Q: Aumber ofmoney managersI'vespoken to have said that bluechipssuchasWal-Mart (WMT
), Citigroup (C
), and Pfizer (PFE
) now tradeat price-earnings ratios that aren't much higher than that of the market as a whole. Is it time to buy brand names again?
A: A dollarearned by Wal-Mart isn't worth more than a dollar earned by any other company, so the fact that Wal-Mart and other big-name companies sell atlessof a premium than they used to doesn't get us excited.Brandywine Blue is a little different in that it typically doesn't hold the mega-capblue chips that are common in most other large-cap growth funds. The mega-cap stocks usually growtooslowlyto meet our growth standards and tend to be followed by a hoard of analysts, making it harder for us togain theinformationedgethat's central to our approach.
Still, wedo own big-name companies when they represent appealing opportunities. We bought McDonald'sin October ata price-earning ratio of lessthan 15 times 2005 estimates, a reasonable price regardless of the company's reputation. Many investors appeared to deem the McDonald's turnaround story was over last spring, but the company appears to have taken advantage of its tough times to look internally and make thoughtful changes.
It's accepting credit cards. And it's making itself more appealing to parents by revamping its salads to be appetizing, healthier options for them while taking the guilt out of kid's meals by offering apples and bottled milk as alternatives to fries and soda. At the same time, products such as the McGriddle show that McDonald's is not abandoning its other customers.
Q: Do you see growth stocks finally beating value in 2005?
A: Forus, earnings growth determines whether a company falls into the growth camp. Some other folks consider high p-e ratios, industry affiliation, and other factors unrelated to individual-companyfundamentalsas the marks of a growth stock, so it's hard for us to say whether "growth" in general is poised to outperform since we don't all use the same definitions.
That said, we saw the tail end of the bear market in 2002, a speculative rally fueled by the economy'sturn for the better in 2003, and an environment in which oil prices,the election, and other macroeconomic factors overshadowed strong earningsgrowth for much of 2004.Now, we expect moderate economic growth and, wehope,lessmacronoise in2005. That will put investors in a position to evaluateeach companyon its own merits. In such an environment, above-average earnings growth shouldattract attention, especially in instances when it sells at a reasonable price.
Q: What are some of your favorite sectors and stocks?
A: Wedon'thave favorite sectors, or even favorite stocks.We arebottom-upinvestorswho seek companies experiencing rapid earnings growth regardlessofwhat sector they occupy. We might love a stock today and sell it tomorrow if its fundamentals deteriorate or a new opportunitywith greater upside potential displaces it.
Brandywine Blue's portfolio adapts to reflect the changing earnings landscape. Earlierthisyearwe sold some technology holdings, as their earningsfortunesbegantopeak, in order to fund new opportunities with improving earnings prospects, most of which we identified in the energy and raw materials sectors.
We purchased oil-field service provider Weatherford International (WFT
) in April and still hold it today. June- and September-quarter earnings grew 29% and 40% percent from year-ago levels, beating consensus estimates both quarters. Weatherford's new yield-improving technologiesare in strong demand as drillers worldwide increase productionto capitalize on higher energy prices.
We also bought copper-mining company PhelpsDodge (PD
) in June.Quarterly earnings this September jumped to $2.95 per share, up fromjust 6cents ayear ago.The company is benefiting from consistentlystrong copper demand and tight supplies. Atthe time of our purchase, a single copper mine in Indonesia responsible forroughly 5% of the world's production was shut down following a massiveslide. Afterrecentlyrestarting, theIndonesian producerreported its productioncostswould be 10% higher than previously forecast.
As productioncosts rose elsewhere this year, Phelps Dodge made investments that will lead to lower production costs in 2005, fueling opportunities to expandits profit margins as margins contract among its competitors. This is aparticularly promising situation, as Phelps Dodge is the only copper producer currently in a position to increase incremental copper supply.
Q: Forthe past few years, small-cap stocks have beaten large-caps. Do you see this trend persisting in 2005?
A: From a valuationstandpoint, there are more promising opportunities in the large-cap arena. Theaverage S&P 500 company sells at 17 times 2005 earnings estimates with analystsforecasting just 6% growth, but an investor focusing on the individual-company level can do much better in terms of price and earnings power. For example, the average Brandywine Blue holding sellsat less than 15 times 2005 estimates with 23% earnings growth expected.Weaimtouncover companiesthatwillexceed consensus estimates,so Blue's average holding's p-e is lower and its growth rate is even higher based on our own estimates.
Q: Whatare the keys to being a successful growth stock investor in this environment? Has your strategy changed at all since the bear market?
A: We don't change our stripes to suit the environment. We consistently focus onearningstrendsonthe individual-company level, which enables us to migrate to pockets of earnings strength as conditions shift. The portfolio changes, but the strategy doesn't.
We isolate companies experiencing rapid earnings growth with good prospects to exceed Wall Street earnings estimates to capitalize on the relationship betweenearningsperformance and stock prices. Beyond that, we focus on thoserapidly growingcompanies thatsellatreasonable multiples of earnings estimates to maximize upside potential and mitigate downside risk.
Earningsgrowthdefines whether a company is a growth stock to us.Given thechoice betweena semiconductor company selling at 30 times earnings estimates with 10%earningsgrowth and a shoe retailer selling at 10 times earnings with 30% growth, we'll take the shoe retailer without hesitation.