Excellence in Fund Management: T. Rowe Price Growth Stock Fund

As of March 31, 2005, the fund’s ten largest holdings comprised Citigroup Inc. (C), 3.26%; Microsoft Corp. (MSFT), 2.95%; General Electric (GE), 2.70%; UnitedHealth Group (UNH), 2.64%; American International Group (AIG), 2.33%; Wal-Mart Stores (WMT), 2.31%; WellPoint Inc. (WLP), 1.80%; Dell Inc. (DELL), 1.75%; Tyco International (TYC), 1.72%; and Danaher Corp. (DHR), 1.62%. The portfolio totalled 117 holdings.

Among the top holdings, Smith especially likes Citigroup for its favorable risk-reward ratio, in addition to an 11%-12% growth rate, 4% yield and strong management team.

Smith unloads stocks from his portfolio when double-digit earnings growth is no longer achievable. Moreover, he sells only when the stock bounces back to a set target price, thereby avoiding major losses. Smith also disposes of stocks when presented with better ideas, absorbing the new holding and shedding his most worrisome stock. During unfavorable market conditions, Smith takes on a more aggressive stance, tilting towards economic growth and risk — buying risk when the market is selling it, and selling it when the market is buying.

However, Smith trades far less often than other large-cap growth managers — his fund has a modest turnover rate of 30.70%, compared with a 87.55% peer group average.

Large-cap growth managers like Smith have been facing some challenges — funds in this category have gotten the cold shoulder from investors as a result of poor performance in the early part of the decade, while value portfolios have outperformed. Indeed, for the five-year period ended April 2005, as the average large-cap growth fund shed 8.43% and the average small-cap growth fund lost 4.16%, small- and large-cap value funds gained 11.99% and 2.97%, respectively.

Smith asserts that one of the major factors impacting the large-cap growth sector in recent years lies with the theory of “multiple compressions.” This occurs when a stock trades at a certain multiple and, while earnings may be strong, the equity price doesn’t move up (or even goes down). As a result, the given P/E multiple is reduced, even though nothing is fundamentally wrong with the company. Compression of a stock’s multiple can be interpreted as investors questioning its valuation. The multiple is based on many factors, but most importantly, the company’s future growth expectations. Generally, investors would only pay higher multiples on prospects that the company will grow significantly faster than its competitors or markets in general. When a company’s growth rate starts to slow, investors might start to doubt its prospects, and not pay an expensive premium.

Looking forward, Smith feels quite bullish about the economies of the U.S. and other developed markets, forecasting expansion for the remainder of the year, although at a slower pace than that of 2004. Economic growth in 2005, he believes, will likely be accompanied by slightly higher inflation and interest rates, resulting in positive, but not spectacular, stock market returns. He particularly expects the consumer discretionary sector to perform well.

*S&P’s methodology for the Excellence in Fund Management Awards is built upon funds that have received a BusinessWeek category ranking of “B+”. The BusinessWeek methodology uses the five-year total return of the Standard & Poor’s 500 Stock Index as the underlying benchmark. Using the BusinessWeek category fund rankings, the top 7.5% of the funds are assigned an “A” score.

Contact Bob Keane with questions or comments at: .