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Get Four
|  | JULY 19, 2005
The Acid Test: Good GovernanceGreat Companies' James Huguet thinks there is nothing more important than transparency -- the reason he likes GE, Motorola, and MicrosoftTo spot the best stocks for your long-term portfolio, check the quality of corporate governance. That's the strategy of James Huguet, co-CEO and chief investment officer of Great Companies, which manages the TA IDEX Great Companies-America fund (IGAAX ). He recommends looking for a strong outside board of directors and how the company handles financial disclosure, among other factors. Another criterion, Huguet says, is to measure an outfit's intrinsic value against the market price of its shares, which preferably should be at a discount to value. This approach appears to have had a long-term payoff: Since the fund's inception in 1998, it has done 15% better than the S&P 500 index. Huguet reports that his biggest holdings include General Electric (GE ), First Data (FDC ), and Medtronic (MDT ). He also looks for potential turnaround situations such as Hewlett-Packard (HPQ ), Motorola (MOT ), and Prudential (PRU ). A recent acquisition in the technology area was Logitech International (LOGI ). These were a few highlights of an investing chat with Huguet presented July 14 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a full transcript at aol.businessweek.com/chat Q: Jim, the stock market did a little better today -- what's your outlook? A: We're really positive on the market. As we look at it, we see a strong dollar and strong economic reports. Despite the fact the Fed is raising rates, we have a strong economy, and we're positive on the way things are looking right now. Q: How do you see the earnings season shaping up? Looks like tech already has some good news from Apple (AAPL ) and Advanced Micro Devices (AMD ). A: Yeah, we think earnings are going to be strong.... Our biggest caution is the price of oil -- if oil can stay in check and end around the low $50s, we should do quite well. But even with the high oil prices, companies are hanging in there and doing just fine, so unless there are some huge surprises, we think earnings reports should be on target for the most part through the end of the year. Q: What companies would you buy for the long term? Maybe you can give us some names that attract you because of quality of corporate governance. A: We tend to be long-term investors in general, so when we look at companies, we look for ones we'd own for five years. We like General Electric right now. We have recently added Hewlett-Packard to our list -- with their new management they'll get stronger. We like Fortune Brands (FO ) -- very well-positioned, well-managed company. One of the recent additions we've made to our tech portfolio is Logitech International -- very well-positioned, and one of the better-managed tech companies out there. We also own Genentech (DNA ) -- we really like them. Electronic Arts (ERTS ) is an excellent company that we've owned for a long time. So there are quite a few companies across a variety of sectors that we like. PepsiCo (PEP )is another, as is Colgate-Palmolive (CL ). Colgate has generally done well over a long period of time -- they hit a slow period but have come out of that and have done well for some time. Q: How do you know when to buy and when to sell? A: Well, there are several things we consider. We look at the market price of the company relative to intrinsic values. Those at discounts to value are attractive. We also look at a company's return on invested capital -- somewhere in the 8% to 10% range is desirable. We also like companies that have returns on capital above their cost of capital. Essentially, we're looking for companies making money. We also like those that are in turnaround situations -- say a new CEO has come into the company who can take the company to a new level. Look at Prudential (PRU ), where that has been the case. Look at HP, Motorola. We think Motorola's new CEO is going to do a tremendous job. So we like those situations where the basic fundamentals are in place, but the companies just needed a great leader.... When companies are closing in on their intrinsic value, we'll reduce our position in the company -- if not sell it outright, then take it down to market weight. We'll also sell if there are major changes in corporate governance. That's our main screen, really -- What's their corporate governance? Our sell discipline really looks at the company and says, "Has something materially changed?" -- corporate governance, value, these key factors. If the governance has changed for the worse, we won't hesitate to take them out of our portfolio. Q: What do you think about the Procter & Gamble (PG ) and Gillette (G ) merger? Is PG worth buying? A: I think PG is the best-managed consumer-products company in the world. The addition of Gillette makes PG an even stronger company. With PG's marketing and sales power, they'll do even better with certain products, like Duracell, than Gillette did. Add the fact that you've got Warren Buffett saying he's going to put more money into PG, and you've got another sign that this is a terrific company to own right now. Q: How do you feel financials will do over the next few months, JP Morgan Chase (JPM ) in particular? A: We like financials, and JPMorgan is an interesting company. The new CEO there has proven himself in those kinds of situations, and we have a lot of confidence in him as a manager. However, we don't think the credit-card business is as attractive as it has been. I wouldn't be surprised to see the folks at Morgan Stanley (MWD ) get rid of Discover Card. Of all the sectors out there, though, the financials have expanded faster than any other sector in the S&P 500, from 6% in 1975 to over 20% right now. We like financials, but the challenge there is to really accurately calculate their intrinsic values.... We like Goldman Sachs (GS ) a lot right now. Morgan Stanley has an opportunity to turn around right now as well. But overall, we like the sector very much. Q: Any comments on Bank of America (BAC )? Or on its MBNA (KRB ) deal? A: I think BAC has done a terrific job positioning itself through the various acquisitions it has made. I'm not as crazy about the MBNA deal as some others -- it's a decent move, but not a home run. I look at BAC as a company that has done a tremendous job building their franchise and has made some tremendous acquisitions. This isn't their best, but it won't damage the company either. Q: Your thoughts on Citigroup (C )? A: Citigroup, if you look at it from a financial standpoint, the market price is around $46. The company's intrinsic value, according to our estimations, is $64. So that's a tremendous discount. We also look at something we call "perpetuity value." It's like the ongoing value of a company, if it were not to increase its sales or do anything different. For Citigroup this is still $51, higher than the market price. From a valuation standpoint this is a real opportunity to buy a well-performing company at a discount to just about any sort of value metric you could use. This is something you don't get to do very often. However, the company is still having some corporate governance issues -- they're doing the right things, but there are people who are concerned that the company is not doing enough.
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