The Tortoise and the Hare Race Again


By Robert Barker The past two years have been a harrowing time to invest in the stock market. The Standard & Poor's 500-stock index in that stretch lost more than 16%. Which is why Mark Sellers' stock-picking performance is so remarkable.

Sellers edits Morningstar's StockInvestor monthly newsletter. In 2001, the Chicago investment research firm asked him to invest real money in twin portfolios, the Tortoise and the Hare. The Tortoise relies on solid if stodgy stocks, while the Hare focuses on zippier growth stocks.

Results: The Tortoise returned 26.6% over its first two years, and the Hare lost 9.6%. Put them together, and Sellers' stock picks returned 8.5%. The average large-cap mutual fund? It lost 15.7% over the period. The Tortoise wound up beating every one of the 1,069 large-stock mutual funds in Morningstar's database.

What does Sellers have to say for himself? I reached him by phone this week to find out. Here edited excerpts of our chat:

Q: What do you attribute the success to?

A: I call it the Fat Pitch Approach to stock investing. We wait for the perfect pitch to come in rather than being afraid to strike out after three pitches that are on the outside corner of the strike zone.

Warren Buffett has used this analogy -- he likes to swing at the perfect pitch and take a big swing. We do kind of the same thing: We wait, we hold cash, and if stocks are too expensive, we just wait. Then when we see a stock which falls below our buy price, we take a big position in it.

Q: I see.

A: The strategy is based on five parts. The first one is that we focus on companies with wide economic moats -- and we ignore all others.

Q: What's a "wide economic moat?"

A: A company with a wide moat is one that has sustainable competitive advantages in an industry that has some barriers to entry, so you're not going to get a lot of price competition. This would be a company like Automatic Data Processing (ADP), which is in the payroll-processing industry and kind of dominates the market for large-company payrolls.

Avon (AVP) is another. It's in a good industry, long-term. Women are going to continue to wear makeup, and Avon has a good management team and a strong network of sales associates, so it's kind of shielded from competition.

Q: I see.

A: And we like to buy these types of companies at a price that's significantly below what we consider to be the fair value. So we always look for a margin of safety before buying these companies.

The third part of the strategy is just to hold cash when we can't find a fat pitch at a big margin of safety. If we can't find the right company, there's no reason why we have to buy something else.

Q: Go on.

A: We're always going to hold a concentrated portfolio with this kind of strategy because there are only a few good ideas in any given year, maybe 5 or 6, or 10 at the most. And you just hold on to them. You don't trade very often. It lowers the taxes, transaction costs, and the chances of your making a mistake if you don't trade very often.

Q: It sounds like you have to be very patient.

A: The difference between great investors and average or above-average investors, in my opinion, is discipline and patience. There's no way you can outsmart the market, but what you can do is out-discipline the market. That involves taking a longer-term view of individual companies rather than trying to guess the direction of the aggregate stock market.

Always take a very long-term view. As Buffett says, if you're not going to hold a company for 10 years, don't even hold it for 10 minutes.

Q: How much of your portfolios have you typically kept in cash?

A: The Tortoise has averaged about 15% cash and the Hare has averaged around 20% cash. Right now, we're significantly above that in the Hare. It's almost 40% cash.

Q: Why?

A: We've sold a couple of stocks this year, year-to-date. But we haven't bought any stocks in the Hare. We haven't found any growth stocks that we think have an acceptable margin of safety that we didn't already own.

Q: What did you sell out of the Hare Portfolio, then?

A: We sold Linear Technology (LLTC), which is a wide-moat company, and we sold Intel (INTC) recently. Both of them hit our sell price, which for a wide-moat company is 30% above what we consider to be their fair value.

Q: Is Linear Technology a semiconductor company?

A: Yes. Both of those are semi stocks. We made decent profits on both, but they had just gotten overvalued in our opinion. And we would be happy to buy them back if they get back to the right price, 20% below what we consider to be the fair value of each stock [Morningstar puts Linear Technology's fair value at $24 a share and Intel's at $15].

Q: What have you bought in the Tortoise this year?

A: We bought Automatic Data Processing. We took a fairly big position when it was around $32 a share. That was back in February. And we bought Northern Trust (NTRS) when it was around $31 a share back in late February.

Q: What have you learned through all of this about investing?

A: If you have a strategy, and you [believe you] should stick to it no matter what, and it's a strategy that has worked well for other people and you truly understand that strategy, it can probably work for you as well.

I just copped Buffett's strategy. I haven't come up with anything new. I've come up with some new terminologies to describe the strategy, but really we've just copped Buffett's strategy and put a new twist on it, and it works. There's no need to recreate the wheel.

Q: What else?

A: There's no need for most investors to buy speculative companies because you can do very well just buying wide-moat stocks. When speculative companies are beaten down, it's very difficult -- and sometimes impossible -- to know whether it's beaten down for a good reason or whether the market is being irrational.

Dynegy (DYN), for instance, is up like 1,000% since its low last October, but at the time no one thought it was going to survive. The only people who bought it at that price were the people who didn't care if they were going to lose all their money because they were just playing with Monopoly money. If you've got money that you would care about if you lose, buying these speculative stocks when they're down is a very risky proposition.

If you buy them when they're up, you can take advantage of some momentum. The only problem is you don't know when the music stops and the chairs get taken away.

Q: In the coming year, what worries you the most?

A: That investors still have expectations that are too high and that stocks are overvalued right now. If you do the math, they're just not a compelling buy. But I worry that I'm wrong. I'm holding a lot of cash, and if I'm wrong, that will hurt performance. Barker covers personal finance in his Barker Portfolio column for BusinessWeek


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