August 14, 2000
Barron's Features
Cornerstones
Doug McKay likes brick-and-mortar companies, New
Economy style
By NEIL A. MARTIN
Given technology stocks' violent tumble this year after a roaring 1999, is it time
for shell-shocked investors to retreat toward bricks-and-mortar issues? Yes,
says Doug MacKay, who co-manages the $1.46 billion Red Oak Technology
Select Stock fund. But the "bricks and mortar" he's referring to isn't the stuff
that corporate chiefs often use to build grandiose headquarters. Instead, it's the
routers, switches, fiberoptic lines and other equipment and material needed to
construct the high-tech world's foundation.
Considering MacKay's record over the stock market's tumultuous past
year-and-a-half, his opinion is well worth considering.
Through Thursday, Red Oak Technology, a sector fund that owns only 23
stocks, was up 47.3% this year, a nice encore to the 143.4% return it scored in
1999, its initial year. Not bad, considering that the tech-driven Nasdaq
Composite was down about 7% in the same span this year, after having jumped
more than 85% in '99.
MacKay has prospered by concentrating on
companies such as JDS Uniphase, Newport
and Ciena in fiberoptics; Cisco and Juniper
Networks in networking; EMC and Network
Appliance in storage; PMC-Sierra, Broadcom
and Maxim Integrated in semiconductors.
"I guess if I had been in business in northern
California during the 1860s, I would have been
selling pots and pans and digging tools, rather
than panning for gold," MacKay says, laughing.
"It would have been more profitable, less risky,
and demand would have been pretty constant."
MacKay's earliest purchases after Red Oak
opened in January 1999 included three that few investors had then heard of:
JDS Uniphase, a manufacturer of fiberoptics communications products, which
he bought at around $7 a share, Network Appliance, a computer storage
system provider, for which he paid about $14, and Ciena, a maker of
optical-networking systems, which was then changing hands at around $15.
These bets all paid off handsomely; the stocks recently were fetching $119,
$86 and $148, respectively.
While other fund mangers were maintaining positions in AT&T or WorldCom
or Sprint or cellular phone outfits, MacKay was buying their chip suppliers,
such as TriQuint Semiconductor and Maxim Integrated. He figured that
Broadcom, a manufacturer of specialty integrated circuits, would be a better
bet than its two main customers, General Instruments or Motorola.
And while many investors rushed to buy into the e-commerce boom by
purchasing eBay or Amazon.com, MacKay focused on the companies that
supply networking products for the 'Net -- Cisco, Sun Microsystems and
Juniper Networks.
"We didn't want to worry about which of the dot.coms would strike gold,"
MacKay observes. "But we were sure that their suppliers like Cisco, Sun and
Juniper would prosper."
Of course, most of MacKay's top picks are well
off their 52-week highs. But this doesn't ruffle him
because his strategy is essentially to buy the most attractive growth companies
in the strongest high-tech sectors and hold on to them. Indeed, he views
declines in many of the shares as buying opportunities.
While the average portfolio turnover of a technology-stock fund averages
around 100%, and can exceed 1,000%, turnover at Red Oak Technology was
only 17% last year and about 30% this year. In fact, about 70% of MacKay's
portfolio has remained unchanged since the fund's founding 20 months ago.
Many of Red Oak's holdings trade at nose-bleed multiples. For example,
Juniper Networks has been changing hands at around 470 times this year's
expected earnings; Brocade Communications, at 269 times; Newport Corp.
at 114, and PMC-Sierra, at 165.
This, too, doesn't fluster MacKay. "P/E ratios are always a factor in stock
selection, but can't be considered in isolation," he maintains. "If we worried only
about P/E ratios, we would have all our money in bank stocks, which are
trading at around 10 times earnings," he adds. "The difference between a bank
stock and a PMC-Sierra at 160-170 times earnings is its growth. If
PMC-Sierra can grow 100% in the next 12 months and at an average 70%
over the next three years, it has 10-20 times the growth of a typical bank. So its
P/E is actually lower than an investor might recognize."
In any case, MacKay thinks the worst is over for the techs: "We believe the
Fed is through [raising interest rates] for the year, which will allow the market to
focus on earnings, which look good long-term and very positive over the short
run."
Profits of tech companies will lead the market, MacKay predicts, but he
cautions: "Just as is the case in the so-called Old Economy sector, there will be
certain areas that will do better than others." He expects the leaders to be
companies in fiberoptics, networking, data storage and, to a lesser extent,
semiconductors.
That's why "we don't own the older tech companies like IBM or Computer
Associates or Lucent Technologies," he adds. "These companies may have
large franchises, but they're in slower-growing markets, most of which had
difficulties during this past earnings season."
Two recent additions to his portfolio, Broadcom, whose products allow huge
amounts of data to move through broadband computer connections, and
Newport, whose equipment is helping fiberoptic companies improve their
manufacturing efficiencies, reflect MacKay's approach. He bought Newport
seven months ago at around $20 and it is now near $113, while Broadcom has
nearly doubled to about $227 in the same stretch.
So, MacKay has struck plenty of gold while mining for pots and pans.
I tried to paste the table of his favorites, but it was a mess. |
