has been right a lot more than he's been wrong. And right now, amid the stock market's rubble, he sees a slew of tech bargains.
Ward is the price-conscious
Gabelli Growth fund skipper who has quietly posted a 23.3% annualized gain over the past five years, beating the
by more than 5% and a cool 98% of his peers, according to
. Rather than chase the highfliers of the day, he's stuck to fundamentals, shopping for big companies he thinks are trading for less than they're worth in light of his earnings growth projections.
This measured, pragmatic approach makes sense for fund and stock junkies alike, particularly after a tough year like this one.
Top Three Holdings:
Percentage Rank in Category:
1. Where are we today, what put us here, and where do you think we're going?
It's important to begin considering the year 2000 with an examination of the previous five years of stock market returns. That five-year period was unprecedented in terms of recording very high returns for investors. The S&P 500 compounded at 28% for the five years. The combined growth compounded at 33% and other growth funds did as well -- some did better, some did worse, but to be compounding in five years at anything close to 30% without taking a quantum level of risk is pretty much unheard of. You finished that period with record high stock market valuation; you had record public participation in the stock market, and, I think very high expectations going into the year of 2000.
With certainly a very large audience of new investors to the stock market, a new generation of unsophisticated investors that really got caught up in the last stage of the biggest bull market in history.
They made the common mistake that present experience is the way things have always been.
Right. I think we've all seen some of the surveys that were done at the time saying people thought that 20% return on stocks were expected.
So the market had some obstacles. Actually, it got even worse because going into the year you also had a sort of bias toward tightening interest rates. You had a
tightening, you had record high valuations, you had record returns, very high expectations, a whole new audience of investors in the stock market that were not smart investors in a sense.
So you had the ingredients for a bubble being pricked and you had that spectacular run in the
from Nov. 1 through March 7, from 3000 to 5000. The funny thing was if you pulled the Nasdaq up on a chart, it actually looked like a bubble. And you had record levels of IPOs -- you had all of these dot-com stocks without any earnings, and in many cases, without any business model to get you to the earnings. So it was a wild ride.
I think people needed to enter the year with expectations much lower than they would in the past. We cautioned our shareholders in our report to do just that. It's been fantasyland, don't expect this to continue and don't invest in the stock market for the short term.
Sure enough, the bubble was pricked and those very high expectations have been going through the process of getting reconciled to reality. And that's been a tug of war that started in March, and it's continued to this day, and the good news is, I think it's about over. The speculative bubble has burst, the Nasdaq has plummeted by 50% from its high, expectations have come way down, the valuations on the most speculative stocks have come way down, there may be still some outliers that need to be shot, and the market seems to be discovering them pretty quickly these days.
But for most of the established blue-chip stocks in the large-cap growth category, in most cases the valuations have reached attractive levels, unless you believe we're headed into a recession.
2. Do you think there are some tech bargains out there today?
I do, and I would say that one of the mistakes that people make is we'll make a call on the market, and embedded in that call is the assumption is that our stocks either bottom or peak at the same time, and they don't.
And so you will have some stocks which I firmly believe have already bottomed and are well on their way to recovery, that are never going to go back to the lows that they reached earlier this year. Within technology, some names that I would point out:
, which was available at $50 a share and it's now $85. Of course, it started the year at $200, but I don't think it's going to go from $85 back to $50.
was $35 when it was downgraded by a lot of Wall Street people a month or two ago. It's $49 today. I really don't think it's going to go back to $35.
was $40 or $38 not that long ago. I don't think it's going to go back to the low.
is another one that I think has probably seen its low for this cycle, although it's not nearly as inexpensive as some of these other names. So I think that there has been a bottoming, a flushing out process taking place, and I would like to think the smart money has been taking advantage.
, one of my biggest holdings, is a perfect example of a stock that was at $40 when they reported their third quarter, and it's now $61. That's a 50% move up in a market that's been going down. Is it going to go back to $40? I don't think so. If it is, I'm going to be crying a lot.
And at the beginning of this year, to take this whole discussion one step further, at the beginning of the year, it was very unpopular for people to be owning financial stocks. And admittedly, some financial stocks were dogs this year -- particularly some of the banks -- but a lot of the brokers and asset management stocks were home runs. If you did not buy the financials because of this fear of owning financials in the fear of an environment of a hostile Fed, you lost. You could have owned
State Street Boston
Marsh & McLennan
-- a whole slew of these things that were huge performers. Yet it was unpopular at the time to be doing it. It became popular after the Nasdaq crumbled and the money was looking for a safer place to run.
