SEPTEMBER 3, 1999
about bad times. Veteran stock picker David Schafer can't remember
a rough patch as long as the one he's been in for the past two years.
Strong Schafer Value Fund (SCHVX)
last year lost 6.6%. This year through August it's down 15.6% -- among
the worst in its class -- and assets in the fund, once more than $1.5
billion, have shrunk to less than $950 million.
In the Dumps with David Schafer
The veteran stock picker says he's "made some mistakes,"
but he's hanging in there |
Plenty of funds do miserably, but Schafer had rolled up an enviable
record since opening the fund back in 1985, beating comparable funds
by an annual average of more than two percentage points through October,
1997. Now, though, Morningstar says "the fund's glory days are swiftly
retreating from view."
What went wrong? What's Schafer doing about it? And is he ready to
call it quits? He answered all those questions and more when I caught
up with him recently by phone at his home in Jupiter, Fla. Edited
Q: You've really hit the skids here. What's going on?
A: Number one, we've made some mistakes on stocks, although that's
nothing new. Every year we make mistakes on stocks. Maybe we made
a few more, or maybe they were treated a little more harshly than
they might've been in years past. That's one issue.
A: Also, the extreme narrowness of the market. I think in 1998,
if memory serves me correctly, 15 stocks accounted for 51% of the
move in the S&P 500. And we owned one of those: Ford Motor (F,
$50.94). The other 14 we couldn't have owned even if we had been smart
enough to pick 'em because they were basically high-P/E, high-growth
stocks, as opposed to low-P/E, high-earnings-growth prospects, which
is what we look for.
A: The mid-cap stocks have really generally over this period of
time not performed very well.
Q: I see.
A: Finally, we had bought some oil stocks, and we sort of focused
on the large drilling-rig group of stocks...
Q: ...such as?
A: Falcon, or what was Reading & Bates when we bought it and became
R&B Falcon (FLC,
$13.75) and Diamond Offshore (DO,
$37.31).... The price of oil got down to slightly below $10 at one
point, and it hovered around there in the very low double-digit level
and...it didn't augur particularly well for the earnings of these
companies. And one of the things that we try to have on these companies
is rising earnings, and better than the S&P over the next two or three
years, as well as a price-earnings multiple that's below the S&P 500.
So, my feeling was, O.K., you're going to see declining earnings and
reduced estimates on these companies. So, therefore, it doesn't make
a lot of sense to hang on to these. Well, we sold them at absolutely
the wrong time. These stocks have had a real run.
Q: Do you count that, selling the energy stocks, as your most egregious
A: Probably, because it was six, seven, maybe eight percent of
our portfolio. So it was bigger than any one error that we made in
an individual stock.
Q: What other individual stocks disappointed you?
A: Probably the biggest one was a company called Cadence.
Q: Cadence Design Systems (CDN,
A: Yeah. I think it is still a pretty good company, but they were
a little bit late in coming in with the next generation of products,
and more importantly they had a change in accounting rules.... This
gives them a higher-quality of earnings down the road, but it caused
a dislocation. And the stock just really got hammered and we're down
probably 50% on that stock. We looked at it, and we thought, this
is probably shutting the barn door after the horse has been stolen
if we would sell it at this point, so we still own the stock.
Q: What stock is your biggest holding now and why?
A: Well, we equal-weight our stocks, so whatever stock has done
the best the last few days generally is the largest one in the portfolio.
We take a 3% weighting now. We've got about 33 or 34 stocks in the
portfolio. I think Merrill Lynch (MER,
$75) is our largest holding, but not by a whole lot.
Q: What's to like about Merrill?
A: Merrill has gotten batted down quite a bit. We bought it when
it was getting batted down the last time, probably a year, year and
a half ago. Our feeling is we're not looking at this as a takeover
play, the way some people are. We would look at that as the icing
on the cake if it ever happens.
A: It's the largest brokerage firm, and they've done a pretty
good job of asset gathering. And, again, the quality of their earnings
has been greatly enhanced by the buildup of their asset management
business over the years. They've got this question of what they're
going to do on the Internet. They've got the $29.95 [per trade] program,
but I suspect they'll come out O.K. on this, and they may take a little
bit of a hit on earnings, because maybe they used to get $99 a trade
or $129 a trade, and now they're getting less. But it's the best-managed
company in that business -- that's probably not saying a whole lot!
Q: ICN Pharmaceuticals (ICN,
$20.94) is a new holding. Why?
A: We got in too early on the thing, but it still has pretty good
possibilities because of one product, which is one that Schering-Plough
$53.50) is doing the marketing on. It's a combination product for
hepatitis. The product will probably do well in excess of $500 million
in revenues this year. It also has some potential competitors.
Q: Mylan Laboratories (MYL,
$18.88) also is a new holding. What's the story?
A: There are an awful lot of drugs that are coming off patent
over the next three or four years. Twice what had come off over the
last four years. And these guys are the first or second generic drug
manufacturer, and there should be plenty of opportunities for them
to grow their earnings, and with the pressure that you've seen on
drug prices, that might help them also, just by fostering the use
of more generics.
Q: One more new one, Raytheon (RTNB,
$68.12). What's to like about it?
A: The defense business has had a declining budget for something
like 10 years in a row, and our feeling was that this is not going
to go on forever. The more hot spots you have around the world, the
more it points out that you really need to be ready. You don't need
atomic bombs or nuclear, but just electronic gadgetry and warfare
that helps you keep on top of things is very important. It's been
a growing business over the last decade or so, and these guys are
right on top in that.
Q: I see. The biggest of them all, Lockheed Martin (LMT,
$36.81) also qualifies as a value stock.
A: We own that one. Same thesis.
Q: Others in defense?
A: We don't own Boeing (BA,
$44.94). I get tempted from time to time on Boeing, but I haven't
done anything with it.
Q: In the course of this past two years, have you had to sell stocks
to handle shareholder redemptions?
A: Yeah...but while you're having to sell something, you're only
selling a few thousand shares here or a few thousand shares there.
I wish I could blame the underachievement on something like that,
but in my own mind I think that had almost nothing to do with it.
Q: Do you find yourself questioning the potential for beating the
A: It certainly makes you think about it. When I see what's going
on in the market, I'm a little bit flabbergasted. And yet I'm not
ready to give up and say value [investing] doesn't work anymore. It
sure hasn't worked. But there hasn't been a five-year period that
I've been in this business in which we didn't have some time when
we were fairly severely out of favor. This is the longest period.
I guess late '89 and the first three quarters of '90 was the longest
period prior to that. Then, if you looked at the three years or so
after that, they were outstanding years for value, both on a relative
and an absolute basis.
I'm not ready to throw in the towel yet. I must say it gets a little
discouraging from time to time, because nobody likes to lag the benchmark
or have negative numbers. I don't like it from a shareholder standpoint,
and I'm a shareholder also.
covers personal finance in his weekly column, The Barker Portfolio,
for Business Week from Melbourne Beach, Fla. And he appears every
Friday on Business Week Online
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BY DOUGLAS HARBRECHT