Hang around the stock game long enough and you'll see growth stocks turn into value names and fallen angels morph into rising stars. And, of course, vice versa.
Nowadays it's not uncommon to find former growth phenoms like
in a so-called value fund. David King, veteran portfolio manager of the $1.7 billion
Putnam New Value fund, for example, owns both of these onetime highfliers in his value-based portfolio. He also expects the trend to continue as the more traditional growth stocks fall into the value category. King's fund is down 1% year to date, roughly flat with the
, but has beaten the index by over 10 percentage points annually over the past five years as value triumphs over growth in the postbubble era.
chatted with King about the gradual role reversal between growth and value, the rise of fallen angels and Putnam's own climb from the depths of the mutual fund scandal.
The conventional wisdom nowadays is that the market is going to get a shift from value to growth. As a value manager, what's your stance on that outlook?
I would not be surprised to see that shift occur. As I look at my universe, I am finding more stocks in it that people would traditionally call growth stocks. And also, some of the industries that are traditionally thought of as value, such as financials and energy, have had really good runs over the past five years.
What is your methodology for choosing stocks? Even after the changes in the market that you mentioned, you still have some high multiple, growthy-looking names in your portfolio.
Our approach to valuation is very cash flow driven and less reliant on traditional P/E analysis. We do look for stocks that are the most attractive on cash-on-cash returns, and our focus is on large companies as measured by their revenue and how long they have been in business rather than their market cap. So this can lead us from time to time to stocks that others might put in the "growth at a reasonable" price category.
Any examples of a stock which best describe your method?
is an excellent example of our process. This is a stock we got interested in when it was back in the $20s, and really, it was a combination of a low P/E on what we thought earnings would be several years out with attractive free cash flow valuation that caused us to buy it. And at the time, we thought it may have been expensive for our usual tastes. And as a matter of fact, the forward P/E multiple of Home Depot, now looking out to next year, is not much more than that of the average electric utility.
is another good example. That's a stock we never owned until only a few months ago. Pfizer has over a 3% dividend yield and is selling at a reasonable P/E ratio compared to its own history. And once again it's the strength of the balance sheet and strong free cash flow that attracts us.
So if these companies are in fact growth stocks that we bought at a value price, so much the better.
You also have some fallen angels in your portfolio. What's the attraction to companies that have had to overcome problems in the past?
Well, we don't take a short-term focus. In some cases, the stocks are simply out of favor and we are able to buy them without any particular fundamental concern. But in other cases we will end up owning a
where there is clearly some negative short-term news. We really don't differentiate among them.
I believe that value investing is about taking what the market gives you. So a group can be fine, but out of favor, like when the newspapers fell when people thought you were going to get your news on the Internet. Or it could be there are specific short-term controversies like at Tyco, Pfizer or Xerox. We really don't care either way because we are long-term investors looking for an attractive price. So you are right that we will end up owning some fallen angels and other times we will end up owning high-quality companies, like
, which don't have a particular short-term problem but their stock is much cheaper than its been over the past several years.
We have reduced our stakes in more aggressive energy stocks. We did take some profits in Amerada Hess. We also eliminated all of our coal stocks, which have been excellent performers over the past three years, as well as all of our oil-service names.
Conversely, which sector are you currently most excited about?
Most recently I've gotten interested again in the basic industries. It seems that investors have gotten overly pessimistic on the near-term economic prospects. Two stocks where we have been adding to our position are
. Alcoa really has been a laggard in the broad market, but I look for it to do quite well over the next couple of years as the aerospace cycle continues onward and upward.
The other company, Huntsman, is one of the largest chemical companies in America but only recently came public. The stock is trading with a lot of volatility, which reflects the unseasoned nature of it as a public company. In terms of its business, it's a strong company that's going through a lot of positives in its exposure to various organic and inorganic chemicals. And I believe they can earn $4 a share in the 2006 and 2007 time frame and you can buy it today at only $19 or so.
In an era where a lot of funds are increasing their holdings and becoming closet index funds, your fund only holds around 70 stocks. Why do you like to keep it leaner than your competitors?
Our fund is not designed to lower volatility or to be conservative. And I believe that the reason why we've outperformed many of our competitors over the last 10 years is that we have been willing to take larger bets where we have conviction. To me, it boils down to the fact that I don't think I have 120 great investment ideas, and when I look at some value funds, I consider them to be overly conservative and overly diversified.
Finally, you have been managing this fund for over a decade, a period that included the mutual fund scandal, which was not particularly kind to Putnam. Is there any residual heat from the market-timing scandal or is it now ancient history?
I have managed the New Value fund since its inception and I have been at Putnam over 20 years. I would point out that we have been in positive flows in our fund for about a year now and our performance was very strong when people were reading negative headlines about Putnam. I think it's safe to say we were unscathed by those events. At this point, we are experiencing inflows and looking forward to continuing to deliver superior performance.