Same thing with the drug stocks. It was very unpopular to own drugs going into the year because of the fear of what Washington was going to do to prescription drug prices. And so you would have missed a 50%, 60%, 70% move in the major drugs if you waited on the sidelines until it became more evident that not much of anything was going to happen in Washington anytime soon with respect to prescription drug prices.
So opportunities are there, the problem is having the conviction to step up to the plate and take advantage of it. And within technology today, the stocks that I think are truly bargains fall into really a couple of different categories. I think the PC stuff in general is overly beaten up, and
is my favorite holding there.
But here's a stock that has fallen from $60 to $18. Of course, when it was at $60, everyone loved it but now that it's at $18, everyone thinks PCs are dinosaurs. I actually disagree with that point of view. I think the PC market is currently soft and may have a couple of quarters where comparisons may not be all that pretty. But you know, at this price, with a valuation of 18 times reduced estimates for next, company is probably still going to grow at a rate at least as long as the expected unit shipment growth for PCs, which is still somewhere in the 15%-20% neighborhood over the next few years.
In fact, it's over 20% for the current year. And with half of their profits coming now from non-PCs, I think Dell is a bargain at $18.
Right. Folks have said before that it just seems to be that one of these cases where there's a misperception, the business has changed a bit, people aren't realizing that.
And I think that people are still saying it's a PC company, it's a PC company. Well, yeah it's a PC company but if you're getting half your profits from higher margin, faster growing businesses and getting no credit for that, I think there's an opportunity there.
Let me talk about
. Our cost on Sun is $2 a share and when we bought it, nobody liked it. It was selling at 15 times earnings and the Street thought they would struggle to go at 15%.
Well, guess what? If you had listened to their message and paid attention to what was going on in the Internet infrastructure world, you would have realized that Scott McNeely -- who was sort of discarded as this brash, outspoken guy who liked to poke fun at
and so on -- really was onto something, and that their business was getting stronger and stronger. And the next thing you knew it, stock's priced at 100 times forward earnings and everyone on Wall Street loved it, it was one of these so-called "bulletproof" names, one of these so called "best of breed" names, with this so called "robust platform," leader in its space, all those catchwords that drive me crazy and it could do no wrong.
And the funny thing is about the analysts' community these days is that nobody seems to pay a heck of a lot of attention to the valuations. They talk about current business momentum and how that translates into price momentum. And so when the stocks hit $64, as it was earlier this year, selling at over 100 times forward year earnings, as long as the business trends looked robust, they looked fine.
I mean, no one wanted to come out and run against that train. The problem was, the question they had to ask was: Are the assumptions that you need to sustain a valuation of that magnitude realistic? Or are they dangerously unrealistic? And we reached the position that they were unrealistic, and so we sold. We had 2 million shares of Sun Microsystems and in January and February we sold it and we sold it and we sold it and we're down to 780,000 shares now.
So what happens is, reality starts to set in and people start to realize, oh, those assumptions that we used, those were too robust, they're not going to make it. But in the meantime, the stock's been cut in half by the time they realize it, and then they downgrade it. I don't know why anybody gets paid any money to make that call. I mean I guess if you don't read newspapers or listen to the news ... It's like people downgrading the PC stocks after they've been cut in half or more because of the fear of a PC slowdown. Why the hell do you think the stocks fell 50%, 60%, 70%?
3. There's an awful lot of tech stocks out there that are about half of what they were a year ago. And it seems like there might be some real value there because some of this might be a bit overblown. But also, if you do want to own some of these names, don't we have to realize that we may not see Nasdaq 5000 for a long time?
There is a secular growth market for these technology products. There are certainly companies on the fringe that are not going to make it, and they're not going to live up to expectations, but I believe that the real leaders of the pack of the pack are going to persevere, survive and thrive.
And if you have a point of view that says we're going into a recession and that the earnings growth and the earnings estimates for these companies will continue to come down markedly, then you should probably stay away. But if you have a point of view that whatever slowdown the economy has is going to be short-lived and that
is going to be easing aggressively as we move into the new year, and you continue to believe that the Internet is going to grow and networking is going to grow and so on and so forth, then you've got to be buying these stocks. And you've got to be willing to take the risk that maybe you're not picking the bottom, but these things can move up so quickly when they move that it's pretty hard to get in.
4. When we talk about these leaders that aren't going to go away and they're standing in the way of a lot of secular growth, what are two or three that stand out to you as fitting that description and also having shares that are oversold these days?
Well, there's a couple of different ways of looking at it. I think that if people want to talk about the stocks that they can just put away for a few years and not worry about whether the next quarter's estimate is in line with Wall Street expectations or now, I think
is certainly going to be around for a long time to come. It's going to grow at a very rapid rate. I think
is also in that category and their multiples have pretty much been cut in half over the course of the year.
