Which way is up? Our experts discuss strategies to thrive no matter what the market brings.
SOMETIMES IT SEEMS AS IF GOOD NEWS FOR investors brings up more questions than answers. Midway through 1997, for example, with the market fresh from an unstoppable 20% tear in the first half of the year, there were riddles aplenty to figure out. On one side, pundits had warned even before January 1 that stocks were overvalued and that a correction--an overall drop in the level of the market--was long overdue. And true enough, the market slid almost 10% in February, rebounded shortly thereafter and proceeded on to a record 8,000 mark for the Dow Industrial Average. Could so many great financial minds be so wrong? Not necessarily, many experts said, repeating the same gloomy forecast.
Much to our relief, no sooner had we begun to puzzle over what had happened, than it was time for the biannual BLACK ENTERPRISE Investment Roundtable, an opportunity to gather some of the best professionals around to ponder tough questions we all need answered to best structure our portfolios. On July 10, we brought together a noteworthy group at our Manhattan headquarters. There was Barbara Bowles, CEO and founder of the Kenwood Group Inc., a Chicago institutional investment firm managing $300 million in assets and running a mutual fund that specializes in mid-cap value stocks. Another value stock expert in attendance was Nathaniel Carter, president and chief investment officer of Lakefront Capital Investors, a Cleveland money management firm running $20 million in institutional assets and the newly minted Key Victory Lakefront Fund to boot.
We didn't want to neglect growth stock managers, so we invited two. We had Dawna J. Edwards, director of equity investments and principal of Alpha Capital Management Inc., a 100% African American-owned money management firm headquartered in Detroit that manages $120 million in assets. Teaming with her was Robert Lamb, president and co-founder of Highland Investment Group, a Fairfield, Connecticut, firm that recently launched the Highland Growth mutual fund. Finally, to help with guidance on the fixed income and bond front, we added Frankie Hughes, founder and president of Hughes Capital Management, a Washington, D.C., firm with $225 million under management.
Our panel covered the gamut of investing what had happened and was going to happen to the market; what are some of the best long-term investments to be found; and whether another drop in the stock market is in the offing. And to best help you comb through some of their invaluable advice, we've divided the proceeding up to address specific questions you, the investor, would most likely ask.
Is the market too high? Are stocks overvalued?
BE: At our roundtable six months ago, the consensus was that stocks were very expensive. Since then, the market has run up about 20%. What's up?
BARBARA BOWLES: The market is selectively overvalued. Large-cap, blue-chip companies have made the most gains so far with the top 50 companies up 40% year to date, while the rest of the market is up only three to 10 percentage points. If there's value to be found, it's in smaller companies under $10 billion in market cap.
BE: The S&P 500's P/E ratio has historically fallen in the range of nine to 20 times earnings. Where is it now?
BOWLES: It's at 22 times earnings.
Is it time for a correction, or drop in stock prices?
BOWLES: At those levels, I think we really need a correction. Earnings growth rates are beginning to slow, and the market continues to rise. The stock market can't continue to rise based on anything other than fundamentals, like earnings or profits. Right now bulls are looking for reasons for the rise to continue, and those reasons are disappearing. I would suggest that individual investors who are moving into the market do so cautiously. Don't pay very high multiples for the stocks, even though they are high quality companies.
DAWNA EDWARDS: No one seemed surprised by a Dow of 8,000. Well, despite that; I believe that we might see a correction, and estimates I've seen say the market could come down 10%. The belief, though, is that once that occurs, the market will have cleansed itself and would then resume the upward trend.
BE: Is it time for the market to drop, or are those parameters ancient history?
NATHANIEL CARTER: We've already had almost 10% correction in February, and the market bounced back. Another correction would be short term because money keeps flowing into 401(k) plans, and when investors look and see the bond market up only 3.5% year to date, they naturally turn to stocks. For the rest of the year, we're likely to see the market upend at anywhere from 20%-28% higher than last year; we're already 23% higher now. There might not be much growth at all in the stock market in 1998. I don't think we're going to see a correction of the magnitude of anything near 1987; we're more likely to see a period of plus or minus 5% from here to the end of the year.
With the overall market uncertain, does it still make sense to invest in index funds?
BE: We've heard that when the market has a downturn money managers do a lot better than the index. Conversely, when the market's up it looks like a lot of money managers trail the indices. Would you recommend an index fund right now?
BOWLES: Indexing at the large end, using an S&P 500 index, is appropriate for individual investors. People failed to realize that up until three years ago, active money managers were beating the index.
CARTER: I agree that indexing is a cheap way to get diversity, but in the current environment, you should try to look for funds tracking indices besides the S&P 500--perhaps the Russell 2000--to get access to the smaller companies, particularly after large caps have been growing rapidly.
