BusinessWeek Online
Picking Stocks for a Market Rebound
Tuesday August 27, 9:49 am ET
Once the market gets through the typically weak months of September and October, stocks should be ready to rise again in late autumn as the economy and corporate profits strengthen. Since interest rates and inflation remain low, William A. Muggia, president and CIO of Westfield Capital Management and co-manager of the Touchstone Emerging Growth Fund (Nasdaq:TEGAX - News), thinks small stocks will continue to beat large ones.
Muggia, who runs the growth portion of the top-rated fund [5 Stars from both Morningstar and Standard & Poor's], currently favors health-care and financial stocks. Lately, he has been picking up shares of biotech companies and consumer-related stocks that fit his small-cap, emerging-growth standards. One of his favorite names is security products and services provider Armor Holdings, given the increasing emphasis on homeland protection.
Muggia made these points in the course of a chat presented Aug. 22 by BusinessWeek Online on America Online. He responded to questions from the audience and from BW Online's Karyn McCormack. Edited excerpts from this chat follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.
Q: Will, the Dow passed 9,000 today and has come a far way from its lows of the summer. Do you think the worst is behind us?
A: I think the July low is a pretty important one. My guess is we will have a pullback sometime in September/October, but the trend is likely to be higher in the near term.
Q: Why do you think the market will weaken again in the fall? The typical seasonal weakness?
A: Exactly. For whatever reason, October always seems to be a bad month for the market. But I think the economy is recovering, and corporate profits will follow, so I will expect seasonal strength in November and December.
Q: Will, can you tell us how your fund has fared so far this year?
A: We run the growth portion of the Touchstone Emerging Growth Fund. To date, the growth portion of the fund has held up fairly well. We're down approximately 17%, I believe, and the Russell 2000 Growth is down 28%.
Q: How do you go about picking stocks?
A: We're a fundamental, bottom-up, research-driven firm. We spend 20% to 30% of our time on the road visiting companies, and we build all of our own earnings estimates. All the new buys [have] $1.5 billion [in] market cap and below.
Q: What sectors are you purchasing now, given that your funds have cash inflows?
A: Most of the additions recently have been in biotech and consumer.
Two names we've been buying recently: One is Celgene (NasdaqNM:CELG - News), [an outfit with] an approved cancer product called Thalomid, which is growing at about 30%. The other name we've been adding to is CV Therapeutics (NasdaqNM:CVTX - News). It's a company with two large phase-three trials done addressing angina, a very large market.
In consumer, one name we've been buying recently is P.F. Chang's (NasdaqNM:PFCB - News). It's a casual Chinese restaurant chain.
Q: Any opinion on financial stocks -- particularly those banks positioned to benefit from the market recovery, like Mellon Financial (NYSE:MEL - News)?
A: We have been overweight in financials for over two years. Mellon is too large for this fund, but we have large holdings in East West Bancorp (NasdaqNM:EWBC - News), UCBH Holdings (NasdaqNM:UCBH - News), and Southwest Bancorp (NasdaqNM:SWBT - News) -- niche thrifts growing earnings in excess of 20%.
We also own several insurance stocks.... Philadelphia Consolidated (NasdaqNM:PHLY - News), Converium (NYSE:CHR - News), and Willis Group (NYSE:WSH - News) are our current holdings.
Q: Will, can you name your largest holdings? You may have already named a few of them.
A: Sure, let me quickly pull those up. The largest holding right now is Ann Taylor (NYSE:ANN - News). Sylvan Learning Systems (NasdaqNM:SLVN - News) is another major holding, as are Brooks-PRI Automation (NasdaqNM:BRKS - News) and Armor Holdings (NYSE:AH - News).
[The latter is] one of my favorite holdings...because I think national security is unfortunately going to be a big part of our lives for the next 5 to 10 years, and Armor is a dominant player.
Q: Can you give more detail of how you pick your holdings? What characteristics do you look for?
A: High-quality franchise, with a solid management team, accelerating earnings growth, and a unique and differentiated product or service.
Q: Do you own any small-cap drugmakers? Or are you only in those biotechs you mentioned?
A: There just aren't many small-cap drugs, unfortunately. Mostly, [we've picked] biotech, health-care services, and we own several medical-device companies. I really like Wright Medical (NasdaqNM:WMGI - News), which provides niche orthopedic devices, and we're very positive on the orthopedic space over the next few years.
Q: Is health care one of your favorite areas? Does this sector make up a large portion of your fund now?
A: Yes, it's one of my favorite areas. It's almost 30% of the fund. It certainly has the best fundamentals and fastest growth rates right now in the economy.
Q: Do you own any HMOs or hospital stocks?
A: We do, actually. Humana (NYSE:HUM - News), for example. Pricing has been outstanding, same-store admissions growth has been strong. These stocks have been great performers this year.
Q: What about tech stocks? What's your favorite one there?
A: My favorite tech company is called Precise Software (NasdaqNM:PRSE - News). Last quarter, they grew revenues in excess of 40% -- I think greater than any other tech company in the industry. They had been growing at over 100%. Great franchise, high margins, strong balance sheet, and they continue to beat expectations. Overall, though, technology is our biggest underweight in the fund, as a sector.
Q: Do you like Level 3 Communications (NasdaqNM:LVLT - News) or anything else in the telecom area?
A: No, the fundamentals are awful. The stocks look cheap, but on a risk-reward basis, I just don't think they're worth investing in. Telecom will eventually come back in some form, but I think there needs to be some big consolidation in the group, and several will undoubtedly go out of business. [If I owned telecom, I would take a loss and go invest elsewhere.]
Q: You named a few consumer stocks earlier. Do you like any Internet-related stocks, like online retailers?
A: No. We like other consumer names, like the discount stores. Cost Plus (NasdaqNM:CPWM - News), Dollar Tree Stores (NasdaqNM:DLTR - News). We also like Williams-Sonoma (NYSE:WSM - News). But Internet retailing is, again, very low-margin: Nothing proprietary, no barriers to entry, not a good business model in general.
Q: What do you think the answer is to all the accounting issues? Is making CEOs certify their books the answer?
A: I don't think that's the answer, but I do think the worst is behind us, and going forward, companies will adhere more rigorously to accounting standards. Once CEOs see others going to jail, I think it's much less likely that this will happen going forward. By and large, most management teams are honest, and the few bad people are going to get caught and are going to get prosecuted. I also think that accounting issues are much less prevalent in small caps than in large, because it's much harder to hide things in small companies.
Q: What advice would you give investors now, considering the market has already risen from the lows? Should investors hang on or look for more buys?
A: Given a low interest rate, low-inflation environment, and recent massive mutual-fund redemptions, my feeling is that stocks are more attractive than bonds and cash right now. As long as investors are rational with expectations, meaning stocks may return 5% to 10% per year over the next few years, and small caps will outperform large caps, stocks are still the place to be [vs. the alternatives.] |
