Stocks are still the place to be for the long haul, says Timothy Vick, senior vice-president of the Sanibel Captiva Trust Co., despite recent issues such as high oil prices and terrorist attacks. A long-time practitioner of the methods taught by Benjamin Graham and Warren Buffett, Vick thinks that as long as the economy continues to have strong legs and earnings rise, stock prices will keep pace.
The money manager has modified the Buffett-Graham approach to target long-term growth companies that are trading at attractive values. Instead of "cheap-value plays," Vick prefers to focus on growth at the right price. Companies that fit this bill that he has recently purchased include eBay (EBAY ), Chico's FAS (CHS ), UPS (UPS ), First Data (FDC ), Washington Mutual (WM ), and Wal-Mart (WMT ).
FAMILIARITY BREEDS CONTENT.
Among smaller-cap names, he likes VeriSign (VRSN ), Affiliated Computer Systems (ACS ), and Mercury Interactive (MERQ ).
These were a few highlights of an investing chat with Vick presented July 28 by BusinessWeek Online on America Online, in response to questions from the audience and from Karyn McCormack of BW Online. Edited excerpts from this chat follow. AOL subscribers can find a full transcript at aol.businessweek.com/chat.
Q: Tim, the stock market finished on a strong note today, as investors cheered earnings news. What's your outlook for stocks at this juncture?
A:We think that a lot of the uncertainty that has been facing investors the past several months has been slowly evaporating. The market is getting used to oil at $60 a barrel, getting used to periodic terrorist attacks in the Middle East, and getting used to conflicting economic signals.
Beyond that, we see, so far, unexpectedly good growth on the part of a lot of companies that have reported earnings. This should be a good catalyst, propelling the market upward in the second half of the year. As long as earnings continue to rise at current rates and we can sustain economic growth in the 3% range, the stock market has to keep pace.
Q: Update us on your investing strategy -- are you still practicing the teachings of Benjamin Graham and Warren Buffett?
A:Absolutely. I think any long-term investor needs a good educational grounding in the methods of Graham and Buffett. It can't help but make you a better investor. At Sanibel Captiva Trust, we've modified the Buffett-Graham approach to target long-term growth companies that are trading at attractive values. We don't necessarily chase the traditional value stocks that trade at single-digit price-earnings ratios.
First and foremost, we study companies looking for the best and brightest in each industry. Then we measure how fast these companies can grow and whether or not the present price can deliver a suitable return for our clients.
In a market like this, there are many types of cheap-value plays out there that anybody can make money on. But we prefer to focus on growth, foremost, while making sure that the price we're paying for growth can deliver a return that can exceed the S&P 500-stock index. We think the S&P 500 can deliver returns between 5% and 7% a year over the next decade. (Given that, we are always on the prowl for longer-term investments that can get us returns in the 10-15% range.)
From time to time, we will sprinkle in some shorter-term value plays if we think the fundamentals are strong and the market has mispriced the security egregiously. But we're not finding too many of the traditional Graham-Buffett plays right now.
Q: What are the stocks that you're buying or holding right now? (Top holdings?)
A:Lately, we've been picking up a lot of mid-cap and large-cap companies that show good growth prospects but that have recently been beaten up to good values. For example, and this may surprise a lot of value investors, we were buying eBay (EBAY ) at around $31. We were also buying the apparel retailer Chico's FAS (CHS ) in the low $30s.
We have also picked up shares of UPS (UPS ) under $70; we averaged down on Harley-Davidson (HDI ) when it sunk into the mid-$40's, and we've been taking positions in more traditional, established, growing companies such as First Data (FDC ), Washington Mutual (WM ), and even Wal-Mart (WMT ).
In the small-cap sector, we like VeriSign (VRSN ), Affiliated Computer Systems (ACS ), and Mercury Interactive (MERQ ).
Q: What would Buffett say about Google (GOOG ) today and in the future?
