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Get Four
|  | JUNE 7, 2005
Large-Caps at Not-so-Big PricesFarr, Miller & Washington's Taylor McGowan makes value his watchword. It's the reason, he says, why he likes Bank of America, GE, and Wells FargoFor all the confusion about which way the market is going, there are still attractive stocks to buy, in the view of Taylor McGowan, vice-president and portfolio manager of investment firm Farr, Miller & Washington. In any case, says McGowan, "we don't spend too much time trying to determine the position or direction of the whole market." His firm seeks industry leaders on a bottom-up basis, basically large-cap stocks at a reasonable price. Among its recent acquisitions is Education Management (EDMC ), which McGowan says is growing three to four times faster than others in the for-profit education market. And he's adding to his outfit's position in American International Group (AIG ), on the theory that its $40 billion loss in market capitalization is out of proportion to an accounting error of less than $3 billion. Beyond those specific stocks, McGowan says he's spotting buys in health care, tech, consumer cyclicals, and financial stocks such as big banks Bank of America (BAC ), Citigroup (C ), and Wells Fargo (WFC ). These were a few highlights from an investing chat with McGowan presented June 2 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff and Karyn McCormack. Edited excerpts follow. AOL subscribers can find a full transcript at aol.businessweek.com/chat. Q: Taylor, how do you see the market at this point in history? A: At Farr, Miller & Washington, we're bottom-up stockpickers -- thus we don't spend too much time trying to determine the position or direction of the whole market. However, the p-e multiple of the S&P 500 has fallen to less than 17 times forward earnings, a level slightly above the often-cited long-term average multiple of 15 times. These aren't bargain-basement valuations, but they appear appropriate, given the low level of interest rates. Q: What do you make of the rally in the bond market, with the yield on the 10-year falling to 3.9%? Do you pay attention to bonds? A: We definitely pay attention to bonds, for two reasons. First, the bond market affects the stock market, and second, we have plenty of clients with balanced accounts. We're definitely nervous about the movement in the 10-year Treasury. We're nervous because the yield curve, which is the spread between short-term interest rates and long-term rates, has flattened out significantly. History is a good guide -- if the yield curve becomes inverted, we're very likely to have a recession. The buyers of long-term Treasuries are clearly signaling that they're not concerned about inflation and that economic growth may be slower going forward. Q: On a bottom-up basis, what's most important to you now? And to what kind of stocks does that lead you? A: We're fairly consistent in terms of what we look for in a company. We look for companies that are industry leaders in attractive industries; companies that have solid historical financial track records -- specifically, companies that grow sales and earnings per share well above the average company in the market. We also look for companies that have solid balance sheets, create high returns on capital, and have significant free cash flow. Finally, we try to buy these companies at reasonable valuations. We continue to find attractive investments in the health-care sector, we're finding attractive stocks in the tech sector, in consumer cyclicals, and even the financial sector. Q: Are you making any new purchases? Or adding to existing ones? Just want to see if you're in a buying mood these days. A: We're still finding attractive stocks to buy at these levels. We've recently purchased a company called Education Management (EDMC ). They're one of the leaders in the for-profit education sector. The entire sector was hit with negative news recently regarding aggressive marketing tactics, especially some of Education Management's competitors. The entire education stock sector has sold off. EDMC is probably the most conservative way to play this trend in for-profit education, however, given that it's still growing at three to four times the rate of the rest of the education market. In terms of positions we're adding to, we're adding to our position in American International Group (AIG ). We believe that the sell-off that has accounted for over $40 billion in market cap is way overdone for an error in accounting that was far less than $3 billion. We're also adding to Waters (WAT ), which we've owned for several years. The stock isn't inexpensive, but they missed earnings in the first quarter, and we believe it's a good buying opportunity. Finally, we're also adding to our current positions in Colgate-Palmolive (CL ), First Data (FDC ), and IBM (IBM ). Q: You used the phrase "even the financial sector" -- what do you like (or dislike) there? You cited AIG. A: Well, we're definitely committed to the financial sector for the long term. We like the large-cap, diversified banks, such as Citigroup (C ), Bank of America (BAC ), and Wells Fargo (WFC ). These stocks are all offering dividends between 3% and 4% and trade at p-e multiples that are discounted relative to the market. Still, we're concerned about the sector overall because of the flattening yield curve, which makes it harder for these companies to grow earnings. In addition, we have concerns about the status of the housing market in the various coastal areas. We believe that a significant slowdown in these areas could significantly affect bank earnings. Therefore, we believe this is an especially good time to own a larger, more diversified, more conservative bank in the sector.
BW MALL
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