A Value Fund by Any Other Name
By James A. Anderson
When it comes to investing, money manager John C. Thompson literally keeps his distance. He's content to run his Thompson Plumb Growth Fund (THPGX ) -- which makes the A-list of high-return, low-risk funds on BusinessWeek's Mutual-Fund Scoreboard -- from Madison, Wis., more than 1,000 miles west of New York's Wall Street and some 150 miles north of Chicago.
Thompson maintains his space figuratively as well, opting for an arm's-length relationship with corporate management, especially in this time of earnings revisions and near-term profit collapses. "I find that [in a lot of cases], the CEO doesn't know that his business is going to slow down, or else knows and can't tell you now because of the law, or knows and is hoping things get better," he says. "You end up liking a person -- and CEOs can be very likable -- but the relationship [can make] you think twice about selling a stock. It's just better to...remain objective."
It's that type of cool, detached approach that has helped value manager Thompson focus on the numbers when selecting stocks. The proof is in his results. At the market's close on June 12, Thompson's fund had managed to keep quite a ways ahead of its benchmark, the Standard & Poor's 500. Thompson Plumb Growth was up 7.9% so far in 2001, almost 15 points beyond the 7.1% decrease posted by the S&P 500. The fund's 16.5% average annual total return over the past three years has dusted the S&P 500's 4.9% tally for the same period -- and Thompson's 22.0% over five years has bested the S&P 500's 14.6%.
You're bound to do a double-take on the fund's name. The Thompson portion is self-explanatory. The portfolio was launched by Thompson's father John W., now 55, in 1984, and named after the founder and his partner, Tom Plumb. The elder Thompson remained on as co-manager when John C., 32, assumed the leadership of the fund beginning in 1994.
Don't look for a clear sense of Thompson's investing tactics from his fund's moniker, however. Despite the "growth" tag, Thompson at heart is a value manager, and his modus operandi relies on several measures of a stock's relative worth. Sometimes, he leans on a stock's price-to-sales ratio. Other times, he'll aim for a low price-to-earnings multiple or price-to-free cash flow.
Whatever the yardstick, Thompson likes to help narrow the field by examining the trading patterns of stocks going back 10 years or so. He'll buy if a company is mired at the low end of historical valuations, holding on until the stock approaches the high-point.
Thompson says he often likes to spot a catalyst to jump-start a cheaply priced stock. In some cases, he'll find it in a company's return on equity, in which case he says a mark of 15% or better piques his interest. Other times, he says cash-flow growth -- preferably 10% or more -- will make the difference.
Paint manufacturer Sherwin-Williams (SHW ) is a good example of Thompson's scanning technique at work. In April, a Rhode Island court cleared the way for a lawsuit holding Sherwin-Williams and other paint companies liable for public costs covering the removal of lead-based paint from sites scattered across the state. Then, too, during the first quarter, an economic slowdown socked the company to the tune of a 5% drop in sales year-over-year.
The market chimed in, dragging down Sherwin-Williams shares the mid-20s to around $20 a share. That left the company priced 10 times estimated earnings for the next 12 months. On Thompson's radar, Sherwin-Williams has tended to trade between 10 and 25 times earnings, while the company's return on equity is 20%. So around Apr. 19, shortly after the news of legal problems hammered the stock, Thompson began buying, paying an average $21.00 a share for his stake. Sherwin-Williams finished trading at $22.51 on June 15, down from its 52-week high of $27.25.
Thompson says Europe's recent meat scares have also earned McDonald's (MCD ) a spot on his roster. With the Continent apoplectic over Mad Cow disease and hoof-and-mouth maladies, the fast-food company's stock has faded to a p-e multiple of 16, by Thompson's estimates. Over the past decade, however, McDonald's has moved between 12 times and 13 times estimates during the recession of 1990 to as high as a p-e multiple of 35 in 1997. At the same time, McDonald's has a return on equity (ROE) in the low 20s, by Thompson's calculations.
Thompson, who has paid an average $27.50 a share for the stock, says he'll reevaluate his position once McDonald's moves to a p-e in the mid-20s. At the end of trading on June 15, McDonald's was priced at $28.67 a share, down from a 52-week high of $35.06.