A:First of all, from Mr. Buffett's perspective, there's no way it can pass the "moat" test. I don't think any of us here can close our eyes and imagine what kind of company Google is going to be in 5 or 10 years. We don't know, still, how competitive the market is going to be for its services, and whether companies like Microsoft (MSFT ) might one day muscle them out of business.
Keep in mind that while Google sounds very sexy to the lay investor, it is still essentially a new-era model of an old telephone book. At some point, companies like this experience mature growth and start generating a lot of cash flow. Only then can you really value the stocks in the marketplace.
I took a look at Google when it came public and determined the company was not worth the offering price. Since then, the stock has nearly quadrupled, although there has not been a concurrent growth in the intrinsic value of the company. Momentum players might make more money on it in the near term, but the company is going to have to generate significantly more sales and earnings to make it worth the present price of $294.
Needless to say, we didn't buy Google, and we are crying into our finance textbooks.
Q: Would he invest in China stocks?
A:He already has. If you recall, he took a sizable interest in PetroChina (PCCYF.PK ) in 2003, back when the company was trading for around $21 per share. He has more than quadrupled his money in that investment in a couple of years.
I don't think Mr. Buffett necessarily bought the company because it's located in China, however. That country is still fraught with economic, political, and corruption risks. What Mr. Buffett saw was a huge oil conglomerate being valued at about five times its earnings, perhaps six times its cash flow, throwing off a 6% dividend yield in a market where oil prices were still only $21 a barrel. He hit the proverbial Chinese home run.
This gets to the point that Mr. Buffett is starting to scour more of the world in trying to find values that can add to the share price of Berkshire Hathaway. In the future, it would not surprise me to see him take multibillion-dollar positions in foreign companies, especially if he can latch onto companies with economic moats.
Q: Anheuser-Busch (BUD ) -- what do you think? What about Coca-Cola (KO )?
A:Mr. Buffett's recent purchase of BUD was interesting to me. Yes, Busch has that moat quality that he covets. But by his own admission, it was not a springing bargain. The beer and beverage market is very mature now, and many of these established companies, such as Busch and Coca-Cola, are going to be lucky to get unit volume growth above 3% per year.
If we ignore the recent sluggishness in the beer and beverage markets, however, I think we will have general, long-standing rebounds in both stocks. These companies could go from 3% growth to 10%. Given valuation levels, however, new buyers of Busch could probably get a total return averaging about 10-11% a year going forward. The same would go for Coca-Cola. These aren't exactly fat pitches for Mr. Buffett, but Anheuser-Busch can beat the S&P 500 over the next decade, due mostly to the price to which it has fallen.
Q: What trend does he see as having the greatest impact on stocks in the next six months?
A:Mr. Buffett doesn't really play short-term trends, and neither do we. Based on the bets he has made, we can infer that he believes the U.S. dollar will start falling again and that the falling dollar will likely start propping up interest rates in the U.S.
We don't see Mr. Buffett playing many other trends at the moment. The reason for that is valuations -- pure and simple. There are not many asset classes right now that have the ability to deliver long-term double-digit returns. That goes for equities, bonds, foreign stocks, commodities, energy, precious metals, and certainly real estate.
My colleague, Dick Pyle (he is our CIO), and I have had long discussions about the relative return potential of many asset classes. We've come to the conclusion that while the equity market has not produced the returns that it did in the 1990s, it still has the potential to beat every other asset class. That's if you're patient and choose the right companies at the right price and are willing to ride out economic fluctuations.
Q: Are there trends in the economy that you see as profitable?
A:Yes. For one, the economy still has very strong legs, is capable of growing at 3% rates, and is capable of providing an environment that allows many sectors to grow at 10% rates or above.
Really, the question comes down to, what sectors can beat the growth rate of the economy? Certainly, we feel that business services can grow at strong rates, which is the reason we like companies such as Verisign, Oracle (ORCL ), Affiliated Computer, Paychex (PAYX ), UPS, and Cisco Systems (CSCO ).
