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."