Stock picks (pg. 2)
It's also led us to some consumer names that we've never owned before because they were much too expensive. We actually picked up McDonald's (MCD, Fortune 500) (MCD, $56) under $50 in October. I just didn't think it would go there.
GRANTHAM: What we've found is that high-quality stocks aren't dependable in an ordinary bear market - not even in a severe bear market. High quality is really dependable only when economic fundamentals start to collapse. If there's fear running through the system that there'll be a severe recession, the great recession, or a mild depression, quality is dynamite. Quality was brilliant between 1929 and 1932. You did not want to own the low price-to-book stocks, because half of them went bust. You wanted to go down in Coca-Cola. Overpriced Coca-Cola lost only 75% of its money.
Are those high-quality names worth buying today?
GRANTHAM: Absolutely. They're still the cheapest part of the market. And I don't do individual companies, but the five classic positions - and the biggest in the fund - are Coca-Cola (KO, Fortune 500) (KO, $44), Procter & Gamble (PG, Fortune 500) (PG, $60), Microsoft (MSFT, Fortune 500) (MSFT, $19), Wal-Mart (WMT, Fortune 500) (WMT, $53), and Johnson & Johnson (JNJ, Fortune 500) (JNJ, $55). These guys' profit margins did not inflate materially.
The rest of the market, particularly the junk, went to legendary highs. These guys barely moved in comparison. Consequently their earnings didn't go up as much: People thought they were has-beens, and their stocks languished in the great rally. As a result, they came into this time period, when you really need them, the cheapest they've ever been on a relative basis. Now they're extremely cheap on an absolute basis as well.
CHRISTIAN: Let me say one quick thing about Coca-Cola. We have a different view. The world is a different place than it was 50 years ago. There are water problems, and Coca-Cola is a huge consumer of water, both in its product and in the processing. They've run into reputation and financial problems.
For example, they invested in a plant in India but had to shut it down because of regulatory action after concerns about the impact on local water supply. I think that we need to factor this into the analysis to make sure that the way the market's pricing the stock is really the way we would price it as value investors. If we don't, we're in for some nasty surprises.
Tom, your Forester Value fund was one of the few gainers through the third quarter of this year, and even now it's down by only about 3%. What's your take?
TOM FORESTER: I'm a low-P/E guy. When things have hit bottom and they start coming back up, the low P/E stuff's great. But as Jeremy has correctly pointed out, in tough times they can do the opposite. We haven't seen tough times in a long time, so I've really had to protect the portfolio by going up quite a bit in the P/E range.
I bought Wal-Mart (WMT, Fortune 500) last year in the low 40s. I hadn't seen it that cheap in years. I own Johnson & Johnson. I also own McDonald's and Microsoft, which is a recent buy.
On the subject of nasty surprises, what about financials? Is it time to buy yet?
RODRIGUEZ: As far as I'm concerned, it's still way too early. They're going to come under much heavier regulation and be using considerably less leverage. This is lethal for the former investment banks, and commercial banks are going to have to deal with more loan problems.
I've estimated that there's at least $2 trillion in bad loans in the system, and we've really only recognized about a third of that. That's a moving target. Do we have a template today that will work for our financial system? So far the answer is no.
GRANTHAM: The most difficult decision we've had to make in a long time was when we started our quality fund four years ago - the question was whether banks could ever be considered high quality. All the quants in the shop were saying, "What do you mean? They've got high, stable returns."
But all the historians were saying, "Yeah, but every 15 or 20 years, the market takes half of them out and shoots them. That doesn't happen to the Coca-Colas." So in the end we decided that no banks could ever be high quality.
Anybody feeling more adventurous?
FORESTER: I'll stick my neck out there a little bit. I think the stronger banks will be able to pick up assets on the cheap, and the ones that survive could do quite well. I own U.S. Bancorp (USB, Fortune 500) (USB, $24), and I have a small position in Bank of America (BAC, Fortune 500) (BAC, $13). BofA doesn't have as much exposure to the toxic stuff as everybody else. I don't think it picked up Merrill Lynch cheap, and I was a little discouraged by that. I also think that it's going to have some troubles ahead, but I'm willing to dip my toes.
Leslie, what are some of your favorites?
CHRISTIAN: Novo Nordisk (NVO) (NVO, $49), which is a Danish pharmaceutical, has been in our portfolio for a long time, and we're adding to it. They make drugs for diabetes, which is a huge global epidemic, and they're not really dependent on the economy. They're also very, very committed to energy, water, and raw-material conservation and efficiency.
Google (GOOG, Fortune 500) (GOOG, $266) may be expensive, but it's a lot less expensive than it used to be. They're huge users of electricity with all of their server farms, but they've developed an innovative solution to improve server efficiency to 90%, vs. 60% or 70% for the industry.
We like Staples (SPLS, Fortune 500) (SPLS, $15), the office-supplies business. They're expanding outside the U.S., with a commitment to using recycled products. We also like Svenska Cellulosa (SCAB) (SCAB.SS, $7), which is known as SCA. It's a Swedish vertically integrated paper products company. They're transitioning to making more personal products, which should get them a higher P/E, but they're still trading like an old-fashioned paper company.
Then there's Natura Cosmeticos (NATU3.BZ) (natu3.bz, $9), a Brazilian company that's like a Latin American Avon. And then from our backyard in Oregon, there's Schnitzer Steel (SCHN) (SCHN, $23), which processes scrap steel into recycled steel. It's a really beaten-down stock right now.
GRANTHAM: My theory is that the early movers on energy conservation are simply better-managed companies. There is no better way to show that you are quick on the uptake and capable of thinking long term than moving fast on green.
RODRIGUEZ: I had a few other companies. One from last year is Foot Locker (FL, Fortune 500) (FL, $6), which is effectively trading at about 70% of book value. It has a pristine balance sheet. Another is Signet Jewelers (SIG) (SIG, $7). Today it sells at about 45% of book and about 20% of revenues. It has a strong balance sheet, and it's generating about a dollar a share of free cash flow.
We also started adding a position in Reliance Steel & Aluminum (RS, Fortune 500) (RS, $17). We view it as having over $3 a share in free cash flow for 2008 and 2009, and the stock has come down from $78. We've also just started to put some money into Western Digital (WDC, Fortune 500) (WDC, $11). The stock's trading at four times earnings once you account for its cash flow.
Susan, any other stocks you really like right now?
BYRNE: I mentioned McDonald's. I brought four more picks. One is ACE (ACE) (ACE, $44), the reinsurance company that will benefit from the AIG fallout. It doesn't need to borrow, and the business has been very profitable. It had no subprime, and it has a quality balance sheet. The second is Raytheon (RTN, Fortune 500) (RTN, $46), a defense and commercial software company selling at ten times earnings. All these companies, by the way, are generating free cash flow and have no debt problems.
The third is Covidien (COV) (COV, $34), a medical products company spun off from Tyco. On their own they're expanding the margins and having to pay 12 times earnings for it, but doing very well. And then I really like Wells Fargo (WFC, Fortune 500) (WFC, $23). We think the company, with the Wachovia assets, will be a survivor, and we believe the earnings power of this blended company will be about $5 a share.
FORESTER: I want to mention Altria (MO, Fortune 500) (MO, $15), which is in the process of buying UST, which makes smokeless tobacco. Great cash flow, great balance sheet. Another one is UnitedHealth Group (UNH, Fortune 500) (UNH, $20). This stock is down about 70% this year. People still need health care, and it's a well-managed company.
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