Stocks in a Slump Look Who's Buying

By Tomoeh Murakami Tse
Washington Post Staff Writer
Sunday, February 24, 2008; Page F01

While many shareholders have fled the stock market recently, some big-name investors have been buying big-time.

These savvy investors are sifting through the wreckage of financial and consumer stocks, housing shares and battered tech companies to find what they believe are future market darlings, quietly amassing stakes in names as diverse as Kraft Foods, Wells Fargo and J.C. Penney.

The billionaire investor Warren E. Buffett, for example, this month disclosed ownership of 132 million shares of Kraft. That amounts to an 8.6 percent stake in the maker of Ritz crackers, Philadelphia cream cheese and Maxwell House coffee. Nicknamed the Oracle of Omaha for his investing savoir faire, Buffett also took a stake in drugmaker GlaxoSmithKline and raised his bets on Johnson & Johnson, the health-care products manufacturer; U.S. Bancorp; and Wells Fargo.

Bill Miller, a money manager at Legg Mason known for his 15-year winning streak against the Standard & Poor's 500-stock index that ended in 2006, revealed this month that he scooped up J.C. Penney stock in the last three months of 2007 as shares of the department store fell by nearly a third.

The chosen targets are not just domestic companies. Undeterred by market turmoil that has turned global, some investing pros are picking up beaten-down international companies that others wouldn't go near.

"One thing you can say about events like this is, sometimes the baby gets thrown out with the bathwater," said Ray Mills, portfolio manager of the International Growth and Income fund at T. Rowe Price. He recently took a stake in Munich Re, a German reinsurer, and increased his position in Allied Irish Bank, among other names.

So what gives? What do these buyers see that the rest of us don't?

Those who follow Buffett say his recent purchases follow his simple investing style: Bet on good management and businesses you can understand and analyze, priced at a level that leaves room for future growth.

"He bought Kraft because they make dozens of products that are likely to continue to be in demand," said Frank Betz of Carret Zane Capital Management, which does not own Kraft stock but has shares of Wells Fargo. Betz said Buffett has had a large position in Wells Fargo for years. "But he's increased it significantly because almost all of the major financials and banks have been hammered down because of the so-called subprime crisis. . . . Insofar as we know, Wells Fargo was not a major player in subprime underwriting or investing."

Robert Millen, chairman and portfolio manager of Jensen Investment Management, puts it more bluntly.

"Wells Fargo -- that's one we feel is significantly undervalued in the market today. We think the market has taken its price down way too far," said Millen, adding that his firm had enhanced its position in Wells Fargo for much of the latter half of 2007.

The way Millen sees it, Wells Fargo has competitive advantages: a conservative credit culture, solid management, locations in fast-growing areas of the country and the ability to sell more services to existing customers. Furthermore, he noted, the company is well positioned to weather the ups and downs of interest rate cycles, with a large portion of its revenue generated by fee income as opposed to underwriting.


But some money managers and analysts have a more tempered view of the prospects for Buffett's choices. In the case of Kraft, they cite inflationary worries, noting that commodity prices have risen and that the company would probably see an even greater rate of cost increases in the year ahead.

Buffett, a director of The Washington Post Co., was not available for comment.

And while Wells Fargo and U.S. Bancorp are safe bets, they're probably not the names you want to own if you're trying to maximize return from banks over the next few years, said Wendell Perkins, chief investment officer of Optique Capital Management.

Instead, Perkins has turned to another bank in recent months: BB&T, a retail and commercial bank based in Winston-Salem, N.C. The stock is off 23 percent from its 52-week high and trading at roughly 11 times its earning estimates for 2008. (Wells Fargo is off 17 percent from its 12-month high, and U.S. Bancorp is off 11 percent.)

BB&T doesn't have "a big presence in the Florida market or Texas market," Perkins said. "They're not in the Rust Belt, which also is challenged. They're sitting in a real sweet spot: the Carolinas, Georgia, areas of the country that have been much more stable."

Perkins said he does concur with Buffett on GlaxoSmithKline.

