal.
I don't typically get driven by macro calls. Take a look at some of the names that we have historically owned -- health care, for instance. I tend to like services over pharmaceuticals. Well, there are no big service companies overseas. In health care, shifting assets from pharma to health care services, you are moving money out of international. That's part of the reason you've seen a drop in the overseas weighting.
Second, as I said, I'm not real big on technology. But European technology is pretty expensive. I also have some issues with IT services. It's all on a stock-by-stock basis. I do have some overseas tech names I like.
-- we still own those.
My financials are all U.S. companies. U.S. financials tend to be cheaper. I understand the risks better.
9. You have weighed in on the looming pension crisis and that the market may not be taking seriously enough. How are you factoring it into your strategy? Are there companies you've shied away from because of pension liabilities? Any companies that have managed this issue well?
It's something I definitely look at and think about. I do own some
, but otherwise, I tend not to own a lot of the old industrials most affected.
We have a few pharma companies that have issues. But health care service companies really don't have to worry about that issue. The financials are OK with options.
10. Wall Street and investors have been trying to get a grip on how much options are costing companies. I read recently about your efforts to evaluate what percentage of shares to executives in the form of options. Can you tell me how you evaluate options and what it says about management and the stock?
The past won't matter, so the issue is what companies do going forward.
I don't think anyone's going to have options that are more than a couple of percentage points per year dilution. How they account for it will be determined by somebody else.
If you think of tech companies, if they're trading at 25 times free cash flow, a portion of that cash flow is going to go to buying back stock to pay the options. For non-tech companies, it will probably come down to about 1%.
For earnings as a whole, it's probably going to drag earnings about 1% for a four- or five-year period as it layers in.
We'll be much tougher on companies that try to issue a lot of stock options.
Are there any that stand out to you among companies you own?
I'd say we're still in the process of working that through, without nailing somebody here.