Every single stock-fund category is underwater so far this year.
That may be the most telling factoid about this ugly market, one that shows how difficult it is to find a winning formula or even one that doesn't lose. Because harried investors are casting a wider net in the search for the right way to put their money to work, we thought we'd do the same for this week's 10 Questions interview. Instead of putting 10 questions to one stock picker, we've put five questions apiece to one of our favorite value fund managers, Bill Nygren of the Chicago-based
, and to one of our favorite growth managers, Jeff Van Harte of the San Francisco-based
Transamerica Premier Funds
Both have solid resumes. Nygren's mid-cap value
Oakmark Select fund boasts a 19.9% annualized return over the last three years that beats all of his peers and outdoes the
by more than 16 percentage points, according to
. For his part, Van Harte's
Transamerica Premier Equity fund has averaged an 18.6% gain over the last five years. That beats the S&P 500 by more than 4 percentage points and some 92% of his large-cap growth peers.
As you might imagine, each sees the same market differently. Nygren is sticking with picks like
Toys 'R' Us
and believes that tech stocks are still too expensive, while Van Harte is nibbling selectively in the tech sector, which he admits was grossly overvalued. Both agree that the next few months could be awful. And both agree on the biggest mistake you could make in this market: Buying shares in a tech company just because its shares are way down from their peak.
The two skippers make case for their respective styles, and both have been right a lot more than they've been wrong over careers that each span more than 20 years. So let's hear them out, shall we?
1. Is the Nasdaq oversold at this point or does it have further to go?
: We think the values today are still more in the traditional companies than in technology stocks. If you look at the Nasdaq, to me it's trying to find fair value, and that has been kind of like walking up to a mirage in the desert.
A year ago, you would have said if the Nasdaq got to 2000, it would be a bargain based on
companies' earnings growth forecasts, but as the year went on, the forecasts changed dramatically and instead of 40% growth, we're probably looking at 15% to 25% growth.
Instead of looking for straight-line growth, we're saying, Guess what? Technology is cyclical just like every other sector of the economy. And based on those new numbers, I find it really hard to justify paying two to three times the P/E
price-to-earnings multiple for large technology stocks that I have to pay for high-quality financial and consumer companies. Historically, the
P/E multiple spread has not been nearly that large.
: It depends on your time frame. Short term, you could still see more weakness, but at some levels we're seeing some stocks that look oversold, and we've been nibbling away at some stocks.
Jeff Van Harte
We don't want to go overboard, but there are definitely some quality businesses that are oversold. If you're looking out two years, we think these levels look good. Then again, it might look lousy over the next six months. Companies just don't know what their visibility is, so it's hard to say. It could change on the upside in a hurry, though. Inventories might be under good control by the time demand picks up.
2. Specifically, what companies do you think are cheap?
: My largest holding,
, despite performing very well over the last year
up 109% over the last 12 months, sells at about 10 times expected 2002 earnings, which puts it at about half the S&P multiple. Now, historically, banks have sold at a discount
to the market, but selling below half the market multiple still puts you in the better-than-average category for that kind of company. I could go down the list of companies we own where on year-ahead numbers the multiple is in the low teens for businesses that have typically sold at around S&P 500 multiples. I also like
Toys 'R' Us
at about 13 times next year's expected earnings, and
, at about 12 times cash earnings.
Now This Is Value
Source: Morningstar. Annualized returns through March 16.
in the low $30s is one. And
at around $50 is another. We've added to both as they've come down.
, too, at around $20. I just think fair value is higher. That doesn't mean they won't go down more from here. We're not taking new positions, just adding incrementally to what we've liked. In some of the more mature areas of tech, on the other hand, like PCs, we've sold some.
Beating the Pack
Source: Morningstar. Annualized returns through March 16.
3. Was there ever a time in your career that reminds you of this one where a burst of positive sentiment for a big sector like tech was followed by an equal and opposite burst of negativity once things came down to earth?
: Oh, boy. That's hard to say because the times I'd be tempted to point to I think were quite a bit different. At the beginning of my career -- I've been doing this for over 20 years now -- energy stocks had a huge run and became a very large percentage of the S&P, but I think the people who bought those stocks were still tied to valuation criteria, it's just that they guessed wrong on where prices were going.