"You're dealing with a world-class pharmaceutical that has a wonderful breadth of resources, a great reputation, a super drug pipeline long-term," he said.

Perkins, who owns the stock, said it has been hit mainly because of disappointments surrounding Avandia, the diabetes drug that hurt the company last year after a report of increased cardiovascular risks.

Others said there were larger issues, including competition from generic drugs and a new White House administration that could be tougher on pharmaceutical companies.

"Big pharma stocks' valuations are very attractive, but they face some significant headwinds," said Mills of T. Rowe Price. "Glaxo is not my favorite position in the portfolio. It hasn't been a success story for us. It's cheap enough that it's reflecting a lot of the bad news, and obviously, I think it's worth hanging on to."

In the meantime, Mills is putting new money into select financial stocks and other areas while shedding some names in the sector.

Financials present some excellent opportunities, Mills said. "But you have to be careful, because the market has gone down for a reason, especially in the financial sector."

And so, last fall, he started buying shares of Munich Re. By the end of the year, he had accumulated $25 million in shares. He thinks the management has a reasonably conservative philosophy and he likes that the company is returning capital to shareholders through dividend increases and share buybacks. "It's a good sign that they feel the business is healthy," he said.

The fund also added to its position in Allied Irish Bank, a stock he said is more diversified than is commonly recognized in the market. Although housing prices in Ireland have come down, only 6 percent of the bank's revenue is tied to Irish mortgages, Mills said.

At the same time, his fund shed its stake in UBS, which has announced billions of dollars in write-downs related to subprime mortgages.

Going against the tide, Mills's fund also took a $14 million position in Sumco of Japan, which makes silicon wafers from which semiconductor chips are made. While some investors are worried about falling prices and a slowdown in U.S. consumer spending that could hurt demand, Mills said that there aren't many quality players in the industry niche and that the stock is trading at "almost ridiculous valuation with a single-digit" price-to-earnings ratio.

"This is a name that at some point is going to be off to the races," he said. "We don't pretend to be able to time the bottom perfectly -- no one can do that -- but when you see a really compelling valuation on a reasonably high-quality company that has a good industry niche like Sumco, that's something we like to buy."

While weak consumer spending has kept investors away from clothing stores, leisure-equipment companies and luxury retailers, Legg Mason's Miller is one man boldly striding into consumer stocks. Legg Mason Capital Management, an investment subsidiary run by Miller, held 4.6 percent of J.C. Penney, with 10.2 million shares, as of the end of last year.

Through a spokesman, Miller declined to comment but said in a recent note that consumer stocks may "have seen their worst days" now that the Federal Reserve had begun to cut interest rates aggressively.

"I think the market is in for a period of what the Greeks refer to as enantiodromia, the tendency of things to swing to the other side," Miller said, noting that the poorest-performing parts of the market, including housing, financials and the consumer sector, were at valuation levels unseen since late 1990 and early 1991, an "exceptionally propitious time to have bought them."

Perkins said his firm also took a look at J.C. Penney but ended up passing. His bet is on a competitor, Kohl's, which he started buying in January, in part because he likes that the department store chain has more free-standing property outside of struggling malls.

J.C. Penney has dramatically increased its operating margins in the past five years, and Perkins said that it was hard to see it improving substantially more but that the stock was indeed "depressed and cheap."

Some analysts see a case for buying J.C. Penney. Writing in a note to investors on Thursday -- the same day J.C. Penney reported a 9.9 percent drop in quarterly profit on weak consumer spending -- Citigroup analyst Deborah Weinswig said she was impressed by the progress the company had made in clearing excess inventory. She also made note of American Living, a new lifestyle brand designed by Global Brand Concepts, a division of Polo Ralph Lauren, whose launch is the biggest in the department store's history and "should potentially bring new customers into the stores."

She reiterated her "buy" rating, saying she thought that recession and other concerns were already reflected in the price and that the stock is "poised for appreciation based on . . . solid fundamentals."

