Ronald Sloan of AIM Mid-Cap Equity Fund/A (GTAGX) wants to get behind the earnings curve by investing in companies going through some sort of positive change. It could be a new product in the pipeline, or a change of stripes resulting from an acquisition or a divestment -- something that can eventually lead to better returns.
For the one-year period ended in May, the fund rose 11.0%, versus a gain of 1.8% for the average mid-cap blend portfolio. For the three years ended in May, it returned 17.1%, versus 9.0% for its peers. One place Sloan is finding a lot of opportunities now: technology, where he has beefed up his exposure. He currently has about 28% of the fund's assets there. The fund has an S&P 3-Year Overall Rank of 4 stars.
What's in the portfolio? The fund's top holdings include Conseco Inc. (CNC), Apogent (AOT), and Ceridian Corp. (CEN). Sloan thinks corporate spending on technology will start to "reaccelerate" in the second half of the year. Away from tech, Sloan recently added to the fund's position in Adolph Coors (RKY) on a pullback in the share price.
Rick Micchelli of Standard & Poor's FundAdvisor recently spoke with Sloan about the fund's investing strategy and its recent portfolio moves. Edited excerpts from their conversation follow:
Q: How would you describe your philosophy on this fund?
A: We are one off what people usually identify as the normal AIM process or AIM philosophy of earnings momentum. From a value standpoint, you can't buy much if you wait for the earnings to show up. As a result, the value part of the equation has become more important in the blend category, where you have to get ahead of earnings momentum. I love momentum after I own a stock, not before.
Q: What do you look for exactly when choosing stocks and how do you go about constructing the portfolio?
A: The portfolio is built stock by stock. We use some screening techniques but not exclusively. We talk to the Street, and to peers in the industry. I have a feel from a general standpoint of the stocks we might want to take a look at during certain points in an economic cycle.
Q: What kinds of companies are you looking for generally?
A: Companies that are going through some sort of change, in effect. That is one of the keys.
Q: A catalyst of some sort?
A: Yes, this could be a catalyst, or something takes effect more slowly -- a new product that could be large in the scope of things a few years out from now, for instance.
We want something that will help the earnings profile and profitability profile to change. A company might have a history of being profitable several years back and maybe is going through a sinking spell where it isn't as profitable, or has been an underachiever in recent quarters. However, it could be changing its spots through either an acquisition or a divestment that will lead to opportunities for better returns. These are the kinds of things we look for, because that is where the valuation will occur going forward. We generally buy companies that have disappointed for very company-specific reasons.
Q: What other fundamentals would you look at?
A: As with most blend or GAARP [growth at a reasonable price] investors, one of the things you want to focus on is the PEG [p-e to growth] ratio. Is the p-e ratio below what we think the next 12-24 month growth rate is going to be? Obviously, we are looking for accelerating growth.
Q: About how many holdings do you have and what are your top five?
A: We have about 75. The top five as of the end of April are Conseco, Apogent, Ceridian, Orion Power (ORN), and Coors.
Q: Could you single out one and illustrate how it reflects your investment strategy?
A: Each has its own story. Apogent, which sells commodity products to medical and dental laboratories -- such as beakers and glass slides -- is kind of an acquisition story. It used to be called Sybron International and had two divisions. The intrinsic growth rate of the two businesses -- the medical and the dental -- was about 8%. The company got up into double-digit top-line growth though acquisitions. They had the currency to kind of roll up these small competitors and offer a broader product line.
About a year ago, they announced they were going to split the company into two parts and reorganize. The more valuable medical business had a lot more appeal to Wall Street than the dental one. About half of their customers in the medical business are in the biotech, or advanced medical science industry.
The expectation was that they would continue to acquire little companies to offer broader, more interesting products so the growth could be a little faster.
Q: What is your outlook now?
A: It is kind of a steady-eddy company, and we feel very confident in the earnings growth. We feel confident, too, that business is going to be there. As a result, we have been willing to make it a top holding. It hasn't been a star performer, but we don't expect it to be. It kind of fits the profile of what most people think about when they think of a company in a blend or core portfolio.
Q: What about a more recent addition to the portfolio?
A: We just got involved in Advanced Fibre Communications (AFCI). The stock was at about $85 in the first quarter of last year and now it is at about $18. We didn't really have any exposure to the telecom/hardware area. What attracted us to the company was that they have a large share of what they call the digital loop carrier (DLC) business, a necessary product to the telecom carrier industry in the loop around major metropolitan areas. They dominate the DLC business in those "rural" markets or outside metro areas.
A few years ago they jointly financed a venture with Cerent Corp., a chip manufacturer focused on the networking industry. Cerent was acquired by Cisco Systems (CSCO). Cisco paid $5 billion or $6 billion for this private company. Advanced Fiber received some Cisco stock. A collar on the Cisco stock was written for Advanced Fiber. In short, Advanced Fiber was guaranteed at least $65 in their Cisco shares. This is worth about $8-$9 a share to Advanced Fiber, pre tax. They are trying to find a tax advantageous way to liquefy the Cisco share holding right now. The fact of the matter is that a large part of the value of Advanced Fiber is guaranteed.
Q: What do you like about Coors?
A: This is one we have been adding to recently.
The macro environment for beer is probably as good as it has ever been. Pricing power and demographics are the two key items. They have probably never been better in 20 years.
Q: What is your largest sector?
A: The biggest sector we have exposure to is technology. A year ago maybe we had half the weighting in technology than we have now.
In our view, we have to be ahead of visible earnings acceleration to get stocks cheaply. We wanted to take advantage of some of the carnage in technology. In the beginning of the first quarter we have been basically net buyers of technology and net sellers of some of the things that have worked the last few years.
Technology capital spending basically came to dominate all spending and all economic growth at the margin over the last few years. Maybe we are having a little hangover from that in the past nine months, but nonetheless we buy into the fact that technology basically creates its own rejuvenation since the life cycle of most of these products is short. We think technology spending in the corporate world will begin to 'reaccelerate' in the second half of this year.
Q: What else do like in the tech sector?
A: I think you are going to get more growth for the dollar in the component part of technology, as opposed to what I call the black box part. I think there is more growth in semiconductors and semiconductor equipment, which a lot of tech investors view as more cyclical. We have a diversified exposure to semiconductors, including Integrated Device Tech (IDTI), Lattice Semiconductor (LSCC), and Microchip Technology (MCHP). We also own Cirrus Logic (CRUS).
Q: Do you have an overall view of the market and the economy going forward?
A: We have positioned the portfolio for economic growth, because we own sectors such as technology and capital goods and consumer cylicals. I think Greenspan is going to give us economic growth. From Standard & Poor's FundAdvisor