The growth style is out of favor, but it always makes sense to talk to Jeff Van Harte.
Like just about all of his peers, Van Harte's
Transamerica Premier Equity fund had about 50 cents of every dollar in tech stocks in 1999. But unlike most of his competitors, he didn't ride all of the tech faves down as they buckled beneath the weight of an economic downturn, outlandish expectations and thin-air valuations. He bit the bullet in 2000, taking profits in tech holdings that triggered a big capital gain, but avoided the eye-popping losses posted by many growth managers.
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Of course, he and his fund's shareholders didn't emerge from the past two years' downturn unscathed, losing 14% and 18%, respectively, in 2000 and 2001. But he has beaten the average big-cap growth fund in four of the past five years. In fact, he ran a variable annuity subaccount that quietly topped the
for nine straight years, a streak that ended in 2000 and was exceeded only by Legg Mason's Bill Miller.
Today, he admits that he's "sharpening the pencil on stocks' valuations" more than ever and is spreading his bets among an eclectic blend of companies. While he does own big tech bellwethers like
, he's taken a pass on sagging networker
. At the same time he still loves long-time favorite transaction processor
What does he see coming, what's he buying and why has he shied away from health care stocks? Read on.
1. As a growth investor, where are we today and how did we get here?
We think we're not going to go back to have really, really high multiples on growth companies that we had in 1998 and 1999. If you look at what we've done over the last couple of years, starting in early 2000, we've just started to diversify our portfolio, and generally sharpen the pencil on valuation. It's hard to get out of the way of the whole
economic downturn, but we did some good things like lightening up on technology.
Fund: Transamerica Premier Equity
Assets: $139 million
5-Year Return: 11%/Beats 87% of Peers
Expense Ratio: 1.26% vs. 1.46% category avg.
Sources: Morningstar and Transamericafunds.com. Returns through Jan. 23.
In terms of how we got here, we think you have to accept that things have really changed since 1998 and 1999. Back then the investment banking machine was geared up to bring every dot-com company you could ever think of
to the market. As it turned out, almost all of those didn't work as sustainable businesses.
Also back then businesses were afraid of being Amazoned
surpassed by an online competitor a la
. Companies are no longer afraid of being Amazoned.
What a lot of us had trouble distinguishing was how much money was being spent on
information technology back then, vs. really what was the appropriate level of IT spending to have a successful business.
2. Where are we going now?
Our outlook is that the economy is broadening, that there are other sectors to look at than technology. The recovery will not be dominated by the kind of intense levels of IT spending that occurred in the late 1990s, but still IT spending is a big part of the capital expenditure pie. So you will see a pickup there, and you want to own certain companies in technology.
Our overall theme is you want to own companies that are going to catch the recovery. You don't want to own a lot of secondary companies that may not get it.
3. What do you look for in companies before you think about buying shares?
We're looking for companies that have the balance sheet strength to withstand the recession. We like companies that are generating excess cash flow and companies that we believe have improved their competitive position in this downturn. Also, we're focusing on companies that are growing organically, not by acquisition. The only exception to that rule in our portfolio might be
Sources: Morningstar. Returns through Jan. 23.
4. Has the downturn and collapsing earnings among tech companies led you to change or toughen your criteria?
We shored up our valuation models. Clearly for a lot of high-growth companies, especially in tech, returns on capital have come down, growth rates have come down, and earnings have certainly come down. All of that changes your valuation models quite a bit, and I think growth managers have to be cognizant of valuation. It's OK to own higher-multiple stocks. Those companies just have to able to sustain higher returns on capital and
earnings growth rates.
is an example of how much this matters. We thought they could have lower earnings in a cyclical downturn, but we didn't think their
earnings estimates were going to go from $1 per share to zero. That's what I'm talking about. Those of us on the growth side have to really think about what's changed and how to incorporate some of this into our valuation model.
5. Given your approach, where are you finding opportunities today?
A couple of names that were on our radar screen prior to Sept. 11 and made our valuation cut afterward are three sort of mundane businesses:
. We really like the drugstore industry and like all of these businesses. Paychex got down to
trading at 30 times cyclically depressed earnings in the downdraft. Same thing for Walgreen.
All those are really high-quality businesses with excellent managements who've improved their competitive position in this downturn. We think they're all going to emerge stronger, and we think they're all at reasonable prices given the level of interest rates and their improved growth outlooks from here.
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6. A lot of growth managers have shifted from technology to health care, but you have modest health care exposure. What's kept you away?