USA's Next Top Growth Stock

Growth stocks are the beauties of the stock world, plain and simple. They're exciting, they have good stories, and they can make you a lot of money. Apple's (Nasdaq: AAPL) stock may have taken a hit with the rest of the market, but its iPod-fueled profit growth has left investors with huge gains over the past five years.

But for all their beauty, growth stocks are also the prima donnas of the market. They can be erratic, they don't always live up to their billing, and they tend to attract a shareholder base that's ready and willing to run at the first signs of a slowdown. For those reasons, caution is certainly in order when you enter the world of growth investing.

Fortunately, The Motley Fool's CAPS service brings us the collective intelligence of a community of more than 120,000 investors, and it’s a great resource for separating the Jessica Albas from the Jabba the Hutts. Each of the stocks competing for this week's top spot has a market cap of at least $100 million and grew its net profit by at least 20% over the past year. So let's go ahead and meet our contestants.

Symantec
There are a lot of choices for consumers and businesses when it comes to data security, but with its Norton suite of products, Symantec (Nasdaq: SYMC) remains one of the granddaddies of the data-security market. Today, Symantec addresses not only security, but also the rapidly growing area of data storage. For the third quarter, 7% year-over-year revenue growth and improved margins led to non-GAAP earnings-per-share growth of 28%.

Steel Dynamics
Steel Dynamics (Nasdaq: STLD) is one of the largest steel producers and scrap processors in the U.S. The huge global demand for steel helped propel Steel Dynamics' results -- and stock price -- over the past few years. More recently, the stock has come back hard on economic concerns, and the third quarter showed some signs of slowing. But earnings per share over the last 12 months are up an impressive 61% from the prior year.

Range Resources
With a focus on oil and gas exploration -- especially gas -- Range Resources (NYSE: RRC) has been on both the profitable and the painful end of the wild ride in energy prices. By expanding production in an environment of rising energy prices, Range saw its stock skyrocket along with its profits. Energy prices have fallen well off their highs, but Range still managed to grow production and net income in the third quarter. On an adjusted basis, net income for the quarter was up 24% from the prior year.

Occidental Petroleum
Sticking with the oil and gas theme, Occidental (NYSE: OXY) is an oil and gas company with operations around the world. The company also has a subsidiary that manufactures and markets chemicals and vinyls such as chlorine, caustic soda, and PVC. As with Range, the fate of oil and gas prices has had a huge impact on the company's stock, but for now at least, results continue to be impressive. For the recently announced third quarter, net income jumped 72% over the prior year on higher prices, higher production, and lower exploration costs.

CA
Software giant CA (NYSE: CA) hopes that it has not only left behind its former name, "Computer Associates," but also the controversy it faced while operating under that moniker. Former CEO Sanjay Kumar is now gone, and new CEO John Swainson hopes to continue getting the company back on track and able to measure up with formidable competitors like IBM (NYSE: IBM) and Symantec. Based on the most recent quarter's 28% year-over-year non-GAAP earnings-per-share growth, it looks like things may be moving in the right direction.

The envelope, please ...
Symantec and CA may be showing rising results, but CAPS members are far from won over on either stock. Both stocks are rated just two stars out of five, and the opinions of many CAPS players range from lukewarm to downright hostile. Range Resources hasn't been the subject of quite so much ire on CAPS, but its three-star rating does keep it off the top of our list.

Steel Dynamics, on the other hand, makes our short list with its four-star rating. Though the global demand for steel is cooling, CAPS members think that the company's scrap operations, the stock's low valuation, and the healthy dividend make the stock a worthwhile choice.

But the four stars for Steel Dynamics couldn't top the perfect five stars that CAPS members have given Occidental Petroleum. Of the nearly 1,200 CAPS members that have rated Occidental, 1,150 of them have rated it an outperformer. CAPS members have been drawn to Occidental's valuation and dividend, as well as the longer-term prospects for oil. Back at the end of September, DemonDoug, one of CAPS' top players, chimed in with:

[Occidental is a] solid oil company, beaten up by the rest of the market (16%!!!), didn't actually get to it's 52 week low but got close, will continue to be making money in the near and long term future.

