Stress for Success


Just two years ago, value investors -- cheapskates who buy stocks only at sharp discounts to the worth of their underlying businesses -- were widely ridiculed. Even the best of them, such as the group running Mutual Series Funds, were scorned by growth-stock partisans as being hopelessly out of touch.

It turns out that two years ago would have been a perfect time to buy value-stock funds. Today, Mutual Series' six funds are going great guns while growth-stock funds are falling by the wayside. The $7.5 billion flagship Mutual Shares (MUTHX), for example, is up 1.6% this year, while the Standard & Poor's 500-stock index is down 14.4%.

Since investing styles come in and out of market favor, there's an unavoidable question: Is value investing now reaching a peak? Not at all, says David Winters, Mutual's president and chief investment officer. To find out why not, I reached Winters the other day by phone in his Short Hills, N.J., office. Here are edited excerpts of our discussion:

Q: Your style of investing had been dragged off to the ash heap by many mutual-fund investors, and now all of your funds are sitting on five-stars from Morningstar. Why the turnaround?

A: We didn't get sucked into the silly euphoria, nor have we gotten sucked into the incredible fear that has existed at times. We just continue to do what we do.

Q: Which is?

A: We buy cheap stocks. We do [merger] arbitrage. We do bankruptcy investing. If you had invested with us three years ago, you would've made 12.5% or 13.5%, compound. If you had invested in an index fund -- which at one point was all the rage -- you've made no money. And if you had invested in most growth funds, you've probably lost money.

Q: These things move in cycles. With value funds beating the market, does that indicate maybe this isn't the right moment to put a disproportionate amount of money in value investing?

A: The way that we approach value investing, it's almost always a good time to invest with us. We may go out of favor, but even in bad times we preserve people's capital.

Q: There are so many businesses in trouble right now. Are you salivating at the possibilities? A number of firms will have to be reorganized or go through some kind of bankruptcy.

A: You never want to be gleeful about anybody's financial problems, but I would say we think there will be tremendous opportunities in the bankruptcy-and-reorganization area. And part of the reason the funds have done well this year is because of our activities in the bankruptcy area.

Q: What's a good example?

A: Finova (FNV) is probably the best. The other one is Pacific Gas & Electric (PCG) -- the whole California utility debacle. It's been very profitable for us.

Q: Have you been buying equity as well as debt?

A: We do [also] own the stock of PG&E. It was a classic case. We first got involved in the most senior bonds, and as you get more comfortable, you buy more subordinated bonds. The situation with PG&E was that there were assets that protected our downside, and we felt there was upside in the re-org.

Q: Other opportunities?

A: At some point, the deal market will come back. Companies will be looking to buy growth. So we're constantly looking for the pieces of the puzzle that will be attractive to an acquirer.

Q: What companies or industries are you focusing on now for prospective takeovers?

A: It's hard to know exactly what's going to be taken over, but we sometimes view the New Lows list as a shopping list.

Q: Are you looking in the technology area -- where some former three-digit stocks are now go for one digit, and often low ones at that?

A: We've never been big technology investors. [My predecessor as chief of Mutual] Michael Price years ago did Storage Technology (STK) when he was able to buy the claims at a big discount to the receivables. Because technology has been such a disaster, we feel it makes sense to do [research]. We're always looking for where is there a lot of stress. And if there's a lot of stress, usually there are opportunities, and technology has been an arena where there has been great stress. We've done a few little things, but nothing major. But we might find some gems there.

Q: What's an example of some of the tech names you've examined?

A: We own some Autodesk (ADSK), which is a CAD-CAM software producer that we bought very cheaply with a clean balance sheet. We own a little Apple Computer (AAPL) that we bought when it was trading at a discount to the cash and the real estate. If we can find technology companies that have a sustainable technology with a clean balance sheet and an honest management at a very cheap valuation, we're interested.

Q: With Apple, you pointed out the value of the cash and real estate on its balance sheet. Cash is readily reckoned, but real estate can be tricky.

A: Yes.

Q: Particularly right now, when it's probably falling in Cupertino and Sunnyvale. Did you find that property values in Silicon Valley are really coming down fast?

A: It's probably coming down a bit, and it's probably worse now than when we first got involved in Apple. But what we try to do is go back to the basic principles of Benjamin Graham (co-author with David Dodd of the Security Analysis, the value investor's bible, first published in 1936) of and find what something is worth, and then buy at a margin-of-safety discount.

Q: Another One of the unusual aspects of your approach has been getting active with management -- turning up the heat if investors aren't being treated right. Are there situations now where you're nudging management?

A: Yes. There's a company called Meredith Corp. (MDP).

Q: The publisher based in Iowa?

A: Right. It publishes Better Homes & Gardens and Ladies' Home Journal, and it has a bunch of TV stations. We believe the asset value was far in excess of the stock price. We were concerned with certain things that were going on at the company, and we filed a 13-D [filing with the Securities & Exchange Commission] in which we made some comments and recommendations. One of the recommendations was that they add an independent director or directors to their board.

Q: What happened?

A: Meredith [is adding] a very good director to their board, who will be elected in a couple of weeks. And that is a very good example of Mutual doing its thing, basically looking after our shareholders in an activist manner.

Q: Where's the stock now, and what's the asset value?

A: Well, the stock's $33-ish, $34-ish. I haven't publicly articulated exactly what I think it's worth. I don't think now is a perfect time to be selling media assets. I think that Meredith publishing assets are really special. They have, give or take, 45% market share in the women's magazine segment.

Q: Retailers are also hurting right now. Gap (GPS) and JC Penney are two that have been beaten down. Are you buying them?

A: We have pretty reasonable positions in Federated Department Stores (FD) and May Department Stores (MAY). We like them. We think they're really quality companies. We don't own Gap, and we didn't warm up to Penney.

Q: What else should a prospective investor know about your funds?

A: Mutual Series Funds are very well-positioned to capitalize on whatever lies ahead. Because we have this unique three-pronged approach.... We have a special tool bag, and we will find a lot to do. And we will do it in a relatively low-risk manner.

Q: Things don't always work out. You owned Sunbeam (SOCNQ). Do you still?

A: No, it's gone. Look, we're not perfect. No one's perfect. We're going to make mistakes. We learn from our mistakes, and we don't want to make the same ones ever again. But the fact is that over time, we have done very well for people, and we really believe that we will continue to deliver good results in good times and bad times. We want our shareholders to be able to eat well and sleep well.


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