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Think Like an Owner, Not Just a Trader

In what he calls a "desperation market," value is the key for Timothy Vick, senior analyst for Arbor Capital Management and author of How to Invest Like Warren Buffett. He recommends putting stock prices in perspective with a company's historical growth rates.

Above all, Vick suggests that to reap results on a Buffett-like scale, an investor must consider whether the entire company would be worth buying if he or she had the money. For now, he sees Buffett staying out of the market for the most part and accumulating cash for opportunities when stocks bottom.

Vick calls this a time "for sitting in the tall grass and waiting for large-cap companies to run in front of your gun one at a time so you can shoot them dead" when the price is right. Among stocks he sees as worth buying now are semiconductor names such as Altera, Atmel, LSI Logic, and Intel, and restaurant chain Applebee's. He also urges investors not to keep looking for the same stocks they were following in the late 1990s.

These were among the insights offered by Vick as guest in a chat presented June 7 by BusinessWeek Online on America Online. He was responding to questions from the audience and from BW Online's Jack Dierdorff. Following are edited excerpts from the chat -- a full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Tim, do you see any pattern in the stock market's recent ups and downs?

A: I see absolutely no pattern since the Nasdaq posted its bottom 500 points ago. I would classify this as a desperation market. Most managers are so under water from last year's market that they're jumping in and out just to make back the gains they lost. I gave up trying to guess short-term trends in the market years ago, and I certainly won't try to do it in this fickle market.

At the same time, I'm seeing some wonderful values being unlocked from all the selling last year -- yet they're being ignored. If you really want to beat this market, you've got to focus on valuation and not just short-term trends. It's very important to put price in perspective with historical rates of growth and make sure you're not expecting to see rates of growth improve to where they were in 1999.

Q: Why don't you tell us some of the values that you've identified?

A: When I screen for new stock purchases, I look for entitities that can deliver at least a 15% annual return over the next 10 years.... A few months ago, we dipped very heavily into the semiconductor stocks, knowing full well that they could fall on us in the near term. But we also realized that over the next several years, at these reduced prices, we were going to hit home runs with them. We bought, for example, Altera (ALTR), Atmel (ATML), Applied Materials (AMAT), LSI Logic (LSI), Power One (PWER), and a little bit of Intel (INTC).

We have also cherry-picked some cyclical sectors, picking up stocks such as Moody's (MCO), restauranteur Applebee's (APPB), Triad Guaranty (TGIC), and steelmaker Nucor (NUE). We bought Nucor at around $30, which was its cheapest valuation relative to cash flow, sales, and growth rate in more than 18 years. It was a screaming buy, and the low price suggested to us that a new investor could get an approximate 20% annual return on their money.

Q: This is up your alley as author -- how can I invest like Warren Buffett?

A: The first major rule is always picture yourself as the owner, not just a trader, of paper stock certificates. When you see a stock priced at $50, your first instinct should be to multiply the price by the shares outstanding -- let's say 10 million -- and ask yourself whether the whole company is worth $500 million.

Your second question should evolve from the first: If I had $500 million to invest in the company and could be the sole owner, would I buy it?.... Using this method, as Warren Buffett does, price fluctuations, moving averages, and chart patterns will have no place in your life -- period. Generally, when you analyze this way, you make very few mistakes. If you wouldn't want to own the entire company, don't even buy 100 shares of it.

Q: In today's climate of investing, what's the best sector to invest in, or is it purely by individual stocks?

A: At the moment, I would say this is a stock-pickers' market, not a market where you should try to time sector rotation. This is a perfect market for sitting in the tall grass and waiting for large-cap companies to run in front of your gun one at a time so you can shoot them dead. I think an investor should be open-minded and not just look at the same 20 or 30 stocks they have been looking at since the late 1990s.... Don't be afraid to look at beaten-down sectors such as chemicals, building materials, restaurants, real estate investment trusts, or even the textile industry. Generally, if it's unsexy today, it will probably beat the market tomorrow.

