Ariel's Fidler Bets Surviving Banks Will Grow

Ariel portfolio manager Timothy Fidler says banks that survive the financial crisis will emerge as stronger companies.
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CHICAGO (TheStreet) -- Timothy Fidler, a fund manager at Ariel Investments, says banks that survive the financial crisis will emerge as stronger companies. He's bullish on Morgan Stanley (MS) - Get Report, in particular.

Fidler co-manages the firm's Focus and Appreciation portfolios, which have earned three stars from

Morningstar

and are among the top-performing funds in their categories. The

Ariel Focus Fund

(ARFFX) - Get Report

has climbed 32% this year, outperforming 89% of its peers. The

Ariel Appreciation Fund

(CAAPX) - Get Report

has advanced 53%, beating 97% of its rivals.

Welcome to

TheStreet.com's

Fund Manager Five Spot, where America's top mutual fund managers give their best stock picks in five fast and furious questions.

Are you bullish or bearish?

Fidler:

Bullish. There has been a great deal of attention paid to the recent rally, suggesting that the market has moved up too far, too fast off of the March lows, running up faster than fundamentals would suggest. However, this line of thinking assumes that stock prices were at rational levels earlier in the year. We think first-quarter prices were more a function of the overwhelming fear that consumed the market at that time, rather than a rational assessment of long-run business values.

Current stock market valuations are not excessive and are reflective of where we would normally be in a typical recession as opposed to the "end-of-the-world" scenarios being discounted back in March. We think the investment community is undervaluing the massive cost-cutting that has taken place over the last few quarters. When we get some relief on the top line, companies will enjoy material operating leverage that's not considered in consensus earnings estimates.

What is your top stock pick?

Fidler:

One of our favorite stocks is Morgan Stanley, which exhibits very strong competitive advantages and differentiation in the financial space. The global investment banking area has suffered greatly over the last two years and we feel that the survivors are going to gain global market share and find themselves in even stronger competitive positions than they were before the turmoil.

Even though Morgan Stanley has a terrific franchise, the stock price didn't enjoy the strong recovery as others such as

Goldman Sachs

(GS) - Get Report

and we think this is unwarranted. If you look beyond a one- to two-year timeframe, it's not a stretch to see $5 to $6 in earning power for this world-class franchise, yet the stock wallows in the low $30s.

We looked at how their business model was changing and we could see lot of changes for the good. The balance sheet is in order and we see them moving away from high-risk, capital-intense businesses. They are now in a joint venture with

Citigroup's

(C) - Get Report

Smith Barney, which is a high-return, low-capital business. The merger advisory market, which was completely bombed out, is staring to revive.

Morgan Stanley is trading near book value right now. We believe this company can easily earn 15% to 20% returns on shareholder equity capital -- if not more -- in a less risky fashion. Companies are always going to need capital and related advice and services, especially those in emerging markets. There are only a few firms around with such economies of scope and Morgan Stanley is one of them.

What is your best under-the-radar pick?

Fidler: Hewitt Associates

(HEW)

is a leading human-resources consulting and benefits outsourcing company that has been under the radar for awhile, though it continues to grow even through this difficult economy. It has tremendous brand strength and a long history of thought leadership in the HR space. Hewitt is a classic case of a company where a small, underperforming division -- the HR business process outsourcing (BPO) unit -- has gotten a great deal of negative attention that has obscured the tremendous value in the core operations of the company.

Despite the fact that Hewitt has completely overhauled its management team, distanced itself from its competition in benefits outsourcing, and fixed the issues in BPO, it still trades at one of the cheapest valuation levels in the market. The balance sheet is pristine and the company was one of the few that had the financial strength to buy back shares during the last 12 months. We think this conservatively run, growing company is worth at least $55 per share.

What's your favorite sector?

Fidler:

We have spent a tremendous amount of time on the health care sector. As value investors, there have not been many times over the years in which we could own meaningful positions in health care. As contrarian investors, however, there have been two times in the last 25 years during which these businesses went on sale because of macro sector concerns: 1994 and now.

The obvious connection here is with respect to potential health care reform. While we don't have a better crystal ball than others, what know these stocks are discounted for worst-case scenarios that we don't think are likely outcomes.

Which sectors or stocks are you avoiding?

Fidler:

We have a general skepticism toward sectors and stocks where groupthink can take over and push prices higher. We also tend to view certain areas as outside of our circle of competence, meaning we can't reasonably predict what businesses will look like in five years or so. A number of the metals and mining stocks are good examples these two themes. Guessing future commodity prices is a notoriously difficult endeavor, and big moves in the stocks' prices lower our interest level even further.

-- Reported by Danielle Kost in Boston

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