Vinik, Vidi, Vici: A Talk With Magellan's General
Three years ago, Jeffrey N. Vinik took the reins at the gargantuan Fidelity Magellan Fund. Since then, Vinik has handily beaten the Standard & Poor's 500-stock index and left most of his competitors in the dust. So far this year, the fund is up 19%. Those returns, however, don't come without risk. Vinik, 36, makes large bets on stocks and industry groups, which could be costly if he's wrong. Right now, Vinik has 46% of the $43 billion portfolio in technology stocks. BUSINESS WEEK Correspondent Geoffrey Smith spoke with Vinik in his Boston office on June 13.
Q: Are you still putting money into technology? Which tech stocks do you like?
A: I'm still extremely bullish on the tech sector. Every day I am buying some technology stocks, maybe ones that haven't run up but have good prospects. Every day I am selling some tech stocks, or trimming some that have had good runs.
I continue to be very positive on semiconductor companies like Motorola, Intel, and Texas Instruments; software companies like Computer Associates and Oracle; hardware companies like IBM, Digital [Equipment], and Silicon Graphics; and cellular infrastructure companies like L.M. Ericsson.
Q: Why is IBM your top holding? And are you concerned that a large share of its business is coming from old hardware--mainframes?
A: I'm amazed at how well IBM has done in the last couple of years. Most of us at Fidelity have virtually doubled our money on the stock over the last two years. But despite its great run, I see a terrific outlook.
I expect IBM to earn over $10 a share this year, perhaps even $11.50 or $12 a share next year, with reasonably good revenue growth of 10% or more....Five years ago, 75% of IBM's profits came from mainframes or mainframe software. Now that's down to 25%. As that percentage continues to decline, people will feel more comfortable with the stock.
Q: We just saw IBM pay a huge premium for Lotus Development Corp. Are we about to see a wave of strategic acquisitions in technology that will give this sector a boost?
A: I don't know if we are in the midst of a wave of strategic acquisitions in technology. I can't think of any technology stocks that I own because I expect them to be taken over.
Q: Motorola, one of your top holdings, hasn't been a barn burner. In fact, some Fidelity managers have been selling the stock. What is your assessment?
A: It's good news, bad news. The bad news is that it's gone nowhere for the last 18 months. The good news is that the earnings have continued to trend upward over that period so that the valuation on the company has declined significantly.
There are a lot of negatives. The company has had an excess inventory of analog phones in the U.S.; it's had to recall some digital phones overseas; it hasn't been as active in [personal communications services] licenses as others. Earnings estimates have been cut somewhat due to some of these problems.
I think for the next two or three quarters, earnings will be in line with Wall Street estimates, which potentially sets them up to beat the estimates in 1996. Right now, you can buy Motorola at 15 times next year's earnings while two years ago it was selling at 25 times earnings. In my mind, the Motorola franchise is as good as it ever was.
Q: The average diversified equity fund is running about four percentage points behind the market, but Magellan is one of the few that's ahead. How come?
A: Obviously, a heavy exposure in technology has helped, especially the semiconductor stocks. Many of those stocks are up 30%, 40%, 50% this year. In addition, the cyclical and financial stocks that I own have done very well. Cyclicals like Cat [Caterpillar] and General Motors have had reasonably good moves. And brokerage stocks like Morgan Stanley and Merrill Lynch have had very good moves.
Q: One of the strongest sectors in the first part of the year has been consumer nondurables (like beverages, foods, and drugs) and you haven't owned those stocks in a long time. Are you beginning to rethink consumer nondurables?
A: I am not particularly optimistic on the outlooks for most of these companies. I still see slowing earnings gains, increasing competition, margin pressure, and high valuations in the stocks.
Q: What's your scenario for the economy, interest rates, and the market?
A: I think the economy is going to remain soft for a while and then pick up next year and in 1997. I don't base the fund on predicting the direction of interest rates. But my guess is, given low inflation and a slow economy, long rates can come down some more, and short rates will also come down, which means the Fed probably will ease some over the next several months. I'm definitely bullish over the long term on the stock market, given the very competitive position of American industry and declining budget deficits in Washington and trade deficits overall. Low inflation, good productivity, gaining market share on a worldwide basis--these are all factors that make me very bullish long-term. I think the conditions are in place for a good market environment over the next six to 12 months.
Q: Given your bullishness on rates, how do you view financial stocks?
A: I like financial stocks a lot [but] not only because my guess is that rates will come down. I see good fundamentals, good earnings growth, and reasonable valuations because a lot of the stocks have corrected over the last 18 months. I like Merrill Lynch, Morgan Stanley, and Travelers, all selling at 7 to 8 times earnings. There's a real trend in this country toward people investing and saving rather than consuming, and that should drive their earnings for several years. I also like Fannie Mae and Freddie Mac in the financial-services area--good 13% to 15% earnings growth selling at 9 to 10 times earnings. In insurance, I like Equitable Cos. and SunAmerica.
Q: What other sectors do you like now?
A: I continue to be very positive on a host of cyclical sectors. The cyclical part of the U.S. economy, which was boom and bust in the 1980s, will be more like boom-boom in the 1990s. I expect continued prosperity from companies like Caterpillar....I'm also bullish on the auto companies, like General Motors, which is gaining share from the Japanese, and is getting its costs under control. I also own railroad stocks like CSX and Conrail. Railroads, at 10 to 11 times earnings, are priced as if this is the peak of the earnings cycle, but their earnings are likely to grow for several more years. Investors don't fully appreciate that.
Q: Since the U.S. market has moved up so much relative to foreign stocks, are there now opportunities abroad?
A: It's no accident that U.S. stocks have outperformed most markets around the world both in 1994 and 1995. It reflects the very good fundamentals of this country. While I do own a handful of companies overseas like Ericsson, Nokia, KLM Airlines and Philips, the vast preponderance of the best ideas are here. I also own some Canadian natural gas stocks.
Q: You have enormous holdings in many companies, some worth over $1 billion. Do you worry about your ability to unwind large positions in a bear market?
A: I worry about bull markets, bear markets, corrections. I try to envision every possible scenario. If there were a correction in the market or a bear market, I would expect that Magellan would go down more than the S&P 500, given its aggressive position. It has done so in probably every market correction over the last 15 years. Last year we had a correction, and I used the time to improve the positioning of the fund for the next better market environment.
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