Quick Take:Funds that invest in undervalued stocks of big companies have performed better than the overall stock market so far this year, although not by much. That’s true of Exeter Fund:Maximum Horizon Series/A (EXHAX), too, which searches for stocks of companies with staying power.
The fund lost 26.1% for the nine months ended in September, but that put it ahead of the Standard & Poor’s 500-stock index, which fell 28.2%. In comparison, the Exeter Maximum Horizon’s large-cap value fund peers were off 25.7% during the period.
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When analyzing stocks in cyclical industries, the team that oversees the Exeter Maximum Horizon Fund borrows from Charles Darwin. The managers search for businesses they see as most likely to outlast a downturn in a sector and to lead the recovery when conditions improve.
“We’re trying to buy the survivors,” says Jeffrey Herrmann, who helps run the portfolio. “One way to think of it is: I want to be the guy driving the cement mixer at the demolition derby.”
In a similar vein, the managers look for businesses that dominate their fields and that have some sort of sustainable competitive edge, like patents or well-known brands. They lean towards inexpensive stocks of companies with growing earnings.
The team also hunts for companies whose stock price does not appear to fully reflect the value of their underlying assets and cash flow. Within this group, the managers then look for a catalyst that can boost a stock, like new management or a restructuring.
The approximately $60-million fund concentrates on large and mid-sized companies and typically owns 45-55 stocks.
A recent addition to the portfolio is toy and game maker Hasbro Inc (HAS). The company stands out, Herrmann says, because it and Mattel, Inc (MAT) are the two biggest players in their field. Hasbro also generates loads of free cash, but doesn’t have to plow a lot of it back into the business, in part because it contracts out manufacturing, Herrmann notes. That leaves money available to pay dividends or buy back stock, he says.
The managers began buying Hasbro three weeks ago. Their shares cost $11 on average. The stock closed at $11.17 today.
Among companies in troubled industries, the team have been investing in aluminium producer Alcoa Inc (AA) lately. Although aluminium prices have been depressed and the industry has been suffering from excess smelting capacity, the managers say, they expect Alcoa to prosper because it is one of the lowest cost manufacturers in the industry. They also like Alcoa’s global presence.
The managers started investing in the Pittsburgh-based company in September, paying $19-$20 per share, on average. The stock closed at $19.11 today.
Herrmann says the team has been finding the kind of cheap stocks it prefers among health care companies, including drug makers, which now account for just over 20% of the fund’s assets. Valuations in the sector, compared to the market and the stocks’ own histories, are lower than they have been since the early 1990s, according to Herrmann.
The team bought a stake in pharmaceuticals manufacturer Merck & Co (MRK) about five months ago. Although the stock has fallen since the initial investment, the managers say they are optimistic about the company’s long-term prospects because of its strength in drugs to control cholesterol, as well as potential new products in its pipeline, such as a new anti-depressant.
The fund’s shares of the drug giant cost about $50 on average. They closed at $44.26 today.
Merck has been working with Schering-Plough (SGP), another relatively new holding for the fund, to develop a new cholesterol drug that the managers say they believe has the potential to become a leader.
Schering-Plough’s stock has fallen over the last three days, partly because the company warned today that earnings in each of the next two years would lag forecasts.
However, Patrick Cunningham, another member of the fund’s management team, thinks investors have overreacted to the company’s problems. The team, he says, thinks Schering-Plough’s bottom line can grow by at least 20% in 2004 and increase again over the following two years as new products are debuted.
The managers added to their stake in Schering-Plough in April. They paid about $30 per share, on average. The stock closed at $17.30 today.
Quick Take:George A. Mairs III has been a money manager for a long time. In 1952 he joined Mairs & Power Inc., the firm started by his father in 1931.
Mairs, who has piloted the Mairs & Power Growth Fund (MPGFX) since 1980 — he was joined by co-manager William Frels in late 1999 — holds stocks for a long time, too. The portfolio’s turnover rate last year was 7.9%, but Mairs says it’s normally 5%.
The fund, which holds only a handful of stocks and features many Minnesota-based companies, lost 12.4% in the third quarter just ended, and 14.4% for the first nine months of the year. But that put it ahead of its peer large-cap growth funds, which were off 16.2% on average in the third quarter, and 31.2% in the first nine months.