Mutual Funds 101

The brain-child of Wall Street, mutual funds are perhaps the easiest and least stressful way to invest in the market. In fact, more new money has been introduced into funds during the past few years than at any time in history. Before you jump into the pool and select a mutual fund in which to invest, you should know exactly what they are and how they work.

What is a mutual fund?

Put simply, a mutual fund is a pool of money provided by individual investors, companies, and other organizations. A fund manager is hired to invest the cash the investors have contributed. The goal of the manager depends upon the type of fund; a fixed-income fund manager, for example, would strive to provide the highest yield at the lowest risk. A long-term growth manager, on the other hand, should attempt to beat the Dow Jones Industrial Average or the S&P 500 in a fiscal year (very few funds actually achieve this; to find out why, read Index Funds - The Dumb Money Almost Always Wins).

Closed vs. Open-Ended Funds, Load vs. No-Load

Mutual funds are divided along four lines: closed-end and open-ended funds; the latter is subdivided into load and no load.

• Closed-End Funds
  This type of fund has a set number of shares issued to the public through an initial public offering. These shares trade on the open market; this, combined with the fact that a closed-end fund does not redeem or issue new shares like a normal mutual fund, subjects the fund shares to the laws of supply and demand. As a result, shares of closed-end funds normally trade at a discount to net asset value.

• Open-End Funds
  A majority of mutual funds are open-ended. In simple terms, this means that the fund does not have a set number of shares. Instead, the fund will issue new shares to an investor based upon the current net asset value and redeem the shares when the investor decides to sell. Open-end funds always reflect the net asset value of the fund's underlying investments because shares are created and destroyed as necessary.

  Load vs. No Load
  A load, in mutual fund speak, is a sales commission. If a fund charges a load, the investor will pay the sales commission on top of the net asset value of the fund’s shares. No load funds tend to generate higher returns for investors due to the lower expenses associated with ownership.

What are the benefits of investing through a mutual fund?

Mutual funds are actively managed by a professional money manager who constantly monitors the stocks and bonds in the fund's portfolio. Because this is his or her primary occupation, they can devote considerably more time to selecting investments than an individual investor. This provides the peace of mind that comes with informed investing without the stress of analyzing financial statements or calculating financial ratios.

How do I select a fund that's right for me?

Every fund has a particular investing strategy, style or purpose; some, for instance, invest only in blue chip companies. Others invest in start-up businesses or specific sectors. Finding a mutual fund that fits your investment criteria and style is absolutely vital; if you don't know anything about biotechnology, you have no business investing in a biotech fund. You must know and understand your investment.

After you’ve settled upon a type of fund, turn to Morningstar or Standard and Poors (S&P). Both of these companies issue fund rankings based on past record. You must take these rankings with a grain of salt. Past success is no indication of the future, especially if the fund manager has recently changed.

How do I begin investing in a fund?

If you already have a brokerage account, you can purchase mutual fund shares as you would a share of stock. If you don't, you can visit the fund's web page or call them and request information and an application. Most funds have a minimum initial investment which can vary from $25 - $100,000+ with most in the $1,000 - $5,000 range (the minimum initial investment may be substantially lowered or waived altogether if the investment is for a retirement account such as a 401k, traditional IRA or Roth IRA, and / or the investor agrees to automatic, reoccurring deductions from a checking or savings account to invest in the fund.

The importance of dollar-cost averaging

The dollar-cost averaging strategy is just as applicable to mutual funds as it is to common stock. Establishing such a plan can substantially reduce your long-term market risk and result in a higher net worth over a period of ten years or more.

Exxon Mobil Has New Record Profit

Exxon Mobil (XOM Quote - Cramer on XOM - Stock Picks) said Thursday that its third-quarter profit soared 58% from a year ago and reached nearly $15 billion, beating its previous record for the highest quarterly earnings from a U.S. company.

The oil and gas giant earned $14.83 billion, or $2.86 a share, in the latest quarter, up from $9.41 billion and $1.70 a share a year earlier. Excluding items, Exxon Mobil earned $2.59 in the most recent period. Analysts were looking for $2.38.

