Sticking to the Fundamentals


Where does a hedge-fund manager look for investments in this market? The answer for James A. Bitzer, senior portfolio manager of EGM Capital, is a selection of retail, tech, and health-care stocks. The strategy he oversees at EGM, combining long and short positions in equities, produced a 30% gain last year.

Bitzer thinks Federal Reserve easing will save stocks from deep shocks, though it will still be a "bumpy ride" because of problems with fundamentals such as corporate earnings. The stocks he likes now in retail include Abercrombie & Fitch, BJ's Wholesale Club, and Family Dollar Stores. In the category of "special situations" and turnarounds he puts Mattel and National Data.

Bitzer commented on the market and his strategy in a chat on Jan. 25 presented by BusinessWeek Online on America Online. He was responding to questions from the audience and from BW Online's Jack Dierdorff and Amey Stone. Edited excerpts from the chat follow. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.

Q: Jim, it was a red-letter day for blue chips, but the seeming tech rally sort of ran out of gas. How does the market look from where you sit?

A: Very interesting market right now. Clearly, the fundamentals for many companies are shaky. They're either missing fourth-quarter numbers or giving lower guidance.... The Fed's cutting rates, but fundamentals are deteriorating. So that can make for quite a bumpy ride.

Q: Can you clarify the outcome of "bumpy ride"?

A: My gut feeling is that the market will probably do reasonably well given the Fed's likelihood of continued easing. However, we're not trying to predict the market. We're buying stocks whose fundamentals we like, and we sell those with deteriorating fundamentals. So I'm more interested in the individual securities than I am in trying to predict overall market movement.

Q: Can you explain how a hedge fund differs from an ordinary mutual fund? I gather you have pretty strict limits on who can invest?

A: Yes, only qualified investors or accredited institutions can invest in hedge funds. Hedge funds actually short stocks and buy stocks, making them less volatile than the market or a typical mutual fund.... A good hedge fund should be able to make money whether the market's up or down. For example, the strategy I oversee was up 30% last year when all major indexes were down.

Q: How does an investor qualify to participate in one? How many millions?

A: Qualified investors need $1.5 million in assets and experience in the markets and a reasonably high income -- something above $200,000 annually.

Q: What's the strategy you use?

A: EGM has five separate strategies. Three hedge-fund strategies, a high-yield-bond strategy, and a long-only small-cap strategy. The strategy I oversee is EGM's long/short growth equity product, which has the largest amount of assets.

Q: What percent are you in cash vs. your longs/shorts?

A: Right now, the gross investment of the strategy is 70%. The remaining 30% would be cash.

Q: Why are you holding so much cash -- 30%? Lack of opportunities?

A: It relates to the difficult environment. We want to buy companies with strong fundamentals, and most of last year was short due to declining fundamentals across many industries. That list is beginning to get longer, and our number of long names is increasing each week.

Q: What sort of things do you look for when shorting a stock -- and what are you shorting now?

A: The things we look for are deteriorating fundamentals -- things like decelerating sales and EPS growth, falling margins, and declining returns on capital. So we're looking for a highly valued stock that has a way to fall. We don't like to talk about specific names that we're short but would suggest there are some excesses in technology where the fundamentals are deteriorating rapidly.

Q: Jim, can you tell us some of the companies you like these days? You mentioned that your list of long names is getting longer.

A: Cyclical names -- those that would respond to Fed easing -- include retailers, and there are many high-quality ones to choose from. Some that we like and are looking at include Family Dollar (FDO), Abercrombie & Fitch (ANF), and BJ's Wholesale Club (BJ), just to name a few.

Q: Why do you like retailers if there's a possibility that a recession in the second quarter could spoil the year?

A: If there's a recession, almost all companies across all industries are likely to miss their numbers. But as long as Greenspan keeps lowering rates, people are likely to look through weak near-term earnings of retailers to what are the expected better days ahead.

Q: Do you think it's time to get out of telecom -- Nokia (NOK), Ericsson (ERICY)?

A: No. The growth of cell phones and its infrastructure means it's a good place to be. The stocks seem to reflect the near-term uncertainties.

Q: Jim, what do you think of storage stocks? Are there any small-cap names you're focused on? Any up-and-comers that could be competition to EMC (EMC) or Brocade (BRCD)?

A: Last year, we did quite well owning some of the fiber-channel plays, including QLogic (QLGC) and Emulex (EMLX). However, we're currently not involved in that sector.

Q: What three things are paramount for a stock to rate consideration for an EGM hedge fund?

A: Good question. First: Improving fundamentals. Two: We like to see a good business -- good management, positive cash flow, little debt. Third: It has to have at least 50% or more appreciation potential.

Q: How's appreciation potential figured?

A: We actually look at the future earnings potential and apply a reasonable p-e multiple to arrive at price targets.

Q: Do you do any global investment plays or currency plays à la Soros?

A: Absolutely not. Everything EGM does is domestically focused.

Q: Fill us in on the sectors you like best for now.

A: One is retailers, which I mentioned. We're nibbling at selected tech stocks. We still have some health-care exposure, and we have a number of special situations or turnarounds.

Q: Any specifics on special situations and turnarounds?

A: Two of them we like right now include Mattel (MAT), with a new management team, and Barbie, Hot Wheels, and Fisher-Price had a relatively good Christmas. The other is National Data. NDC is splitting up into two companies in February, and this will truly be an example where the two parts are worth significantly more than the whole.

Q: What are your favorites in health care?

A: We like some of the nursing homes and Quintiles Transnational (QTRN).

Q: Can we pin you down to two closing forecasts? The interest-rate cut next week -- 1/4 or 1/2 percentage point? And what kind of numbers could we see on the Nasdaq and Dow by June?

A: My guess is a 25-basis-point cut and 11,000 on the Dow and 3,000 for the Nasdaq.


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