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|  | OCTOBER 12, 2004
"Value for Value's Sake Is Not Enough" Farr, Miller & Washington's Michael Farr says he aims to find cheap stocks and build portfolios that will weather short-term uncertainty "A professional manager's job should include admitting that one doesn't know what's going to happen over the next 6 to 12 months" -- and then constructing a portfolio that can endure good times and bad. That's the philosophy of Michael K. Farr, president of investment firm Farr, Miller & Washington. "I'm still essentially trying to find cheap stocks and hold them for the long term," says Farr, who looks for strength in management, earnings, return on equity, and balance sheets, among other things. Some of the stocks Farr likes now are Teleflex (TFX ), Staples (SPLS ), CVS (CVS ), and Johnson & Johnson (JNJ ). The latter is a pharmaceutical outfit he considers stronger than its peers because of its position in medical equipment. On the market in general, he sees it as "stuck in an emotional range," despite positive data, with consumers continuing to spend but Corporate America holding back. Farr considers oil's high price a threat that could make another recession unavoidable. However, he says, any downturn could be alleviated by the strong corporate fundamentals and the reasonable valuation of many stocks. These were among the points Farr made in an investing chat presented Oct. 7 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. A full transcript is available on AOL at keyord: BW Talk. Q: Michael, there's a familiar refrain these days, that the market is stuck in a trading range. Do you agree? A: I think that the market is stuck in an emotional range. In spite of positive economic and earnings data, in spite of enormous amounts of cash on the sidelines, and in spite of rather loose monetary policy, investors don't want to buy. The CEO Roundtable reported this morning that CEOs were cautious because of their concerns over the consumer. That really struck me as the pot calling the kettle black. Consumers continued to support the economy through the downturn when Corporate America was nowhere to be found. Consumers continue to spend, but we still hear excuses and see hand-wringing from executives who refuse to jump back in. Q: Why are CEOs so concerned about consumers? Household spending seems to be holding up, even with high oil prices. A: That's what I find so irritating. I think the CEOs, by and large, are looking for an excuse. It makes sense that consumers will slow down at some point. Consumer debt levels are high, and should interest rates rise, the housing market could slow down, home-equity loans could move out of reach, and large amounts of accumulated credit-card debt could represent significant burdens that could slow consumers' appetite. All of that said, Corporate America has been very slow in resuming capital expenditures and investments in corporate infrastructure. Q: So the climbing price of oil doesn't concern you? Just another excuse? A: No, you've just hit my Achilles' heel.... The price of oil is a major concern, and if it doesn't retreat, recession seems unavoidable. If this continues, we will see, I think, a very different experience from the last recession, because corporate fundamentals are so much stronger, and market valuations are already fairly reasonable. Q: Are you buying any new stocks lately? What are your favorites? A: I like Teleflex. On the pullback, they've been very attractive. At around 15 times earnings with 11% earnings growth, it has been a very well-managed company, and with a 2% dividend, I like it a great deal at these levels. I listened in when one of our analysts went to a Staples analyst meeting. I like them as well in spite of their price. Their growth rate of 20% looks real, and we expect good performance from those shares in the next 12 months. CVS is another consumer name that we're continuing to buy -- again, at 17 times earnings, growing their earnings at 12%, this is a company executing well. We're still buying Johnson & Johnson, First Data (FDC ), Nokia (NOK ), Bank of America (BAC ), St. Paul Travelers (STA ). Q: What's your general strategy right now? A: You will hear some portfolio managers come up with their economic forecast, and from there derive their strategy. If from there, things work out, they look like geniuses, but if they don't, they explain which variables didn't behave. I look at this as almost fraudulent. In my opinion, a professional manager's job should include admitting that one doesn't know what's going to happen over the next 6 to 12 months and constructing a portfolio that will both enjoy and endure a rise or fall. That said, we continue to try to strengthen our portfolio of companies with very strong management, strong fundamentals, superior earnings, superior return on equity, and solid balance sheets that are diversified but not overly diversified, with the hopes of outperforming in both up and down markets. I'm still essentially trying to find cheap stocks and hold them for the long term. Q: What do you think of General Electric (GE )? It's reporting earnings tomorrow. A: I like GE very much. I think we're seeing a rebound in several of its business units, and certainly the '05 estimates are looking better and better -- 11% growth year over year, and that's a conservative estimate. GE is economically sensitive, as we saw during the last recession. If the price of oil doesn't diminish, GE will probably not drop a great deal more, but I wouldn't expect tremendous appreciation, either. If the economy moves ahead, it looks like a great buy at these levels with its decent dividend. I own it in almost every portfolio I manage.
BW MALL
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