Online Extra: Replenishing Gains with New Ideas

Fidelity Contrafund's Will Danoff says he looks to the vanguard of the entrepreneurial spirit for fresh, promising investment leads

Will Danoff, manager of Fidelity Contrafund (FCNTX ) is a smiley-face junkie. His office is decorated with stickers, T-shirts, stuffed toys, and more doodads -- all tattooed with the smiley-face logo. So it seems especially fitting that when Danoff celebrated his 45th birthday in early July, the decorations at his Fidelity office party included smiley-face napkins, plates, and balloons.

Danoff's shareholders have a lot to be smiling about, too. The $49 billion fund, one of the industry's largest, is up an annualized 18% in the past three years. BusinessWeek Personal Business editor Lauren Young recently caught up with Danoff in a telephone interview. Edited excerpts of their conversation follow:

Q: What's your investment philosophy?


For me, it's all about best of breed and staying on the vanguard of the entrepreneurial spirit of our country. That has led me to the Internet and biotech. I think these are going to be continued themes. Consumer companies, health care, and technology also are big parts of our economy -- that's where you see a lot of innovation and new products.

One example is Genentech (DNA ), which was a big contributor to the fund last year. They're doing very innovative science to meet unmet medical needs. Avastin, their cancer drug that seems to be working in many different cancers at this point, could be the biggest drug in the whole industry. They also had very positive clinical data on Lucentis [which treats blindness].

Q: How does research fit into your stock-selection process?


I've been seeing companies for a long time -- my 15-year anniversary at Fidelity is in October. There was a period in 2001 when Roche, the majority owner of Genentech, was selling down its ownership. I met Art Levinson at that time, their very dynamic and intelligent chief executive officer as well as a scientist and a PhD. I said, "This guy can really help me understand what's happening." The initial trial on Avastin failed to meet primary endpoints but showed favorable data in colorectal cancer. I was all over it.

In the Internet space, we were luckily there with Google (GOOG ) at the initial public offering. In meeting with Google, I saw the potential there. They were a great contributor last year. Google has a very powerful business model. They have the smartest engineers, and the company is growing like a weed. Americans spend 12% of their media time surfing the Internet, but online advertising only accounts for 4% of the advertising-revenue pie. Targeted advertising is a more effective means of stimulating the consumer.

You have to give Gordy Crawford [media analyst at rival American Funds] credit. He sold Viacom (VIA ) and bought into Yahoo! (YHOO ) and Google. Being on the vanguard helps you better understand what's happening. When you're talking to [CEO] Terry Semel at Yahoo, it helps you understand where advertisers are going to go. We know that Procter & Gamble (PG ) is deemphasizing television in a big way.

Q: What other industries do you like?


I own some wireless. It's a growth market. I also own some core technology. Gaming has been a good play. In retailing, I own Chicos (CHS ) and Urban Outfitters (URBN ).

Q: What are you staying away from?


I'm not a big fan of mega-caps. My insight is that in a slow economy, these bigger companies have trouble growing.

Q: I see you still have some blue chips in your fund, including ExxonMobil (XOM ). Do you still like energy?


I was early-ish on energy. That has helped me, since energy has performed exceptionally well. I've had a long history in the last 15 years with the energy space. Every time you go through a cycle, you try to identify the executives who can tell you the facts, the ones who know what they're talking about. So often value managers want to buy sick companies because they think they're cheap. My philosophy is that you don't make money unless the sick patient will get better.

One year ago, oil prices were at $34 per barrel. Today, you can call it $60. Basically, Exxon hasn't even increased capital expenditures. All that incremental cash flow is just going onto the balance sheet. I'm going to stay bullish on energy until I see significant growth in capital spending.

I'm not sure it's a great place for new money, but it's a very attractive place to be. And the stocks don't reflect the big move we've had in commodity prices. Companies with good reserves will do well.

Q: What do you say to critics who say your fund is too big?


About 40% of the fund is in companies with market caps under $10 billion. About 18% of the fund is invested in companies with market caps between $10 billion and $20 billion. And then there's another 40% in companies over $20 billion. There are a lot of opportunities out there. I'm looking at everything.

My big advantage isn't that I was given a big fund and told to run it. I've grown up with Contrafund. I've owned a lot of stocks. I've made a lot of mistakes. I've tried to learn from them.

We can afford a strong research team. We have access to people who understand their industries. I've tried to buy companies that I can own for three to four years. Joel Tillinghast [manager of $36 billion Fidelity Low-Priced Stock (FLPSX )] is the master at that. He gets a high return from companies that are temporarily at a cheap valuation.

I've tried to learn from Joel. As I've grown, I've also had to adjust. Hopefully my record is good. You don't have to be the best fund in a big up year -- you just have to consistently be in the top quartile.

Q: Do you expect large-caps to outperform going forward?


It's a matter of time horizon. Small- and mid-cap companies have done exceptionally well. Among companies that I own, there's [dental-supplies company] Patterson (PDCO ). It was 12 times earnings for an 18% to 20% grower when I bought it. In the last couple of years, it's growing 20%, but the p-e has gone up, too.

A lot of my colleagues wouldn't have bothered with Patterson. It's a boring dental-distribution business. What I saw was a stable business and great management at a time when people were looking at Internet companies, which were basically made up of a couple of smart MBAs and a business model -- with revenues projected in '06.

If you fast-forward, p-e's have gone up a lot in small- and mid-caps. There's no question that the relative p-e of big caps has fallen sharply. [But that doesn't mean they're] not a great way to make money. I'm sifting through the GEs and P&Gs. I like to see growth or a positive change. If I had to guess, big-cap names will do well.

Q: What are you excited about right now?


I feel good about names I own. Just recently, I did a screen on companies that are new in the last three years. I came up with 400 names. That's my research list. I'm looking for new companies with new ideas -- a better mouse trap. The whole alternative-energy area could be very fruitful.

One of the hardest questions is: When do you sell a stock? You sell a stock when you have a better idea. And the only way you're going to get a new idea is when you're looking for new ideas.

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