An "All-Cap, All-Core" Strategy

Sarat Sethi of Douglas C. Lane & Associates explains his investment philosophy: We don't believe in style boxes

For all the excitement over its initial public offering, this isn't "an opportune time to invest in Google." That's just one insight from Sarat Sethi, portfolio manager and analyst at Douglas C. Lane & Associates, who warns that Google faces an unknown degree of competition from the likes of Microsoft (MSFT ) and Yahoo! (YHOO ).

Sethi, who seeks out core stocks for a portfolio across a broad range of investing styles and sectors, thinks the coming two years will be telling for Google (GOOG ). Meantime, he's looking for values in energy and in areas benefiting from the weaker dollar, such as paper, steel, and chemicals. Some of the names he cites are Schlumberger (SLB ), Weyerhaeuser (WY ), and Dow Chemical (DOW ).

In technology, Sethi focuses almost exclusively on the wireless area, with companies such as Verizon (VZ ) and Andrew (ANDW ), which is a power in wireless infrastructure. He also likes big pharmaceutical companies -- Bristol-Myers Squibb (BMY ) and Schering-Plough (SGP ) -- as well as the field of medical products, where he names Medtronic (MDT ).

These were a few of the points Sethi made in an investing chat presented Aug. 19 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online Jack Dierdorff and Karyn McCormack. Edited excerpts follow. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: The market has managed to work its way back up over 10,000 on the Dow -- do you see further progress?

A:

I think a good barometer of the market is the S&P 500. The Dow, although it's representative of 30 stocks, can be more volatile than the overall market. But I think that over time, in the next six months to a year, we should be able to see between 5% and 10% appreciation in the market.

Q: What about the uncertainties people cite -- such as terrorism and the election?

A:

Well, I think those are two of the uncertainties that are definitely causing volatility in the market. Additionally, there's the high price of oil, which is also causing investors to be nervous.

I think that over time we should see these concerns dissipate. Terrorism, especially where we're in the middle of the Olympics, the Republican National Convention approaching rapidly in New York, leading into elections in the fall -- these are all on top of people's minds. And as time passes, and hopefully these events pass by without any major disruptions, investors will be a little more calm. I think oil over time will come down...and that could be a positive catalyst for the market.

Q: What makes you believe stocks will be up in the next six months or so?

A:

It depends on the individual stocks and sectors that one is exposed to. Our investments are in areas that we think will benefit from a few macroeconomic factors, such as the weak dollar, increased overseas demand for commodities, and increased industrial production.... Our focus in the last couple of years has been in the commodities and basic-materials area, where we think the weaker dollar has enabled paper, steel, and chemical companies to increase exports and take advantage of the high cost of imports.

Additionally, we feel that investments in the energy area, especially the oil-services area, will prove to be fruitful in the short to medium term as well.

Q: What percentage [of a portfolio] should be core holdings?

A:

That all depends on an individual's risk profile. Core holdings can be defined very differently by different investors. We think of core holdings as those you want to hold for at least three to five years, but we don't really look at it as a percentage of your portfolio but as what stocks we consider as core holdings. And we don't try to own any more than 5% of one stock in a portfolio, no matter how much we like the stock.

Q: Would General Electric (GE ) or Verizon (VZ ) be a core holding?

A:

Yes. Both are core holdings in our portfolio. We're still buying VZ at these levels. We like it for a couple of reasons. Specifically, the company has a close to 4% yield, and when one looks at Verizon, the crown jewel is its 55% ownership of Verizon Wireless. We strongly believe that Verizon Wireless is the strongest wireless player.

GE, we feel, has turned itself around, and basically we consider it as a proxy for the economy.... We feel that GE will perform well in the next few years.... GE also has a good dividend, which they increase over time.

Q: What do you think about Andrew (ANDW ) in wireless communications?

A:

Somebody must have been reading my mind. Our focus on investing in technology is concentrated in the wireless space. We feel that the most amount of value to be created is in wireless, and one of the companies that we really like in this space is Andrew. With revenues of almost $1.8 billion, we think that in the wireless-infrastructure space, which comprises almost 85% of its sales, Andrew has positioned itself very strongly to supply products to the wireless market.