I think even
is a name that at these prices, I would be happy to own, again because I don't think the
PC market is as dead long term as some people think it is. PCs run every business in America. Many people have multiple PCs that they use, they have them in their home and in their office, their kids have them at their school, and that's not going to go away. We're not going to be relying on some handheld device to run our businesses. You may use that to supplement your PCs, but you're going to need your PCs.
And you're going to need to replace them every couple of years. Whether you think you're going to have to or not, as new software with higher demands is created, you're going to have to upgrade. So, I still think that's a pretty good business to be in.
So, I think Intel is something I would own here, and I think
is a stock I would own here. In fact, at these prices, again, for the first time in over a year, I would say
is a buy. Stock's right now at $27 -- it was at $64 -- and it's down to less than 35 times the current estimate for next year and I have a hard time seeing how you don't make money in this stock if you're willing to hold it for a couple of years.
I don't know whether this is the absolute bottom of the stock or not, it is a 52-week-low and I have to believe that there's some tax-loss selling pressure on names like this between now and year end. So I would definitely view Sun Micro as a candidate for what I think is going to be a strong January bounce.
5. As we look toward next year, what kind of a market do you think we're looking at? Is it going to be a more selective, maybe more fundamentally driven market?
I think it's going to be much more fundamentally driven because I think some of the other strategies have failed.
I'm actually quite optimistic for 2001, because I think discipline and risk have returned to the market. The speculative frenzy is pretty much over, people are realizing if you're going to pay 100 or 200 times earnings for a stock, you better be prepared to lose your shirt, and that value investing is not dead. I think that Greenspan is going to be easing; interest rates are heading down. I think the price of oil looks like it has probably peaked for the foreseeable future. Valuations are the best that they've been in a couple of years because you've got this year of 2000 where prices are down, in some cases, down dramatically, while earnings are, for the most part, up pretty strongly for a lot of those companies, so it's really the best entry point we've had in some time.
And so I'm pretty optimistic. The public has not really panicked in the aggregate, the public continues to believe in stocks. I would give the public some credit for not panicking in recent years when we've had some rough spots in the market and they continue to invest money in stock funds and I don't think that's going to change. With interest rates this low, I can't see people getting excited to run out and buy bonds when they're yielding 5.5% or less. Short-term deposits are pathetically low. I think any reasonable person who is willing to educate himself about the stock market should be investing in stocks at these prices.
So, I'm pretty optimistic. In the media area, a lot of stocks have been hammered hard and reflecting the vanishing of some of their dot-com business and also the slowdown in the economy overall, which is perhaps all connected.
But the valuations are way down, again, the earnings continue to grow, the cash flow continues to grow, I think under the
administration you're going to get more merger and acquisition activity than we've had perhaps this year, you're going to have less interference ... the regulatory relief, I think you're going to get some tax relief. I think that what at one point might have been viewed as a tax package that was too stimulative, I think people are going to say look, the economy is sluggish, we can handle this, or at least some version of a tax cut.
So I think with tax relief, I think with regulatory relief, with expectations down, valuations attractive, I think 2001 could be a very good year for the stock market.
We needed a year like we had to consolidate the gains for the past five years. Now we've had it and people shouldn't go running back to their banks to put their money in a time deposit, they really have to learn the rewards of having a long-term commitment to great companies.
So I'm optimistic. I wasn't optimistic last year, and that's in my report. I don't time the market, which I also say, but I said this has been a great period of time, don't think that this can continue forever.
So you see this year as more of a valuation correction, a natural part of the market cycle than a recession?
I think so. I think it's absolutely a significant valuation correction and I think what I've seen from the Wall Street sell-side this year has been the most pathetic research -- I'm not even going to call it research, it's just pathetic people making calls without any strong basis.
Oh, completely reactive.
Considering they're paid to give you ...
They're getting paid to do IPOs or to do something, but not getting paid to make money for people in the stock market.
Well, clearly they're getting paid.
They're getting paid. We can agree on that. It's just pathetic. And if you really want to make money in stocks -- there's lots of different ways to do it -- but in my opinion, you buy great companies when people don't really like them that much. It's worked for me.
6. You ramped up your exposure to financials and health care over the year, two areas that were pretty buoyant amid a bloodbath for tech stocks. That view of next year's market would seem to be positive for those areas as well. Is that what you're saying?
I think it's OK. I mean fundamentally, I think that the earnings outlook for the drug stocks remains excellent, and I think for the financial service stocks that I own, I think they should post a good year as well.
