Oct. 8, 2003 — When Conrad Herrmann visits a company he invests in, he doesn’t necessarily rack up frequent flier miles.
Herrmann works in California, the state that’s home to the bulk of the holdings of the $1.6-billion Franklin Strategic Srs:Flex Cap Growth Fund/A (FKCGX) that he manages.
About 70% of the companies in his portfolio are headquartered, or have the majority of their operations in the Bear Flag state, Herrmann estimates. The 12-year-old fund, which once had California in its name, was originally intended to leverage the local resources of Franklin Templeton Investments, which gets its mail delivered in San Mateo, he explains.
Having convenient access to people who run the companies he buys, as well as reading area newspapers that follow these businesses, gives Herrmann and his team of stock pickers and analysts a better sense of what’s happening with their investments, Herrmann says.
In competing with funds that have no geographical mandates, Franklin Flex Cap Growth has held its own lately. The fund returned 5.9% in the third quarter, and was up 22.9% this year through September. By comparison, the average mid-cap growth fund gained 22% and 5.4% in those periods. For the ten year period ended in September, the fund returned an average annualized 14.6%, versus 7% for its peers.
“We look at it as being a vast, diverse marketplace,” Herrmann says of California, which standing alone would be the fifth largest economy in the world, he points out. There are about 1,000 publicly traded California companies that meet his investment criteria, he says.
Part of the portfolio is made up of companies with leading or dominant market shares, and that generate high returns on capital, as well as “reasonably consistent and predictable earnings,” Herrmann explains.
Two examples of these types of companies Herrmann cites are Cisco Systems (CSCO), which makes equipment for computer and telecommunications systems, and Seattle-based Expeditors Intl,Wash (EXPD), a logistics company. Both have been in the fund for a number of years. Cisco has 24 stocks ahead of it in the portfolio.
Expeditors, the fund’s seventh-largest holding, said last month that it expects third quarter earnings to lag Wall Street estimates. “But we feel this is just a short-term blip,” Herrmann says. “This is a company that we believe is still well positioned for the future.”
The biggest chunk of the portfolio, which usually includes 65-100 stocks, is made up of temporarily beaten down stocks whose valuations Herrmann thinks can improve.
Small, emerging growth companies, typically in the technology and health care sectors, account for a third portion of the fund, which can buy any size company but which leans towards small to mid-sized ones. Those with market caps of $1 billion to $10 billion generally comprise 40%-60% of the portfolio, according to Herrmann.
A large-cap health care stock the fund bought a stake in last month is Medtronic, Inc (MDT), which makes equipment for treating heart diseases and disorders. The company has made a commitment to fatten its top and bottom lines by 15%, and Herrmann is confident they will. “They have been able to produce very good, consistent, stable growth over time, and I think they will continue to do so,” he says of the company.
The fund’s health care investments also include biotechnology company Amgen Inc (AMGN), its No. 1 stock. The drug maker improved sales by 63% and raised earnings per share 29% in its most recent quarter, Herrmann says. While the company has produced above-average growth over the last few years, its stock trades at about 27 times projected 2004 earnings, which, compared to the market, is “not too far out of line,” Herrmann says.
The manager says the fund has not added Amgen shares over the last few months because they have appreciated.
When it comes to selling, the fund will trim or eliminate an investment if a company’s financial fundamentals weaken or the stock becomes pricey. For example, Herrmann says the team that oversees the fund has been reducing its exposure to electronic auctioneer eBay Inc (EBAY) in recent months because its shares have been trading up.
The stock still ranks fifth in the portfolio, however, and Herrmann says he likes it because he feels it can expand its margins.
The fund manager says he has been finding a lot of the kinds of stocks he likes among financial services companies, such as banks, insurers and brokerage houses. This sector comprises a shade less than 18% of the fund’s assets.
A favorite of his in this group is E Trade Group (ET), which he sees as poised to benefit if the U.S. economy continues to strengthen.
Interviewed days before the recall election in California, Herrmann did not envision the outcome affecting the companies he owns.
As for stocks in general, Herrmann foresees a healthy investment environment through early 2004, thanks to low interest rates and Washington’s efforts to stimulate economic activity. “That provides a backdrop for good stock market appreciation potential,” he says.