We also think that the financial-services sector can continue to provide long-term growth rates in the high single digits. Couple that with dividend yields averaging between 2% and 5%, and there is the potential for total returns between 10% and 15% in some financials.
Q: Is Mr. Buffett still investing in insurance stocks?
A:The last significant insurance purchase he made was White Mountains Insurance Group (WTM ), which I believe he bought about four or five years ago. His cost basis was just above $200 per share, so he has made significant money there. If Mr. Buffett could get his hands on a float-generating insurance company with a long track record of prudent underwriting, and could get it at a very captivating price, I think he would add it to his stable of insurance companies.
Right now, many insurance companies are in the throes of accounting and regulatory problems, which is adding to uncertainty when you value these companies. Once these storms blow over, and I'm pretty confident they will, we will be able to separate the wheat from the chaff again and determine if true values really exist.
I've got to admit, we've stuck behind American International Group (AIG ) as a long-term investment, even when the stock hit $50 recently. Mr. Buffett, too, has endorsed AIG's business model, and doesn't believe that the mini-scandal that hit the Greenberg family would cause long-term problems with the business model.
Q: I have some shares of Berkshire Hathaway (BRK.B ). They have been losing value. What would be a good price to buy Berkshire Hathaway A shares (BRK.A )?
A:I would say be patient with your BRK shares. I think the market is waiting for Mr. Buffett to make more acquisitions and to start deploying his cash hoard. There's evidence in the market that investors are impatient with companies sitting on a lot of cash. Look at Microsoft and the fact that they're languishing around $25. Without investing this money, it will be difficult for BRK to grow its book value.
You've got to have faith that Mr. Buffett, as your partner, is constantly scouring the globe looking for good ideas for you. On the other hand, he certainly does not want to make a losing bet on your behalf. When the dust settles in the market and we see some good valuations, he'll put that money to work on high rates of return.
Until that time, Berkshire Hathaway should still be able to grow by virtue of the cyclical rebound of his operating companies, plus the fact that his insurance companies are showing good combined ratios and are getting a better environment for investing their float. Again, stick it out, because Mr. Buffett, I believe, won't make any mistakes on your behalf.
Q: I own Cisco, Intel, and Microsoft. Would you sell any of these?
A:We own all three of them in select portfolios and have no intention of selling any of them. In fact, we have done some buying of Cisco and Microsoft lately. The bigger question is, when is it appropriate to sell any holding that has acted sluggishly?
In my mind, there are only a few reasons to do so. First, you sell when the price is so high that you cannot obtain a suitable return holding the stock into the future. Second, you sell when there's a fundamental change in the business model of the company, or it's showing signs of maturity. Lastly, you would sell when a stronger, more compelling idea came along, and you needed to sell something to make room for the better idea.
At present prices, Cisco can probably deliver the highest total return if you can hold for 10 years or more, followed by Microsoft, then Intel. Cisco might be able to generate a 10-15% long-term return from present prices. If that's the case, you would have to find another stock capable of growth rates higher than Cisco to replace it.
Keep in mind that your past losses are sunk. You cannot erase them at this point. All you can do is model the forward rate of return from present prices. If stocks like Cisco or Microsoft can still generate returns on your money in excess of the S&P 500, they're worthy of holding, no matter what they did for you in the past.
Q: Any last words of wisdom? How should investors position themselves now?
A:First, we think stocks are still the place to be long-term. Second, try to take best advantage of the sustainable growth of the U.S. economy. When doing that, try your best to ignore all the daily noise that Wall Street throws at you.
There are lots of "issues" in the market right now that are causing investors to be hesitant toward buying stocks. I think most of the near-term issues facing us right now won't be around in a couple of years, and we will be left kicking ourselves for missing some of the opportunities available right now.
Repeating what I said earlier, we are stressing companies that can grow, rather than companies that are sluggish but happen to trade at low prices. There aren't that many right now, so you'll have to do more fundamental due diligence than you did in the past. But I think the results will be worth it.