We know that when the Federal Reserve raises interest rates, the market often goes down. What do you expect from the Fed?
FRANKIE HUGHES: They've been quiet most of the year, except for raising rates once in February. I'm starting to hear some talk about the Fed perhaps raising rates a notch in the second half, most likely in the final quarter of the year, probably 25, 50 basis points (bond industry jargon for .25%-.50%). Overall, that's nothing to cause any major disruptions for the stock market.
Inflation, which often pushes the Fed to act, has been at a tame 2%-3% level for most of the last decade or so. One sign that it's benign is the fact that the Treasury introduced inflation indexed bonds, called TIPS--Treasury Inflation Protection Securities--which in the current environment are generating a lot of interest.
As fixed-income investors, how should you react to the current climate?
HUGHES: In our business, we look at the yield curve, which plots the difference between interest rates on bonds maturing two, three, five, 10, on out to 30 years from now. Today, the yield curve is pretty flat. That means the difference in interest paid by a two-year bond and a bond maturing in 30 years is about half a percent. Big deal! Remember, moving to a maturity that far off in the future, you incur higher risk. So for most folks, we say unless you have some definable target that you are investing for, don't opt for bonds maturing much past five years. Basically, at five years you get 6%. That's still a good deal compared to a bank CD. You pick up 50 or 60 basis points--that's five-tenths to six-tenths of a percent. That seems like a little, but when you're talking about 5% interest, that's an extra 10%. The other thing is that essentially you are trading up in quality when you choose Treasuries over a bank CD.
I'd advise readers to look at the long end of the bond market--10-year maturities or greater--only if you have a long-term goal, say a kid's tuition to pay in about 10 years. A long-term holding paying 7% looks good for that kind of goal. The TRIPS or inflation protected bonds might make sense under that scenario too. The bonds guarantee 3.5%, and if inflation stays in the neighborhood of 2.5%-3% annually, you'll get pretty much the same rare as a regular Treasury with a bit of insurance as well.
So how about stocks? Are there any good trends to key into?
CARTER: We like banks and financial institutions. They have traditionally had P/E ratios that were lower clan the market average, but now they are moving up to higher levels. That's because their earnings growth is starting to advance and there is really no concern of any major pull back.
BE: You're not worried that high levels of consumer debt might hit a Citibank or Chase Manhattan that has an extremely large credit card business?
CARTER: It's already hit in the first quarter or early in the second quarter. These days, though, banks can refigure things very quickly. Their profitability is very good, and they can set aside money for those anticipated losses and then tighten up their credit standards very quickly.
HUGHES: A lot of credit card debt doesn't ride on banks' books very long anymore. Banks sell it to institutional investors, so it's not a problem that really affects them like it used to.
CARTER: I like capital goods companies like John Deere, Caterpillar and Boeing. Deere and Caterpillar are benefiting from rising farm incomes and growing grain demand, which means they are going to need to make more capital investments and tractors and combines. Boeing is just now dominating the world airplane market through the purchase of McDonnell Douglas.
BOWLES: We are not really sector oriented, but we have more stocks in railroads and telecommunications. In transportation we still like railroads, airlines and Federal Express. We like Kansas City Southern primarily because of its railroad and money management business.
Which stocks look good now?
BOWLES: I like Pittston Brinks (NYSE: PZB), a company that makes alarms and provides security at ATM locations. It's a small company, with $1 billion in revenues, but it's growing earnings at about 15% a year. The security industry is going to grow at that rare for some time. There are 40 million homes wired for protection now, and that slice of the market is still very strong. In terms of P/E, the company is selling at a significant discount to the overall market, with a P/E of 16 on 1998 earnings. We think its price could double.
Next, I like Illinois Central (NYSE: IC), a railroad. It s selling at 14 times earnings, a 50% discount to the market multiple of 22. It's growing at about 10% a year and has a yield of 2.5%, compared to 1.6% for the market. I think it s one of the most efficient operations around. It could well be taken over. We think the management is very strong. It is true that railroads tend to trade ar a P/E that's 20% lower than the market, but this one is especially cheap.
Finally, I like Medpartners (NYSE: MDM), which is a physicians practice management company, as well as a pharmacy benefits management company. It s growing in excess of 20%, yet with a P/E of 18 times earnings, trades at a modest discount to the S&P. It's under performed the market so far in 1997, primarily because they paid a lot for acquisitions. They also foolishly gave top management options at a price below the market price. Institutional investors like myself really disliked that, and we took it out on the stock. The stock price came down, and it appears that management has seen the error of its ways and promises never to do that again.