Electronics retailer Circuit City Group (CC ) is another recent pick. The mauling many tech stocks have suffered, coupled with concerns over what effect an anemic economy might have on merchants, have ganged up on Circuit City. Thompson's research show that over time, the stock has tended to trade from 0.8 to 1 times revenue. Yet in March, Thompson found the shares languishing at a new low -- 0.6 times revenues. So he pounced, building his stake in the company at an average $11.50 a share. At the end of trading on June 15, Circuit City shares were $15.49, down from a 52-week high of 38.68.
Thompson's picks don't always look like stock-in-trade value plays. In these turbulent times for tech shares, Thompson's weighting in the sector has actually increased, from 15% of his portfolio in early 2000 to around 17% in mid-June 2001. Part of that is from a big boost in the value of Microsoft's (MSFT ), a stock that has rallied some 60%. Thompson, however, has also spied value in the likes of Compaq (CPQ ), which he says is mired at historic lows.
Make no mistake: Thompson is no hardened tech aficionado. "We haven't owned a communications-equipment stock in the past two years," he says. "We've certainly seen bad news pile up on the those companies, and I certainly think there's more to come." In fact, since early last year, he has shed stocks such as Intel (INTC ), EMC (EMC ), and Linear Technology (LLTC ).
Of late, Thompson, has been a big fan of media holdings such as Viacom (VIA.B ). The fund's largest position, Viacom shares make up 4.7% of its assets and are up 16.4% this year. Thompson bought into the company five years ago, at an average price of $37 a share, but added to his position in March. "Between the old Viacom and CBS, the company has some wonderful media assets, in one of the better industries out there," Thompson says. "Good media is a lot like good real estate -- the best properties always get a premium, and with Howard Stern, [Don] Imus, MTV, and Nickelodeon, you've talking powerhouse." Viacom "B" shares finished Thursday's session at $53.55.
One disappointment is razor maker Gillette (G ). "They've missed earnings two years in a row," says Thompson, who paid an average of $35 a share for the stock. Thompson adds that he doesn't see the stock bouncing back until next year. "The product is a great one, but they're having inventory problems that will take a few quarters to sort out," he says. One reason to stick around: Gillette's ROE could hover around 30% over the next few years, according to Thompson. Gillette closed at $28.20 on June 15, down from a 52-week high of $37.18.
As portfolio manager, Thompson keeps an active hand in things. According to Morningstar, which classifies Thompson Plumb Growth as a large-blend fund, or a portfolio that focuses on bigger-name companies and uses a mix of value and growth stock picking ideas, turnover was 72% over the past year. That's a substantial amount of shuffling, but well below the 110% average of the fund's peers. Its expense ratio of 1.3% is a shade above the category's average of 1.2%, but still respectable, considering the fund's small asset base of $127 million under management.
"Over time, [Thompson] has certainly put up good numbers," says Morningstar analyst Scott Cooley. "Still, given the fact that the fund has gone with heavy or light concentrations in some segments in the past, it has run into a few rough patches." In 1999, because of a light weighting in tech shares, Thompson missed out on a big rally in the sector. Thompson Plumb Growth finished the year with a 6.4% total return, 14.6 points below the S&P 500.
To his credit, Thompson bounced back handsomely in 2000, generating some 25.7% for shareholders, 32.5 percentage points better than the index. "Recent results are certainly helping the manager build a pretty good track record," adds Cooley. In the months ahead, look for something of a makeover in Thompson Plumb Growth's portfolio. Thompson says he has recently been shifting out of large-cap holdings and into cheaper mid- and small-cap shares. The likes of Pepsi (PEP ) have disappeared, while Sherwin-Williams and Unisys (UIS ) -- both companies with market capitalizations of below $4 billion -- have filled the gap.
"Looking out over the next decade, I don't expect the S&P 500 to generate returns much in excess of 4% to 7% a year," Thompson predicts. "So right now, about 56% of our money is in mid- and small-cap shares, if only because we're finding better ideas in that part of the market."
Anderson teaches journalism at the City University of New York. Follow his twice-monthly Sector Scope column, only on BW Online
Edited by Patricia O'Connell