A lot of the health care stocks are pretty well combed over. Many did pretty well last year because people were just looking for stocks that were a little more stable. As we come off a tough economic cycle, we think drug stocks will lag a bit. Health care has also really blown up and not done so well.
paid a god-awful price for their stake in
sputtering biotech firm
, and it hasn't paid off so far.
has had some problems, and
disappointed. Also, the federal
Food and Drug Administration has been slow with its drug approvals, and that doesn't help. A lot of the hospital stocks ran and they don't excite me.
We did add one name recently. We've started to buy some
, so we're just looking at positive changes there. We own
in some accounts. That's the kind of thing we're doing, looking at some companies.
7. What's your best- and worst-case scenario for the economy this year?
My best scenario is that you have definitive evidence by the second half of this year that the economy is really firming. I'm not saying that's going to happen, just that when I look at probabilities, I say that could happen. The attacks on Sept. 11 happened right in the middle of everybody's budgeting for the next year. That timing didn't help. I think that
budgeters erred on the conservative side.
As you get into the latter part of this year, I think
budgeters are going to be a little more optimistic and say, "We held back last year, and now we
to replace these PCs." If you get huge shifts in inventory, they build a better outlook, and the growth rates might start to surprise everybody. That's my best scenario for this year; that we'll see definitive evidence of that. I don't believe we're ever going to have the type of investment banking cycle we had in dot-coms and technology. Technology is a big part of capital spending, and you will see companies like Microsoft and
start showing a lot better earnings growth.
My worst fear is that we continue to have these severe pockets of deflation where whatever the
puts in, we just flush it down the toilet because banks are writing off loans. We continue to see deflationary spirals in certain industries. In retail, you see gross margin depression, and telecommunications is still very tough. These kinds of deflationary factors can be very serious, and they're hard to anticipate.
My worst-case scenario is that deflation continues to hover for so long that the economy won't recover because people don't see where the return on invested capital is. Even though the Fed has provided a huge amount of liquidity and interest rates are down a lot, the Fed alone cannot drive the economy into high-growth mode by lowering the cost of capital.
8. What kinds of returns are you expecting for stocks over the next few years?
For the next five years, I think you can expect returns in the 7%-10% range. To give you an example of how I think, recently Microsoft has come down and we've increased our position. I expect to earn 11% to 14% a year on Microsoft over the next five years. If the market's returning 8% and I can earn 10%, I think that's really good.
9. Let's talk about three tech bellwethers, starting with two you own and then moving on to one you don't. First, Microsoft.
Microsoft is so much more relevant in my life than they were five years ago. Their execution has been fantastic. Before I only used Word and Excel. Now I use Outlook and PowerPoint more than I use Word and Excel. I'm probably going to buy an Xbox too, and I'm an MSN subscriber. Microsoft just continues to get more relevant for everybody. They're making it easier and easier for it to become a larger part of your life.
I see more than $9 per share of cash and investments, and they're probably going to generate another $10 per share over the next five years in excess cash flow, so you're going to be close to $20 in cash and investments per share. Over the next five years you've got a business that earns $3.50 a share from operations. If they grow
their earnings by 10%-12%, I'm going to earn 11%-14%.
You also own Intel.
I think they lost their focus a little bit. They bought a lot of other stuff and tried new things like Web hosting. Now they're really sharpening their focus, coming out of the recovery. They're updating their plants, which will lower their costs of producing chips 30%-40%, which will make them tough to compete against. I suspect that their peak earnings power is higher than what people are estimating right now. Intel is certainly more cyclical than Microsoft, but their competitive position relative to
Advanced Micro Devices
is going to improve again.
One giant that you've sold is Cisco.
We're out of it. Cisco has a business, and it's worth something. Things got much worse for them than anyone would have anticipated. I look at Cisco and think it doesn't deserve the multiple it used to have because it's cyclical and it's still questionable as to what their real competitive position is. I still feel the days of acquiring companies to gain technology by acquisition are over. If I owned it, I would be interested in owning it on a cyclical play, but not a company that I would feel good about otherwise right now. Therefore, I probably won't own it. I just don't like the way they constantly come out with projections they can't meet.
10. As you look out over the next five years, what are the three companies that you're most confident in owning because of their valuation, growth prospects and management?
Well, first I'd pick my long-time favorite and top holding First Data. It's still my favorite. They reported this morning, and they're doing very well. The valuation has come up, but it's still pretty reasonable. I might look for 12%-15% returns over the five years, but that's still pretty good.
Microsoft is the next one I'd pick. We also like
a lot. It's very hard to assail them because they have such a solid network in place, so to compete with UPS you've got to do a lot of work and spend a lot of money. So I just think that the valuation is reasonable, and that the stock will offer a 10%-15% return over the next five years. If the market returns 8% or 10%, that's pretty good.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
email@example.com, but he cannot give specific financial advice.