Old Hands Make Wise Moves


By James A. Anderson After four rate cuts by the Federal Reserve so far this year, some market watchers think stocks may have finally hit bottom. John Gunn, portfolio manager for fund company Dodge & Cox, isn't so sure.

"A lot of investors sound like kids riding in the backseat during a long road trip," he quips. "They keep asking: 'Are we there yet?'" Gunn says for all investors' talk about it, he's not sure a lot of them would know a real bottom if it smacked up against their shoe leather. "To me, that's a time of fear, a time when you hear a lot investors speak of utter desperation, and we haven't seen much of that," he says.

PROFITING ON FALLS. However close or far the market may be from its low point, the numbers show that Gunn and his cohorts indeed know how to make money -- even when things are still on the way down. Two Dodge & Cox funds appear on BusinessWeek's top-rated A-list: The Dodge & Cox Stock Fund (DODGX), an equity portfolio with an emphasis on value stocks, and the Dodge & Cox Balanced Fund (DODBX), which combines the stock fund's selections with a weighting in fixed-income investments (see the March update at BW Online's, Mutual Fund Scoreboard). Both have done well, even as the broad market has crumbled this year. At the market's close on Apr. 20, the Stock Fund was up 5% this year, compared to a 4.8% loss for the Standard & Poor's 500. The Balanced Fund has returned investors 4.3% for 2001 by the same date.

In 2000, the Stock Fund's 16.3% total return was more than 25 percentage points better than the S&P 500's performance, and Balanced turned in a solid 15.1% during the year. And the 10.1% and 9.7% Gunn and associates have recorded over the past three years for the Stock and Balanced portfolios, respectively, sure beat the benchmark's 3.7% performance during the same period.

Gunn credits the Stock Fund's showing last year and success early in 2001 to holdings that were left out of the market's stampede. "Look back, and you'll see the market carried a 14.5 multiple at the end of 1994 and one in the low 30s by 2000," he points out. "That was simply a period of an enormous amount of growth-stock speculation that powered the market."

The upshot, Gunn says, was a three-tiered equity market. The top third, made up of New Economy technology and pharmaceuticals stocks, sported multiples of 60 times earnings. It was an area Dodge & Cox skipped over altogether. Next came a strata of Old Economy consumer products that were growth-investing favorites -- the Coca-Colas, Procter & Gambles, and General Electrics -- that traded at an average 30 times earnings. The firm invested maybe 10% of its portfolio there. Finally, the bottom: A place filled with unloved companies that mustered share prices at 15 times earnings or less. That's where Gunn says Dodge & Cox parked the rest of its equity-fund assets prior to last year's stock market tumble.

UNEARTHING GEMS. That neglected corner of the market yielded a number of bargains, especially in finance stocks. At the end of 2000, the fund's two largest weightings were in Golden West Financial (GDW), a stock that had rocketed some 102.6% in 2000, and Bank One (ONE), which rose 19.2% in 2000.

Some Old Economy stalwarts also made the grade, including transport giant Union Pacific (UNP), which climbed 18.5% last year. And finally, a number of oil shares helped the fund's fortunes. Phillips Petroleum (P), up 24.4% in 2000, and Occidental Petroleum (OXY), up 17.6% during the same period, were among the fund's largest holdings at the end of last year.

As much as Dodge & Cox stresses value, Gunn is quick to emphasize that other factors come into play. After looking over price-to-sales ratios, the fund then evaluates a company's franchise and ability to sustain profit margins over time. As a result, Gunn says, the firm's equity portfolio might span a wide range, from dirt-cheap turnaround plays like Kmart (KM) or Xerox (XRX), which sell at a fraction of their overall sales, to pharmaceutical concerns, whose stocks might command as much as four or five times revenues.

The hunting has led Dodge & Cox to places that didn't see much sunlight in the latter half of the '90s. One broad group Gunn especially likes is industrial commodities. "They're the type of companies that provide basic infrastructure items for modern economies," he explains. One example, heavy-machinery maker Deere & Co. (DE), turned in a respectable 8.1% total return in 2000, although the stock stumbled in 2001, with a 13.2% drop so far. Other examples are Dow Chemical (DOW), which has backtracked 5.3% in 2001, and Alcoa (AA), which has enjoyed a 20.9% rally so far this year.

Gunn thinks the group as a whole is positioned to do well the next few years. "We just think prospects longer term are good for global economic progress -- they may slow down during the next year, but they look good over a four- to six-year time frame."

LITTLE EXPENSE. True to Gunn's word, the Dodge & Cox crew takes long-term investing seriously. The fund's turnover is a microscopic 18% a year. Morningstar data show that its peer group, large-cap value funds, average a frothy 87% a year by comparison. In turn, that steadfastness has kept fund costs low: Dodge & Cox Stock Fund posts a 0.54 expense ratio while large-cap value offerings in general average 1.4%, according to Morningstar.

"The Dodge & Cox funds have found a great value formula and have done quite well recently sticking to oil, financials, and industrial cyclicals," says Morningstar analyst Catherine Hickey. "Another important thing about these funds is that they're run so cheaply that more investment returns make their way to shareholders' pockets. The low turnover, too, makes them very tax efficient."

Dodge & Cox doesn't hold onto stocks just for the sake of keeping turnover figures below those of the competition, however. "There's a difference between what we do and being stubborn," says Gunn. "We look over the portfolio regularly and ask ourselves: `Would I invest in this stock with an all-cash account?' If the answer's yes, we stick to our position."

If there's a stock that Dodge & Cox managers have had plenty of occasions to scratch their heads over, it's the troublesome retailer Kmart, which the firm started investing in from the late '90s. But after undergoing a number of corporate makeovers and management recastings, the stock has paid off very well this year, with a 76% advance. "This is a stock that really exemplifies our strategy," says Gunn. For one, Kmart sells at a little over 10% of its sales, a valuation that Gunn says is a mere tenth of discount powerhouse WalMart (WM). He also says the fund would still buy into Kmart shares and did so as recently as December.

NO MO. Dodge & Cox's sangfroid might be just the tonic to weather this year's market. Gunn chalks it up to experience: Of the 27 people that make up the firm's investment-management team, Gunn counts 5 with 20 or more years' of experience. He makes sure, however, to credit the fire of some of Dodge & Cox's newer members. "Things can get heated when we're discussing new positions," he admits.

But no matter how animated the exchanges might get, one thing the San Francisco money-management firm isn't likely to change is its steely resolve. Gunn deadpans: "I guess you couldn't call us momentum investors." Anderson teaches journalism at the City University of New York. Follow his twice-monthly Mutual Fund Maven column, only on BW Online


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