Four Gurus And A Lofty Market

What stocks would you choose if you had $100,000 to invest this New Year? That's the question BUSINESS WEEK asks four top investors each December. These brave souls are required to produce a list of 10 stocks for the coming 12 months.

This year's stock-pickers have an especially difficult act to follow. The market of '95 was just about perfect for value investor Douglas Johnson, now a portfolio manager with Greenwich Street Advisors, a division of Smith Barney Inc. Johnson's bottoms-up stock-picking style reaped him a 65% overall gain through Dec. 1. His portfolio benefited most from a 255% jump in the stock of Data Broadcasting Corp., a manufacturer of portable stock-quote machines. Data Broadcasting witnessed Internet-crazy gains after the company was named a data provider for Microsoft Corp.'s World Wide Web site.

In second place, with a 54% payoff, was Justin S. Mazzon, senior portfolio manager for American Blue Chip Investment Management. He over-weighted his portfolio in high-yield stocks using a modified beat-the-Dow strategy designed to protect his portfolio from a market downturn. Mazzon's home run was Sears, Roebuck & Co. Our international stock specialist, John Horseman, fell from first at midyear to third, in part because of a disastrous performance at China's Luoyang Glass Co., down 40%. Strong U.S. consumer stocks helped him back, though, and Horseman's final return was 24%. Like Mazzon and Horseman, stock-picker John S. Gardner was bearish last January. Gardner, of Van Liew Capital, loaded up on cash-rich stocks as a hedge, and his portfolio finished fourth, still up 20%.

In common with last year's lineup, 1996's quartet is singing a song of caution about the overall market. Our four gurus are focused on company fundamentals, and they're betting that a good story is the best wager in uncertain times.


Desi Heathwood made headlines last April when he led a mass defection from old-line money manager Boston Co. The company's parent, Mellon Bank Corp., felt his loss, as institutional investment dollars began departing as well. Heathwood set up his similarly named Boston Partners within the month and has amassed $5 billion in assets under management since April. Heathwood and his cohorts are strict value managers who focus on buying at a low price.

With the market's current highs, it's not easy to find undervalued companies. So Heathwood is buying companies whose parts, he believes, are worth more than the whole. He looks for managements that are actively trying to unlock that value, such as members of the Tisch family at Loews Corp. They recently sold their stake in CBS Inc. and part of their stake in Diamond Offshore Inc. Heathwood also likes The Limited Inc., a retailer that is spinning off divisions to increase shareholders' returns. Telecommunications giant Sprint Corp. makes the list in part because of the company's decision to spin off its cellular business. Cash-rich carmaker Volvo, which has already sold many ancillary businesses, trades at half its true value, according to Heathwood.

Heathwood favors a few reasonably priced acquisition-minded companies as well. IBM is throwing off enough cash to cover future acquisitions and still buy in shares. Heathwood calculates that IBM will generate $14 a share in free cash flow in 1996, almost 15% of the $96 stock price. Republic New York Corp., which is in the process of buying Crossland Federal Savings Bank for $530 million, boasts an excellent management team and seven years of strong returns. Heathwood thinks it's a bargain at nine times next year's earnings.

Out-of-favor Lehman Brothers Inc., the only brokerage firm trading at a discount to book value, is another Heathwood pick. He argues that Lehman does not get enough credit for its strong fixed-income business. Stolt-Nielsen, a Brit- ish-based shipper that's trading at only seven times next year's earnings, is a Heathwood favorite because cargo shipping rates are firming. Two out-of-favor growth names round out his picks: Nursing-home operator and rehabilitation provider Horizon/CMS Healthcare, and networker Novell Inc. Both companies should resume good growth this year, Heathwood believes.

(All data in tables is as of Dec. 11.)


As manager of the hugely successful $1.9 billion PBHG Growth fund, Gary Pilgrim has racked up a nifty annualized return of 22% since 1986. An investor who plunked down $10,000 nine years ago would have $80,000 today, an accomplishment that earned PBHG Growth Morningstar's highest rating--five stars. Pilgrim is a strict growth manager who focuses his attention on small-cap companies. "As growth managers go, we're among the most aggressive because we always look for companies in the early to middle stages of maturity," says Pilgrim. He pretty much ignores the market. He gamely offered to make an overall market projection for 1996 when BUSINESS WEEK asked, but instead, we let him concentrate on what he does best: picking stocks.

A number of technology issues provide the kind of growth (30% to 40% long-term) and potential for positive earnings surprises Pilgrim looks for. His first pick, Inso, supplies spelling- and grammar-checking software programs to everyone from Microsoft to Lotus Development. In addition to this highly lucrative business, the company is applying its linguistic expertise to products that do everything from searching giant databases by word to helping executives use English as a second language in composing correspondence.

Another pick, Cognex Corp., is a leader in machine vision eriginally used for inspecting semiconductors but now overseeing a variety of tasks from razor-blade production to bottle-cap sealing. He also likes Kemet, a manufacturer of electronic components for circuit boards, which grew 130% last quarter, beating Wall Street estimates. McAfee Associates, a developer of antivirus software and another fast grower, with earnings expected to increase 40% in the coming year, makes his list as well.

