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Hard Times for Easy Stock Pickings

This is a time to be very selective when choosing stocks, since no sector is a sure thing. That's the judgment of Erick F. Maronak, managing director, director of research, and portfolio manager for NewBridge Partners, who leans heavily on earnings growth in his own stock selections.

And it's a challenge for him to find that earnings growth, he says. Maronak does like a few companies in health care, such as Pfizer, Forest Labs, and Allergan. He also cites AIG, Citigroup, and USA Education in finance. He's fond of the consumer sector's Home Depot and Bed Bath & Beyond, and tech stocks Cisco and Nokia in technology.

Interestingly, he looked at Enron several times but never bought it. The reason: He regarded it as a financial company -- comparable to a Merrill Lynch -- that was trading at a vastly higher price-earnings ratio -- which made him wary. Maronak made these comments in an investing chat presented on Feb.14 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts from this chat follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Erick, here we are back above 10,000 on the Dow -- just barely. Is there enough momentum to keep going up? The other indexes aren't so sure!

A: That question is so difficult to answer. Longer term, the answer, of course, is yes. But the market has been rather ambivalent since the beginning of the year as to how quickly the economy will recover, and therefore how quickly stocks will continue to rise.

Q: Do you think good earnings news, like from Dell today, will be a boost to the market? Or is there still too much nervousness about accounting right now?

A: I don't think good news or bad news from any one company will determine the direction of the market. Of course, at the moment, most investors are reacting out of fear more than anything. However, for every negative earnings report, we do have a few companies that are demonstrating improving fundamentals. Hopefully, investors will distinguish between the two and reward companies that are turning the corner over those that have not yet done so.

Q: Erick, what sectors are good for 2002?

A: There are few sectors that are problem-free. Therefore, our preference is always to focus on companies, more so than sectors. Health care continues to be attractive due to demographics, and the fact that if you get sick, you will most likely fill your prescription. Here again, however, it's critical to focus on companies that have good revenue growth now, a robust pipeline for the future, and minimal patent-expiration exposure.

Our favorite companies within that context would be Pfizer (PFE), Forest Labs (FRX), and Allergan (AGN). Outside of health care, the areas we traditionally focused on, that we believe have good long-term potential, are technology, finance, and a few consumer names.

Q: What are some of the companies that meet your criteria in those sectors?

A: Also in health care, Medtronic (MDT). In finance, American International Group (AIG), Citigroup (C), USA Education (SLM). In the consumer area, Home Depot (HD), Bed Bath & Beyond (BBBY). In technology, Cisco (CSCO) and Nokia (NOK).

Q: What do you think of Cisco stock now? You just mentioned it.

A: The stock has performed better of late, in large part due to the company's improvement over the last two quarters. Key metrics investors are focused on have been their aggressive cost-cutting, reduction of inventory, increase in inventory turnover, and stellar balance sheet (which these days is a considerable competitive advantage). Altogether, this places Cisco in a very strong position to benefit as demand in its end markets improves.

Q: This must have been a rough year for someone who watches earnings closely. How did you cope, Erick?

A: It was a difficult year because it really confirmed what we believe. Earnings growth drives stock prices. Many investors thought last year's disappointments were driven by extended valuations only. However, the biggest problem was that earnings went from some very high levels into negative territory rather abruptly. When that happens, regardless of how quickly stock prices collapse, they still look expensive.

So, as long-term investors, the challenge for us was (and remains) trying to evaluate what the long-term normalized earnings power for the companies in high-growth industries may be over the course of the next two or three years.

Q: What's your long-term outlook for JDS Uniphase (JDSU)?

A: Our long-term outlook is that JDSU will continue to be a leader in optical components, but within the beleaguered telecom industry, its turnaround is not yet imminent. The company gets good marks for resizing itself to reflect the current business environment by shutting plants, laying off a significant amount of employees, and general cost-cutting measures. But there's still not enough demand for the company to return to the rate of growth it enjoyed 12 to 18 months ago.

Q: Erick, have you made a lot of changes in your portfolio since the collapse of Enron (ENRNQ)? Just curious if you have changed the way you pick and sell stocks.

A: We started making changes beforehand, as technology faced a challenging year. We've never owned Enron, although we've looked at it on several occasions. But we could never reconcile the fact that it was a trading company, no different from a Merrill Lynch (MER), Goldman (GS), etc. Yet it traded at 50-times earnings, while those top investment firms traded in the high teens at the best of times.

The changes we did make were based on the usual criteria of a minimum of 15% earnings growth, strong financials, and good management. Last year, we added Forest Labs, First Data (FDC), Allergan, and more recently, USA Education and Bed Bath & Beyond.

Q: Why is the market accepting such high p-es (higher than ever) on Intel (INTC)?

A: I ask myself the same question. We sold Microsoft (MSFT) and Intel some time ago, due to the fact that they were dominant companies in the PC industry, and as a result, their ability to grow faster than the industry, which was slowing down dramatically, would be hindered. Intel recognized this some years ago, as it has tried to make inroads into the communications semiconductor market. Unfortunately, many segments of the communications market are well spoken for by companies such as Qualcomm (QCOM), Texas Instruments (TXN), PMC Sierra (PMCS), and others.

Q: Do you follow Sylvan Learning (SLVN), and what do you think of them going forward?

A: We used to follow Sylvan more closely than we do now. As one of the largest companies in the education sector, we followed them in order to monitor developments in education. The industry has seen quite a number of new companies go public over the last year and a half. One of the negatives for the overall industry is the regulatory aspect. Companies must deal with, in the K-12 market, accreditation and general business conditions for the outsourced-training segment.

Q: Any thoughts on holding GE


A: GE is no more immune from the challenging business environment both here and abroad. However, the company has a stellar record of growth, strong financial management, and in light of all the uncertainty facing many investors, it has what most would like to see in a portfolio right now.

Q: How about energy stocks, Erick? Your thoughts on oil drillers?

A: As growth investors, we tend to avoid the cyclical stocks, but in view of oil prices, which ultimately are a good determining factor for most oil-related companies' stock prices, I would focus on the companies with the lowest cost structure, or a competitive advantage that others cannot duplicate. The closest we've come in the oil industry would be Schlumberger (SLB), due to its ability to have 3D seismic technology help companies find oil in locations once thought to be depleted.

Q: How about WorldCom (WCOM) and Lucent (LU)? Are they buys at their current levels?

A: We've avoided both, even when they were doing well. In the case of Lucent, because we favored Cisco, which we've always thought had better management, better technology, and a greater focus on the fastest-growing parts of telecommunication.

As for WorldCom, it was a growth company that we would invest in early on, when it was known as LDDS. As it grew through acquisition, integrating disparate networks became increasingly difficult. Its growth rate slowed, and its long-distance services declined faster than expected. That ultimately led WorldCom to spin off its long-distance operation [MCI] under the ticker symbol MCIT


Currently, the company is placing a greater focus on its data services. It's trying to improve its financial condition and may be worth a look as its quarters improve. But at the moment, it's probably premature.

Q: Erick, we're out of time. Any final words of wisdom for our audience?

A: Following a very difficult ending to 2000 and an equally disappointing 2001, I think the [Fed's] interest-rate cuts and the restructuring many companies went through last year, combined with $2 trillion in money-market funds, set the stage for much better growth. But I would caution against making generalizations and pure sector bets.

As always, and perhaps even more at this moment, focusing on the right companies will determine whether investors are successful or not. So be patient, pay attention to the fundamentals, and ignore the daily noise. Best of luck to all.

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