Revenue jumped to $137.7 billion from $102.3 billion last year. Production decreased 8% from the third quarter of 2007.

Exxon Mobil's results arrived on the same day Royal Dutch Shell (RDS.A Quote - Cramer on RDS.A - Stock Picks) said its own third-quarter earnings climbed 22% to $8.5 billion.

Chevron (CVX Quote - Cramer on CVX - Stock Picks), like Exxon Mobil a component of the Dow Jones Industrial Average, will post its numbers Friday.

Shares of Exxon Mobil were recently down 2.9% to $72.51.

U.S. Stocks Ease Off Their Early Highs

Stocks in the U.S. edged off their opening highs but were staying positive Thursday morning, as a decline in third-quarter GDP was narrower than expected and companies issued a heap of quarterly earnings statements.

The Dow Jones Industrial Average was up 69 points to 9060, and the S&P 500 added 11 points to 941. TheNasdaq jumped 20 points to 1678.

Ahead of Thursday's session, the Department of Commerce reported that GDP contracted 0.3% in the third quarter, providing a strong indication that the U.S. has entered a recession. The decline was narrower than expected by economists but down from growth of 2.8% in the second quarter.

"If you'd been wondering if there was recession, this kind of brings it home," said Phil Dow, director of equity strategy at RBC Dain Rauscher. He said that a recession normally has been ongoing by the time the government says there is one, and that he thinks going forward the U.S. will see a two-quarter recession followed by modest growth.

"We shouldn't look for perfection in these estimates," said Dow. "It's pretty easy to get in a black mood and think that this is going to extend forever."

As for the GDP number's impact on stocks, "Normally you have the stock market recover even when it's cloudy," said Dow, and he said the market feels like it's close to an interesting bottom in pricing.

Steven Wieting, economist at Citigroup, wrote in an email that consumer spending for the third quarter dropped 3.1%, the biggest drop since 1980. Declines in production and employment, coupled with tight credit markets and wealth destruction indicate that GDP may decline more than 3% for the fourth quarter, he wrote.

Are Stock Prices Fair?

One of the great ad slogans of many years ago was, "When was the last time you lost an argument quoting The New York Times?" But David Leonhardt had a column in Wednesday's edition of the Times that I am going to dare to take exception to.

"Are stocks the bargains you think?" was the header. In the text, he mentions that the ratio of stock prices to earnings is slightly below the long-term average, but that there have been times of much lower valuations. That is absolutely true, but with a caveat. The trailing price-to-earnings ratio has averaged about 16 times for a long time, but Leonhardt points out that in 1982 it was 7, and roughly the same in the 1970s debacle. But -- and it's a big "but" -- the yield on the 10-year Treasury bond was much higher in both instances. In 1982, the 10-year yield reached 14.6% and the 1974 stock market bottom saw a 8.5% yield. The 10-year is about 3.6% today. You can't look at the one without the other.

The current value of today's market when compared with the alternate investment option of the fixed-income market makes me believe stock prices are fair. They're fair assuming that earnings bottom in 2009. If we have entered a period of deep recession and a very long laborious recovery, then the sideline is the place to be.

We have been using a very low estimate for 2009 per-share earnings for the S&P 500. Our back-of-the-envelope calculation led us to a $60-to-$65 number. The consensus among analysts a few weeks ago before the extent of the current crisis became obvious was well over $90. We guessed that the consensus would have to come down and stocks at best struggle when estimates are falling. Citigroup's economist reportedly lowered his estimate for 2009 to $64 on Wednesday. We need to see more of that in the weeks ahead before we can possibly hope to get positive surprises in the months ahead.

The big question is how deep and long will the recession be. My guess is that it will not be as deep as could be imagined because of the flood of liquidity unleashed upon the markets. The length could be stubbornly long as consumers retool their balance sheets and raise their savings rates.

I am hopeful that earnings will bottom in 2009. If that proves right, the current market value of 930 on the S&P divided by a $64 estimate for a P/E ratio of 14.5, against a 3.8% 10-year bond, is investable.