I don't think there's as much opportunity there because the prices are higher, significantly higher relative to the growth rates than what you can find in a lot of the technology and media and even telecom stocks.
From a relative performance standpoint, I don't think they're going to see a year in 2001 like they saw in 2000 for financials and drugs, but the current business prospects for the names that we have is very good. But I think you get a lot more bang for your buck in some of the more beaten down names.
7. What have you learned from the past couple of years of investing? We had that kind of once in a generation run-up in 1999, and then we had the comeuppance this year.
(Laughs.) Well, I think this is a humbling business. Sooner or later, the market is going to behave in a fashion that makes you look stupid. It's a very humbling business. And I'm constantly paranoid of what the market is capable of doing to me, but I think it's just important to have a good solid grounding in the history of the market and of the fundamentals of security analysis.
And I think if you have an understanding of that and of what drives stock prices, then you can help steer yourself clear from a lot of trouble. And that's half the game is simply avoiding the pitfalls.
You just have to understand that there is a mechanism in place for valuing stocks. Collectively, the stock market is reaching a judgment about the present value of these companies' future earnings streams, or in some cases, the values of their assets, but there is a mechanism in place that does that and stock prices can get too high. Valuations do matter, earnings do matter, all these fundamentals really do matter.
And I think that people, in some cases, Wall Street people have tended to overintellectualize this whole process. This is not rocket science. We're not building microprocessors here. We're trying to use common sense to buy good companies at reasonable prices. Sometimes that means not doing what the herd is doing, and sometimes it's lonely when you're going against the grain. But I think again if you're well-grounded in fundamentals and in the history of the market, you can avoid stepping in a lot of trouble. I think that there's one thing that I think I relearn every year: the importance of having some patience. Rome wasn't built in a day, and when a stock goes down, you don't necessarily have to buy it today. You don't have to chase stocks on the up side, and panic on the down side.
I think related to the whole issue of learning the fundamentals is, when you're building a portfolio, there's a reason that people have historically said diversify your holdings.
If you've got too much of your eggs in one part of the market, and that part of the market isn't doing well, you really get hammered two ways. First you get hammered because you're overweighted in stocks that are doing poorly, and secondly, you get hurt because you don't have enough money to put in the stocks that are doing well.
I think what we've seen on Wall Street in the past year or two is really Wall Street run amok where the fundamentals just seem to take second place to momentum stories and sound bytes. It was just a speculative phase. It was a classic mania. The good news is, I think it's just about run its course.
8. We talked about some of the PC and PC-related stocks have been punished this year, and one that we didn't really get into is Microsoft (MSFT) - Get Report. Everybody has an opinion on Microsoft one way or the other whether they own it, or whether they don't. What's your take on the company?
Going into this year I think it was my smallest holding. The reason it was my smallest holding was we really felt when we did our little analysis trying to arrive at a present value of the company's future earnings, that the stock was pretty fully priced, pretty fairly priced. If I were to rank my holdings based on the potential returns to the target prices that we arrive at, it would have been close to dead last.
And it was the biggest name in the S&P 500, everybody loved it, people had growth expectations for Microsoft which seemed to ignore the law of large numbers which you just can't ignore. I mean at some point, you cannot grow with these behemoth companies at 40%, 50% rates. And the faster they grow in the short run, the quicker they hit the wall. And Microsoft's size started to play a role in its growth rate. At the same time that there was a clear shift to a more Internet-based computing environment, less reliant on Windows and, of course, now we know also at a time when the PC-end markets overall were
slowing, so Microsoft's valuation was too high, and its growth rate expectations were too high, and this has been a year where those were continuously getting rebased to lower levels.
Microsoft is one of my 10 smallest positions, it's less than 1% of the fund. In terms of the quality of earnings, it's got fabulous quality of earnings, it's got a fabulous balance sheet, it has many, many great attributes and it's not going away overnight. It's really to us a question of what are we going to pay for a company that's no longer growing at 40% -- it's no longer growing at 30% -- there's a question as to whether or not it's really growing at 15%, that in all likelihood it could be growing at 12% for the next few years.
That's a dramatic rebasing of the growth rate. And also, qualitatively, when you look at earnings estimates, do you include capital gains on equity investments and interest incomes? Or do you want to pull those out of your estimates?
Well, we pull out the expectations for capital gains from the earnings estimates, which is about 16 cents in the current year and instead of looking at what at one point was a dollar estimate for 2001 earnings, it was more like $1.85, $1.84 and now it's more like a $1.80. And we probably thought the company was growing at 15, 16, 17 at the beginning of the year and it now it's more like 12, 13, 14, which means that the multiple you pay for those earnings isn't going to be as high as it was. So to make a long story short: If I use an assumption for Microsoft of $1.80 of earnings, which includes some interest income but excludes equity gains, and if I'm willing to say that I think at best I don't want to use a growth rate which I think is unrealistic, so I'm going to use a 12% growth rate in my model, and if I really don't really know how to value this thing. But I know that right now it's selling at about 26 times that $1.80 level and interest rates, current interest rates prevailing as they are, I end up with a fair value on this stock of about $56. It's $46.