CARTER: One contrarian pick I'll give you is also one favorite: Kmart (NYSE: KM), which has gone through quite a bit of turmoil. We like Kmart's management now. CEO Floyd Hall, comes out of Dayton Hudson, a premier retailer. He is doing things to make the company more profitable. Like changing the merchandising mix. The stock doesn't have much in the way of earnings, but we think it can go from $12.50 a share to $20 a share. And after getting rid of Borders and a stake in Office Max, the company is now focused.
I also like John Deere (NYSE: DE), which makes rectors, combines and lawnmowers. They are still trading on significant discounts to the market, however, despite the fact that their profitability is tremendous. They're getting almost 50% of their business from the overseas markets. The company's P/E is about 13 rimes 1997 projected earnings. We also like to look at companies who are trading at a discount to their growth rate. I would say they traded typically, in today's environment, at about 75% of the market multiple.
Finally, we like both Lehman Brothers (NYSE: LEH) and American Express (NYSE: AXP), which spun them off not too long ago. American Express has a unique franchise in their card and travelers' checks, which is a boon as we move to a more global economy. Amex has also begun to pick up some of the credit card marketshare they lost to Visa and MasterCard. They have had some missteps, on the credit card side with Optima, but that is coming together for them, and we think that they will continue to be the dominant player in that market.
Also, American Express Financial Advisors, formally known as IDS, is growing rapidly and they are taking advantage of the growth in the baby boomers market, 401(k) plans and individuals focusing more on savings. Also, there have been rumors that Citicorp and others are looking at purchasing them and they have had discussions.
Lehman Brothers is a premier bond firm on Wall Street. It's small enough for the major banks to absorb them without running into antitrust issues. Wall Street tends to value stocks like this on book value, and Lehman currently trades at 1.3 times book. By comparison, Merrill Lynch is about 2.6 times the book. People think that this company will be taken out at two times. We don't believe it will survive in its current form. We think that they will be bought out some time this year.
We think American Express is going to renew its growth rate, in the 15% area, over the next five years, for the reasons that I've talked about. Yes, we think it's probably fairly valued on the near term--it has gone up 30% this year--but we think that its earnings growth is going to start to increase fairly rapidly and that, as a result, whether it be an expansion of the multiple or earnings growth, the company still has some very good upside.
EDWARDS: One of the names I favor is First Data Corp. (NYSE: FDC). We think the stock is going to benefit from the outsourcing trends and also the way society is depending more and more on electronic transactions. It's a stock that has grown at about 18% over the last five years, versus a market that has grown at about 15%. Its P/E is 31, but at this level it looks like a good value. For the last 12 months, we have seen about a 29% growth rate versus about 10 for the market. First Data Corp. is the biggest payment processor for credit card transactions in world. The company is a direct play on the cashless society of the future; they issue credit cards and work closely with some of the biggest retailers around, with Sears and WalMart among their clients. They also have contracts with 24 of the top 50 bankcard issuers.
We like General Electric (NYSE: GE), an example of a large cap stock with growth potential. It's actually the largest market cap company in the market, but one we think can grow at a 13%-14% rate. The phenomena that are driving its growth reflect themes that are propelling the U.S. economy. One, for example. is globalization--expanding markets overseas--something GE's always pressed. When we talk about technological enhancement, GE is very active in that, too. The company is well managed and focused on cutting costs. Plus, it has close to $7 billion in cash, so a share repurchase plan or acquisition could be in order. Meanwhile, the stock yields about 1.5%.
Another company would be General Nutrition (Nasdaq: GNCI). The company owns about 1,300 stores in malls far and wide. It also has franchises. They are the No. 1 seller of dietary supplements and also manufacture their own private brand of health supplements and vitamins and herbal components. Over the last five years, the company has grown at about 52%. Over the last 12 months, we have seen 24% earnings growth and it is estimated to grow at about 20%, going forward. It has a P/E of about 27.
ROBERT LAMB: We're focusing on broad themes: outsourcing; computer networking and database management; managed care and cost containment; global trade and telecommunications; leisure and retirement planning; privatization and deregulation; financial empowerment; biogenetic engineering; resourced management; and virtual reality.
Starting off with computers, the first is a small company, Metacreations (Nasdaq: MCRE), which makes the software for 2-D and 3-D graphic representations on computers. This technology is used in the entertainment field, construction, engineering and finance. The company typically trades on a P/E between 3044. Right now it's about 35. We see long-term earnings growth of 25% - 30% for them.
We also like Cisco Systems (Nasdaq: CSCO), which is the pre-eminent supplier of Internet networking equipment. I like the fact that they get about 40%-50% of their sales overseas, mostly in Europe, Canada and the Pacific rim. The P/E is in the mid-30s. It typically trades between 25-38 on a P/E basis.