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Mary Richards was last seen in Minneapolis in 1977, three years before George A. Mairs III began managing Mairs & Power Growth fund in neighboring St. Paul.
The portfolio that he oversees doesn’t own many companies, and the bulk of them, particularly those that aren’t giants, can be found in his own Twin Cities backyard.
“We will not look outside this area for either small or mid-cap stocks because we feel we have to be able to visit with management periodically,” Mairs says, adding that he thinks there are enough good investments locally to provide adequate diversity. About 65% of his holdings are headquartered where the Vikings play their home games, according to Mairs.
Moreover, Mairs says he’s found that Minnesota-based companies tend to be successful thanks to unique products or strong franchises, which can give them the competitive edge needed to generate the kind of earnings he likes to see.
To get Mairs interested, a company must demonstrate the ability to consistently fatten its bottom line by at least 10-12%. Because they tend to lack the growth he desires, Mairs says he tends to avoid cyclical companies and utilities. Since he doesn’t want to pay too much for stocks, Mairs prefers those whose valuations are no more than double their earnings growth rates.
In order to facilitate research, only about 35 stocks make their way into the $750 million fund. Mairs is willing to own companies of any size, but “the lion’s share of the portfolio has always been” invested in large-caps, he says.
A recent addition to the portfolio is Genl Electric (GE), which Mairs began buying in the spring when it looked like a bargain to him. The stock’s current price-to-earnings ratio of about 13.6 is lower than he’s seen it in a decade, Mairs says.
Some of the conglomerate’s businesses, like its jet aircraft unit, have been hurt by the weak economy, Mairs acknowledges. However, he says he is drawn to the company’s medical products business, which produces diagnostic equipment, because of its high margins and its leadership in the growing industry.
Mairs began investing in drug maker Merck & Co (MRK) in late 2001 and added more shares this year because they seemed inexpensive. The stock is trading for about 14.5 times projected earnings this year, and about 13.5 times earnings expected in 2003, he says. Also, Merck’s research and development efforts are the “most productive” of any of the large pharmaceuticals makers, he says.
Health care stocks like Merck account for about 22% of the fund’s assets, its largest industry holding. Mairs envisions these companies benefitting as populations age worldwide and need more drugs and medical services.
The No. 1 holding in the portfolio is Medtronic, Inc (MDT), which makes medical devices like pacemakers and insulin pumps. Mairs likes Medtronic’s ability to grow internally and externally by introducing its own new products, and through acquisitions. Medtronic’s 17% growth rate is tops among the fund’s stocks, Mairs adds.
Another of the fund’s investments in the sector is Johnson & Johnson (JNJ), which Mairs says has been his best performer in the group so far this year. The stock has dropped about 4.9%, compared to a loss of 32% by the Standard & Poor’s-500 stock index, he notes. Mairs is upbeat about the company because of its diverse product line, which includes consumer products like band aids and baby shampoo.
Banks and financial stocks make up about 18% of the portfolio. Mairs reasons that these companies will grow as incomes increase and people need more investment services.
His largest holding among these businesses is Wells Fargo (WFC). “They have a whole variety of products they can offer to clients,” which gives Wells “probably a more diverse revenue stream than any other banking company in the U.S. today,” Mairs says.
The fund’s second-largest holding, and one of Mairs’s Minneapolis-based favorites, is retailer Target Corp (TGT). Although the chain is smaller than rival Wal-Mart Stores (WMT), its profit margins are “quite comparable” to that company, he says.
When it comes to selling, Mairs will remove a company from the fund if its financial fundamentals start to erode, or the stock becomes too pricey. However, he doesn’t do much wholesale trading. “In a typical year, we will add about two names, and we will also eliminate about two names,” he says.
In the first quarter this year, Mairs completed selling his shares of Weyerhaeuser Co (WY), which he started shedding in late 2001 because the stock had gotten ahead of itself, he says. Despite his distaste for companies whose fortunes depend on the strength of the economy, Mairs said he bought the company, which grows trees for the production of wood and paper products, about two years ago because it was cheap.
Looking at stocks overall, Mairs believes they can rise at least 10% by the end of the year. He bases that on his outlook for the economy, which he thinks can expand by 3%, which “isn’t bad at all.” In addition, he feels valuations right now are “compelling.”
“We would guess that we’re very close to the bottom of the market, and therefore the end of the bear market,” Mairs says.