Another small-cap sector Pilgrim has explored is health care, where Physician Sales & Service, a distributor of supplies to doctors' offices, is a favorite thanks to aggressive acquisitions and expanding margins. He also likes Quintiles Transnational Corp., a specialist in getting clinical products approved for larger manufacturers in regions around the world. This is part of a broader outsourcing trend Pilgrim is investing in.

Gartner Group Inc., which researches and analyzes computers and software, is a particular favorite, Pilgrim says, because it dominates its market and promises a 50% earnings increase this year. Pilgrim also likes Accustaff Inc., a temporary staffing company that is buying up the competition, and U.S. Filter Corp., which dominates the water-purification market. Although long-term debt is up at U.S. Filter, Pilgrim sees water becoming a more scarce commodity and the company's acquisition strategy paying off. For his finale, Pilgrim has chosen something completely different: Blyth Industries Inc., a manufacturer of aromatic, religious, and citronella candles, which he jokingly refers to as the "cocooning play."


In addition to overseeing a $16.5 billion fund group that bears his name, Dick Strong keeps attuned tm the markets by managing the Strong Discovery Fund. His discoveries for 1996 include a number of manufacturers of disposable products, such as razor blades, that need to be regularly replaced. While he expects sporadic market corrections, Strong is optimistic that the extremely positive environment for business that followed the collapse of communism in the 1980s will continue. He believes inflation and interest rates will remain low in the coming year. "As long as the government stays eut of the way, for a good management team, it's a dream," says Strong.

A typical Strong pick is Dentsply International Inc., one of the largest dental suppliers in the country. It is valued at an attractive 15 times fiscal 1996 estimated earnings and will, he says, enjoy earnings growth in the midteens thanks to acquisitions and demand. "People's teeth break all the time," says Strong, who foresees no dip in demand for this company's services. At Danka Business Systems, a servicer of photocopiers, Strong is looking for a hearty 30% earnings growth based on the company's ability to buy up readily available mom-and-pop operations and streamline its operations. Danka, based in Britain, trades in American Depositary Receipts in the U.S.

Consumer demand for Exide Corp. batteries will help this company, which Strong says is the most efficient manufacturer of batteries in the world. Strong thinks Canandaigua Wine Co. is cheap at 11 times 1996 expected earnings. The stock was recently beaten down after a disappointing quarter, an overreaction according to Strong. For the fearful, he has Sensormatic Electronics Corp., a manufacturer of theft-prevention devices. Growing at 25% a year, Sensormatic, he says, has a new chief executive and a great chance to cut costs over the next few years. For the fearless, there's Harley-Davidson Inc., whose yearlong waiting list for motorcycles and growing international market impress Strong.

Two entertainment stocks have caught his eye. Strong thinks Walt Disney Co. will benefit from new broadcasting and publishing outlets. Harrah's Entertainment, the former Promus Cos., will, he expects, disprove overblown concerns about its New Orleans operations. Lancaster Colony Corp., a manufacturer of glassware, candles, and specialty foods, and Marshall Industries, a rapidly growing distributor of electronic components, enjoy low price-earnings ratios, in part, Strong feels, because of lack of Wall Street coverage of the stocks.


As director of Far Eastern equities at London-based Guinness Flight Global Asset Management, Richard Farrell is waiting for the U.S. market to get tired. That's when money will begin to return to Japan, he argues, and it could happen soon. Rock-bottom interest rates, a decline in the yen, and gradual improvement in the Japanese economy have him bullish on Japanese stocks. A contrarian streak may explain his desire to get in before the rush. "You should buy from the fearful and sell to the greedy," says Farrell.

Japanese telephone giant NTT is especially likely to rise this year, according to Farrell. He thinks this could be the year the company is broken up into component parts, a la AT&T, unlocking now-hidden value. Farrell likes Asahi Bank Ltd.'s reasonable level of bad debt and is betting that margins for Japanese banks, traditionally wafer-thin, will improve. His optimism about the semiconductor cycle continuing its upswing led him to Tokyo Electron Ltd., which should see revenues for the current fiscal year up 50% and an additional 25% gain next year, he says. Oi Electric is a smaller company that Farrell has selected as a pure play on Japanese interest in the Internet, which he says has "almost become an obsession."

He also likes Hong Kong stocks, which he finds the safest way to participate in mainland China's growth. "On the whole, the mainland China exchanges have very small trading volumes," says Farrell. "In Hong Kong, the accounting and legal infrastructure is much better established." HSBC Holdings scores for strong management. First Pacific Co. he thinks is a strong telecommunications play as well as a developer of Fort Bonifacio, a planned business hub in the Philippines. Farrell's third Hong Kong choice, investment bank Peregrine, will benefit in the near term from an upturn in the market, he says, and in the long run from the development of a significant Asian government debt market needed to fund its enormous infrastructure growth. Also available as ADRs are HSBC Holdings, Peregrine, and NTT, which trades at 42.

To the north, Farrell likes Korea's Samsung Group, a result of his generally bullish outlook for PCs. He is recommending Samsung's Global Depositary Receipts, which he calls "unbelievably cheap" on a cash-flow basis. He has also selected Korea Electric Power, which is benefiting from a 12% jump in kilowatt sales in the first six months of this year, a demand trend that Farrell expects to continue. His final pick is Indonesia's Indocement. Indonesia is one of his favorite emerging markets, and Indocement, he feels, will benefit from infrastructure growth and its big holding in Indofood.

Before it's here, it's on the Bloomberg Terminal.