Decent Growth, Reasonable Prices?
Bob Smith lays some mildly contrarian bets
By Barry Henderson
Fund of Information | Fund Scope | Cash Track
Bob Smith is keeping the teeth-gnashing to a minimum these days. Even though growth stocks continue to take a drubbing, he's surprisingly relaxed about his T. Rowe Price Growth Stock fund portfolio.
At a breakfast meeting last week, Smith was mildly nervous about a coming exam for U.K. fund managers (he runs money for British as well as American investors), but unruffled by the current state of the market. Why so calm? Smith -- who considers himself a growth-at-a-reasonable-price manager -- has never chased highflying Internet stocks like Amazon.com. By avoiding these land mines he's managed to stay better than the average fund in his peer group this year.
Now don't misunderstand: Smith owns high P/E stocks like General Electric, Microsoft, Berkshire-Hathaway and Pfizer. Indeed, these make up the core positions in his fund and they've been responsible for a good chunk of his performance numbers during the past several years. Despite his success with these stocks, now he's looking elsewhere for places to put new money. In a recent letter to shareholders, he acknowledged that he was assuming an element of risk in straying from the current market leaders.
Nevertheless, Smith has decided to wade in and make a few mildly contrarian bets on the likes of Network Associates, Waste Management and even Starwood Hotels & Resorts. Why move into names like these now? Because unless you believe the U.S. is going into long-term, sustained recession, it makes sense to pick up bargains that will recover quickly once the market snaps back. And according to Smith, that might happen sooner than you think. Although he's reluctant to get into market prognostication, he thinks the economy will cycle through a soft landing and take off again in the next six to 12 months. To make the most of this rebound, Smith is buying smallish big-cap companies with good growth prospects. (Relativity is an important concept here: Smith says he doesn't like to buy anything that's below a $3 billion market cap, so it's not like he's buying small-capitalization stocks.)
Network Associates, a software company that writes programs for network management, fits into this category. With a market cap of about $4 billion, Network Associates is selling for 33 1/4 per share, or about 16 times next year's earnings estimate of $2.12 per share. Nervous about a company makeover in progress, investors have sold the stock down to current levels from 56 7/8 -- a 52-week high. Smith notes that Network Associates is in the midst of a transition from writing anti-virus programs to writing suite-based network management software. To do that, it's been necessary to acquire smaller firms. And not everyone has been happy about how CEO Bill Larson has been accounting for those deals. "People have brought the stock down because the company's been taking these big writeoffs when it does the acquisitions," he says. The company's critics believe that the company is probably pushing too much into these writeoffs.
Smith feels investors have become skittish about software companies like Network Associates that book a big chunk of their revenues at the end of each quarter. That makes it much harder for management to accurately forecast sales, which means it's more difficult for the company to give analysts realistic guidance on whether it will make consensus estimates for the end of the quarter. That doesn't help the stock, in an environment when investors are especially leery of uncertainty.
But Smith says the selloff in Network Associates has been overdone. He points out the company is first to market with its network-management software products and that it has a viable strategy for its new offerings. The longer-term growth play works like this. Network Associates uses its anti-virus and Internet-security programs to get in the door with corporate customers and then sells the customer's computer department on a whole program of network management. As the transition from the anti-virus products is completed, Smith expects the company to grow earnings by 20%-25% by 2000. He thinks the stock will trade for at least $40 over the next 12 months.
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