Q: How about biotech?

A:

I think biotech has had a great run over the last couple of years. Companies such as Genentech (DNA ) have done very well, and investors have made a lot of money in this area. Our view in biotech is to stay with the winners and those who have very strong balance sheets. And while we reaped some good rewards from our investments in Genentech, we think that the biotech area in general is pretty fairly valued. Our investments in the health-care area are focused more toward Big Pharma, which we think is pretty cheap, and medical-product companies.

Q: In medical-product companies, which ones do you like?

A:

We like Medtronic (MDT ). MDT is the leading medical-device maker in areas such as defibrillators, pacemakers, and areas such as diabetes and spinal. The company has dominant market positions in almost every business in which it participates. And over the last 10 years, it has consistently grown its earnings in the double-digit area.

Another stock we like -- however, this isn't for [investors] who are risk-averse -- is Boston Scientific (BSX ). This stock has been in the news due to its stent product recalls, and we think that as long as there are no further Food & Drug Administration actions and recalls, Boston Scientific's stents are significantly better than their competitors'. And we feel that this is a good time to put some money into this company and take advantage of its low valuation. However, I do need to stress that this is a deep value play.

Q: And in Big Pharma?

A:

Big Pharma over the last couple of years has really not performed well. The overhang of potential legislation from Congress, as well as really a lack of product pipeline, has compressed the multiples of this sector quite significantly. However, we feel that the time to invest in some of these companies is when they're out of favor and when investor expectations are quite low.... So currently we're adding to positions in Bristol-Myers Squibb (BMY ) and Schering Plough (SGP ).

Q: Are homeland-security stocks a good place to be?

A:

We've been invested in the defense area and have benefited from increased spending. One of the stocks we like in this sector is L3 Communications (LLL ). L3 focuses on sophisticated avionics, where they are a subcontractor for the major defense companies. One of the ways to play homeland security is via L3 because they also make the equipment that X-rays baggage at airports.

Q: You like commodities, basic materials, and energy -- what stocks does that lead you to?

A:

We like companies such as Dow Chemical (DOW ). Dow is one of the leaders in the chemical business.... With a dividend of almost 4%, a strong balance sheet, and a below-market multiple, we feel that investment in Dow at these current prices will prove to be a good investment over time.

We also like Weyerhaeuser (WY ). WY is one of the leading companies in the paper and forest-product space. As demand for its products has increased, we're confident that the company will benefit from the current upturn of demand and pricing, and thus we feel that this company will generate good returns over the next couple of years.

In the energy sector, we're increasing our exposure to the oil-services companies. Over the last few years, as oil prices have remained high, many of the integrated oil companies, as well as the independent energy companies, have accumulated large amounts of cash and have not spent a lot of money on exploration for new energy sources. As a result, the oil-services companies over the next few years will be the primary beneficiaries of increased expenditures in the oil patch. And companies that we think will benefit are Schlumberger (SLB ) and Patterson UTI Energy (PTEN ), as well as Baker Hughes (BHI ).

Q: Sarat, what's your view on the subject of much market talk today -- the IPO for Google (GOOG )? Could that become a core holding?

A:

I think at this point it's way too early to judge whether Google is a core holding. The next couple of years will be extremely telling for the future of Google. When one looks at its main competitors, companies such as Microsoft (MSFT ) and Yahoo (YHOO ) come to mind. These are companies that are spending huge amounts of capital to compete with Google and aren't new to this industry. As time will tell, we think that this industry is going to become extremely competitive, and at this point we don't consider this as an opportune time to invest in Google.

Q: How would you define your investing style, Sarat?

A:

We're all-cap, all-core investors where we basically benchmark ourselves against the S&P. Our portfolios contain 50 to 60 stocks that are diversified across a broad range of sectors where we feel our clients will get the most benefit. Whereas some investment managers fit one style, we don't believe in style boxes. Rather, we believe that investing across sectors and styles is the best way to produce returns.

Edited by Jack Dierdorff

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