Another time you might be tempted to point to is the biotechnology boom in the early 1980s, but at their peaks biotechs represented a tiny percentage of the S&P 500. I think what's so different here is you had such large companies get driven to prices that were so different from their intrinsic value, because of an investment style that paid no attention to price. And I think that makes this quite a bit different than the other bubbles that I've experienced.
: When I first came into the business around December 1980, we were at the end of the
malaise. That was a very negative, hopeless time. The Gulf War was not a good time, either. That caused a recession. But this is different. When I first came into the business, it was the unwinding of inflation, and during the Gulf War we looked at a deep recession and a collapse in real estate prices.
I think our current weakness is more a fear of deflation and that we have so much inventory built up in the tech sector. I think that fear is justified, but I do think demand will come back. I'll use
as an example. They're investing heavily to upgrade their manufacturing. That helps them make a more powerful chip at a lower cost to them. That creates return on capital for their customers who will then order more chips. That's how a business creates value.
I think you should be bearish if inflation was coming back, or if you think we're in a stagflation state. You should be bearish if the U.S. has lost its competitive advantage or if inflation is back. I disagree with the Japan analogy, which is silly. If anything, we're increasing our competitive advantages, not losing them.
4. What would you say is the biggest mistake an investor could make in this market?
: I think one of the biggest mistakes an investor ever makes is being unwilling to acknowledge mistakes. And the temptation to say I've got a long time horizon, this is only a paper loss, I think is potentially a very large mistake, still today. For a professional investor, admitting a mistake is the hardest thing you'll ever do; for an individual investor, it's even harder.
I think a corollary to that comment is, I hear a lot of people today measuring value based on how much something has declined from its peak. And I think that is a very dangerous way to try and estimate a business' value. The peak that we had at the beginning of 2000 was off the charts historically, a complete anomaly. And to think something is cheap today just because it's down 50% or 80% may get you a very different answer than an analysis of expected cash flows.
: Averaging down in a stock just because you think it's cheap.
Laughs You want to buy a company because you think its fundamentals are improving.
I think you always want to keep a focus on investing in companies that are increasing their competitive advantages in tough times. You want to stay focused on companies that are healthy and increasing their lead on the competition. If you do that, you'll emerge stronger from the recession. You don't want to just load up on shaky companies. Fundamentally, there has to be a great business there if you're going to be averaging down today.
5. Is the market's current volatility just a natural part of the value-growth cycle where the two styles exchange leadership? It feels like we're working through the frothy returns of 1999 and because of the scale of the valuations we saw then, it's just going to take a while to unwind that.
: I would agree there is a natural cycle where stocks or industries go out of favor. Value investors own them, their fundamentals improve and eventually the value investors end up selling to the momentum investors. And yes, I would say this is a natural unwinding of that cycle, but given the magnitude of the cycle, and to call this a normal unwinding, I think is a gross understatement.
You and I have talked before when the Nasdaq was at 1300 and
first talked about irrational exuberance, and it went on to quadruple from that number, and that's an amazing move from a level someone like the chairman of the
was saying seemed to be a fully priced, if not overpriced level.
Growth Vs. Value
Source: Morningstar. Returns through March 16.
: Clearly tech stocks and growth stocks got overvalued. As a long-term believer in growth stocks over value stocks, it was hard to believe. We did a lot of selling last year, but remember value
stocks can go up more than is justified, too.
This is a discussion that's near and dear to my heart. I favor growth companies because they have high returns on capital vs. cost of capital. I like businesses that do that. If you describe a value stock to me as a company with 12% return on capital, I don't get excited. But you've got to remember that if that company is selling cheaply and that growth company is selling at 100 times its earnings, at that juncture the value company is too low and the growth company is too high. That's what happened over the last year.
I don't like to buy overvalued stocks, but I don't like a lot of what went up last year. They don't create a lot of value over time. But they just got too cheap. We'll probably overshoot on value here, but you've got to believe in growth companies longer term I think.