Q: Would you buy Ford (F) now?

A: Probably not, though I would look at it more closely at a much lower price. It might seem tempting to buy Ford at about five times trailing earnings and at a price tag [of] around $45 billion. [But] I might look, instead, to some of Ford's suppliers, such as Johnson Controls (JCI) or Superior Industries (SUP).... I'm curious to see how far down Superior's stock falls as a result. If it falls too much, you should be ready to swoop in.

Q: You said we shouldn't cling to the same old stock names -- do you have any new names for us?

A: A few questions ago, I mentioned the stock Power One. We also like Advanced Power Technology (APTI), Diamond Technology Partners (DTPI) [now DiamondCluster International], and Cree (CREE). These are, obviously, more hot-blooded names for hot-blooded investors, but they scored well recently as undervalued technology plays in emerging sectors.

Q: What about the B2B [business-to-business] sector and specifically, VerticalNet (VERT)?

A: No matter which part of the alphabet you want to invest in, you still must make sure the company is sustainable and can start earning money for you pretty quickly. If memory serves me right, VerticalNet is still losing about $1 a share and is expected to lose about 70 cents a share this year. That's not the type of track record that will sustain a rally in the shares. Someone once asked me if I thought VERT was a good growth stock. I guess if you consider cancer to be a growth disease, my answer is yes.

Q: If you could pick two pharmaceutical companies to invest in for the long term, which would you pick?

A: That's a pretty tough question because there are several big-name companies that have very good growth prospects over the next 5 to 10 years. Certainly Merck & Co. (MRK), at a price of about $75, seems fairly priced. I think that Merck could deliver a 13% to 15% annual return on your money, dividends included, over the next 10 years. I think you could get the same types of gains with Pfizer (PFE) and Schering-Plough (SGP) at their current prices.

If you want higher returns with higher risk, you will have to dabble in the off-Broadway drug stocks, such as Elan (ELN), and generic companies, such as Mylan Laboratories (MYL) or Watson Pharmaceuticals (WPI).

Q: What's your strategy for when to sell a stock?

A: My general rule is that you should use the same criteria for selling as you do for buying. For example, if you bought a stock with the expectation of holding it for 20 years, and you're only in year two and nothing about the company has disappointed you, keep holding on. Keep in mind that nearly every stock you sell today will one day trade at a price much higher than the price at which you sell it.

If you think a stock in your portfolio has the potential to keep increasing over time, I would be inclined to hoard it like the king's gold rather than try to time purchases and sales. This means you'll have to swallow some paper losses from time to time, but the long-term end result is usually worth it. If you did not buy it for the long term, and the stock has already given you the gains you intended to get, I think the market has made the decision for you. Another reason to sell would be if the stock is so egregiously priced that the potential rate of return going forward is very low.

Q: What do you think about holding INTC

[Intel] for the next two years?

A: It will be very important to watch Intel because it's such a barometer of the sales growth of many industries. I would be a very cautious buyer at these prices. From all appearances, Intel looks like it will barely make $1 per share this year, meaning that a new buyer is paying 31 times forward earnings. That's a very rich price to pay for a chipmaker in any market, unless you were sure that the situation will turn around immediately.

Q: Tim, can you leave us with five or so stocks you think Buffett would buy today?

A: I think over the next couple of years, you'll be reading about Mr. Buffett buying entire companies and taking them private rather than buying minority stakes in public companies just to get the capital gains. Mr. Buffett is behaving today the same as he did between 1969 and 1974, when he mostly exited the market, folded his investment pool, and cherry-picked a few sure-thing investments along the way.

He's still very leery of purchasing large-cap companies at these inflated prices and is content to build a war chest of cash he will put to use -- one company at a time -- when this market finally bottoms. It would not surprise me, when stocks do bottom, to see him buy, for example, an electric utility or two, a major drug company, a few beaten-down cyclicals such as in the industries I described earlier, and some more financial-services stocks.

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