In a market that could drop even further before it finds a bottom, long-term investing in "old, stodgy stocks" is the best strategy. So says Michael K. Farr, president of investment firm Farr, Miller & Washington. Farr is a practitioner of the GARP (growth at a reasonable price) philosophy of investing and looks for companies with value characteristics and superior earnings growth.
As examples of the "stodgy" stocks he likes, Farr cites Honeywell, PepsiCo, Kimberly-Clark, Pfizer, Dell Computer, Microsoft, Wells Fargo, Citigroup, Capital One, and Berkshire Hathaway.
Farr made these comments as part of an investing chat presented June 20 by BusinessWeek Online on America Online, in replying to questions from the audience and from Jack Dierdorff and Karyn McCormach of BW Online. Following are edited excerpts from this chat. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: Michael, what are you telling your clients in this market?
A: We're telling clients that this sort of market action is normal. The market has been on a downtrend for about 2 1/2 years. It hasn't reversed, it will probably go lower, and yet when you look back over a 10-year period, returns are still averaging about 11% compounded, and we think that the next 10 years will provide the same sort of long-term results (for a different point of view, see BW Online, 6/21/02, "The Stock Market's Next 10 Years").
Q: It seems a lot of boring stocks are running up, even though the averages look dismal. Do you have any easy-to-understand stock picks?
A: I have a lot of stock picks, but I caution investors that my stock picks are for the long term, and the reason I have so many is that the prices are so low. And...the prices could go lower still. In 2012, you'll be very glad to have bought most stocks at 2002 prices.
I think that American Power Conversion (APCC) is a great low-tech way to participate in technology. They make the power strips and redundant power supply for computers and networks. The stock is around 17 times earnings, and earnings are growing at 13% a year. It is a very well-managed company, but it has been under a great deal of pressure because its fortunes are tied to PC sales. As we see capital spending resume in Corporate America, we will see stocks like APCC flourish.
Q: What do you think about Nucor (NUE) as a growth stock? Is it time to get out of technology?
A: If you haven't gotten out of technology, I think that it's probably too late now. While there may be a further downside, the preponderance of the decline, I believe, is behind us. Nucor has always been an interesting company to me. I think that the valuation on the stock is probably pretty good right now, but it is a cyclical company that is beleaguered by regulation and import tariffs. It's not as clearly a long-term core holding as it was several years ago. All that said, if you want to be in that industry, Nucor's a fine way to do it.
Q: Some people are saying it may be time for growth. Are you changing your mix between value and growth?
A: No. I've always been a GARP investor -- growth at a reasonable price. I try to buy companies with value characteristics and superior earnings growth. I think that the [kind of] performance [we've seen from] value stocks over the past 2 1/2 years will probably continue for a while longer. Growth and value are typically countercyclical -- a shift into growth right now could be early, but probably prudent.
Q: What was your biggest dot-com mistake?
A: Not owning them when they went up. I never owned dot-coms because they never had earnings. I was labeled as a curmudgeon when I suggested that anything that went up really fast could go down really fast. Our numbers would have been a lot better if we were allowed to trade in and out of those stocks, but that's not our style. We're a buy-and-hold firm, and companies without earnings don't fit our criteria.
Q: How much downside risk do you think still exists in this crazy market?
A: The only correct answer is: Nobody knows.... But long-term investors need to keep in mind that volatility is unrelenting, and therefore [you should] invest in a defensive enough manner to endure whatever volatility the market throws at your portfolio over the short term. The only sound, sensible, reasonable way my partners and I have found to invest over the years is for the long term.
Q: Do you see inflation in our future? And if so, where should I be in an inflationary market?
A: I think that there will be [cyclical] inflation as this economy rebounds and the enormous amount of liquidity goes to work.... You should be invested in a diversified portfolio that will grow at a reasonable rate, [with] superior to risk-free investments.... If you want to try to invest to benefit from inflation, gold is the standard choice.
Q: Do you have any concern about the declining dollar?
A: I'm not overly concerned. I've been calling for a decline in the dollar for over a year. It makes sense that the dollar is pulling back -- my concern is that it will begin to fall too far, too quickly. A reasonably paced decline could be a very healthy thing, particularly for our trade deficit. But it needs to be orderly.
Q: Michael, you mentioned earlier you want to stick to "old, stodgy stocks." Can you name some of those?
A: Honeywell (HON), PepsiCo (PEP), Kimberly-Clark (KMB), Pfizer (PFE), Dell Computer (DELL), Microsoft (MSFT), Wells Fargo (WFC), Citigroup (C), Capital One (COF), Berkshire Hathaway (BRK). And just so you don't fall asleep, the Scudder Asia Fund (SAF).
Q: You listed the Scudder Asia Fund. Do you think there are better investment plays outside the U.S. now? If so, where, and what stocks?
A: The current economic recovery isn't limited to the U.S. It's a global economic recovery. Asia has been through a severe recession, has a sound, established business infrastructure, and seems to be a prime candidate for recovery. While we may be early, I think that the Scudder Asia Fund, selling at a 14% discount to its net asset value, will be a moneymaker over time. It trades in shares on the NYSE and is therefore rather liquid.
Q: What about consumer stocks? You mentioned PepsiCo.
A: I like consumer stocks -- I think that they're defensive, and they're more comfortable places to be. As the market begins to improve, based on economic strength and resilience, I think that this group will lag as money flows into other sectors. The consumer has kept this economy alive for the last 18 months and has to be getting sort of tired.
Q: What will it take to restore investor confidence?
A: I'm afraid that my answer is going to be somewhat cynical. For investor confidence to be restored, we're going to have to see an increase in share prices so that people will begin to see more money in their investment accounts. The only thing that will change people's minds about how they feel about their investments and about the economy, I believe, will be increasing balances.