So it's about 25% undervalued in theory, meaning I wouldn't sell it here, but I'm not a buyer of the stock either, because within my technology universe, there are many other companies that offer me a lot more up side.
Without the baggage.
Right. I can go out and buy Analog Devices with a market cap of $30 billion growing at 50%, and I think I'm going to make more money than owning Microsoft over the next couple of years.
For a widow-and-orphan stock if you want to buy a technology stock and forget about it for 10 years, you're going to make money. Are you going to beat the S&P 500 for the next 12 months? I don't know. It's just a lukewarm holding to me at these prices. It's not a table-pounder, but I wouldn't sell it. It's more of a buy than a sell, but it's not something that I think is going to be a huge wealth creator over the next year.
9. If you had to buy three stocks today and hold them for five years, what would they be?
Only three, huh? Well, I think I'd buy Tellabs, which is my biggest holding, I think I would buy Corning and I think I would buy Dell Computer.
In all these cases, these stocks are up as being at least 40% undervalued on my screen. I think that you're apt to see some healthy multiple expansion in the case of Tellabs and Dell from here, and I think in the case of Corning, you've really got the oligopoly for providing custom fiber, which I think is going to be in great demand, so I think that there's a very strong likelihood that their growth rate at least meets current expectations, which are not as high as they were perhaps a few months ago, but you know, at these prices, I think those are three high-quality names and at pretty reasonable prices. I mean Tellabs is selling at about 30 times next year's earnings and growing about 30% with the highest margins in the telecom equipment business.
Corning's selling at about 46 times next year's numbers, but growing at a 25%-35% rate I think, with a high degree of earnings visibility. The stock is down almost 50% from its high, and in the case of Dell, I think just a huge overreaction to a temporary slump in PC sales. Dell is one of the most profitable companies in the business, and has pure growth, not growth by acquisition, it's been internal growth, strong top-line growth, growing faster than its markets, growing into or moving into higher-margin, faster-growing markets, so I think those are three picks that I would put them away for three years, I think you'd be happy.
10. Last question: It's another one we ask everybody. What was the last new name added to the fund and the last name you added to your personal portfolio?
Well, actually, the fund is my biggest investment because I feel first of all, it's too much of a distraction to invest on a regular basis outside of that, so whenever I want to own growth stocks I just put more money in my fund. If I want to own income stocks or something else then that's different, but the fund is my biggest investment. The latest addition to the holdings is actually an ironic twist:
I think it's a great way actually of playing what I suspect is going to be a rebound in a number of these beaten up tech names as we get into the New Year.
Because you're basically playing Janus' holdings, right?
Exactly. I love the asset management business. We've made a lot of money over the years with Mellon Financial, with State Street, with Marsh McLennan, with Northern Trust, hundreds of millions of dollars in profits in those names today. I like to buy the best asset management companies when they're sort of out of favor.
Stilwell trades at a significant discount to the group, because everybody is so afraid that their asset base is going to shrivel because of the performance situation this year. I think that's overdone, the stock is selling at 13 times our estimate of next year's earnings and that's exactly one third of the multiple accorded Northern Trust which is at 36 times next year's earnings. And if Stilwell grows at a 12% rate I have the stock as being about 60% undervalued.
I think there is a chance, although certainly there's been no announcements to the effect, but I think that the industry continues to consolidate, and that I think as we move into the New Year, this an acquisition candidate for large financial service companies that want to have a larger presence in asset management. Which is just about all of them, because it's the highest-multiple business you can buy in the financial service arena.
Particularly if you want exposure to the growth side of the asset management business.
Exactly, or there are definitely a handful of players that would be interested in Stilwell, particularly Janus as a family within their financial service empires, and at 13 times next year's estimates, with the stock at 36, down from 54, I think it's a pretty solid investment. Do I expect their asset levels to be $350 billion a year from now? No. But they're probably $250-$260 billion right now. There are not too many pure plays in the industry with very high margins, which is what Janus has that you can invest in. So I'm willing to make that bet.
Yeah, definitely, not many funds, all of them big. That usually spells profits.
Yeah, and you know I may be too chicken to go out and buy some of the stocks that Janus owns, but I can get an indirect play on that by owning this Stilwell stock.