In leisure and retirement, we like Cutter & Buck (Nasdaq: CBUK), which makes high-end sportswear, particularly golf shirts. We're hoping that the company can ride the Tiger Woods phenomenon. The stock trades at a P/E in the low 20s. In fiscal 1997 they earned 77 cents a share. We're expecting $1 a share in 1998.
My final choice is Charles Schwab (NYSE: SCH). Here's a company that's blurring the lines in finance, blending things that Citibank or a Merrill Lynch does with services provided by American Express and Fidelity. Schwab is positioned to take advantage of not just the baby boomers who are planning for retirement but also the older generation who are living well into their 80s and are putting more and more of their money in equities.
HUGHES: I've got a corporate bond pick if you've got a good relationship with a broker-dealer or want to go through Schwab. On the corporate side, it was nice to hear Nathaniel talk about Lehman Brothers. We have actually used quite a bit on the bond side in many of our portfolios.
What's your feeling on bond mutual funds?
BE There seem to be two schools on bond funds. There are some that don't like them because the whole portfolio moves in one direction with interest rates. And there are some people who say leave it up to a professional.
HUGHES: Well, I guess I am being just a little circumspect in terms of thinking about bond mutual funds. For one, expenses can run as high as 2% on a bond fund. If you're talking about bonds that are yielding 5%, maybe 6%, to begin with, and if you're faking off 2% for whatever--diversification, administration--I think that's a pretty steep cut. So, for bonds, I'd suggest that individuals should steer away from mutual funds.
BARBARA BOWLES' PICKS
Pittston Brinks (NYSE: PZB): A security company that makes alarms and protects ATMs. Earnings are growing at 15% and the P/E is 16.
Illinois Central (NYSE: IC): Railroad offers 10% growth at a cheap P/E. It boasts strong management, and could be a take out candidate. Stock sells at a low P/E and yields a beefy 2.5%/
Med Partners (NYSE: MDM): Healthcare company that is growing at 20% but sells at a modest P/E of 18.
FRANKIE HUGHES' ADVICE
With the yield curve almost flat, Treasury bond investors aren't going to pick up much incremental yield for incurring the risk of longer-maturing bonds. Currently, it's best not to opt for maturities past five years, unless you have a specific goal that you're saving for, such as tuition or retirement. You might also consider inflation indexed bonds. For investors who want to dip into corporate debt, Lehman Brothers looks like a good bet.
NATHANIEL CARTER'S PICKS
Kmart (NYSE: KM): This turnaround retailer is setting things straight, tidying up stores and focusing on its core business. Stock could jump from $12.50 to $20 a share.
John Deere (NYSE: DE): An agricultural equipment maker that's tapped into overseas markets, yet trades at a modest 13 times earnings.
American Express (NYSE: AXP)/ Lehman (NYSE: LEH): Amex has a great travel franchise, and is starring to regain ground in credit cards. The premier bond firm on Wall Street, Lehman's cheap and could be bought out.
DAWNA EDWARD'S PICKS
First Data Corp (NYSE: FDC): A top financial transaction processor growing at 18%.
General Electric (NYSE: GE): The largest of the large cap stocks is growing at a robust 14%/ Management's keeping an eye on costs and is sitting on $7 billion in cash.
General Nutrition (Nasdaq: GNCI): This health food empire has the malls covered and taps into the needs of health-conscious baby boomers to fuel a 20% earnings growth rate.
ROBERT LAMB'S PICKS:
Metacreations (Nasdaq: MCRE): A graphic software into the entertainment and engineering fields to fuel an earning growth of 25% or greater.
Cisco System (Nasdaq: CSCO): A lending networking company working overseas markets for almost half its revenues to propel at a 30% growth rate.
Cuter & Buck (Nasdaq: CBUK): This high-end sportswear maker is trading at a market P/E, yet growing. It makes high-end sportswear, particularly golf shirts. We're hoping that the company can ride the Tiger Woods phenomenon. The stock tradesa at a P/E in the low 20s, yet earnings growth is almost 30%.
Charles Schwab (NYSE: SCH): A finance-for-the-masses outfit benefiting from America's investing craze, particularly as the boomer age.
|Printer friendly Cite/link Email Feedback|
|Title Annotation:||Investment Roundtable; five Black investment advisers: Frankie Hughes, Robert Lamb, Dawna Edwards, Nathaniel Carter, and Barbara Bowles|
|Article Type:||Panel Discussion|
|Date:||Oct 1, 1997|
|Previous Article:||The feeling is mutual: a bevy of Black-managed mutual funds is bringing new investors into the market. B.E. checks out what they have to offer.|
|Next Article:||It's a family affair.|