Big Cap
Top fund manager focuses on 'dynamics at play'
By Don Scott, CBS MarketWatch
Last Update: 9:06 PM ET Jan 10, 1999
NEW YORK, NY (CBS.MW) -- What makes an ideal large cap growth
stock to add to your watch list and maybe your portfolio?
Look for an earnings growth rate of at least 20 percent at companies
where there's a "dynamic at play" that will drive market share and earnings
growth higher, a driver that is still under- appreciated by other investors.
And stick with a smaller number of stocks in which you have the strongest
fundamental belief.
That's the basic strategy used by Jim McCall to run
the PBHG Large Cap 20 Fund (PLCPX), which
posted a 67.8 percent gain for 1998, versus the
S&P 500's 26.7 percent. The no-load fund's
performance ranked in the top 10 percent of all
diversified stock funds.
McCall keeps the fund to just his 20 best stock
picks. Each position runs 5,6, or 7 percent of the
total portfolio. "It's a pretty simple concept, but it's
one that seems to be coming to the fore these
days," says McCall, "with year after year of
diversified, active managers under-performing the
indices, we think that concentrated portfolios give
you a much better opportunity to outperform."
But of course, you've got to get the picks right.
McCall says he wants to see earnings per share
growing by at least 20 percent per year. "I try to
find some dynamic at play that, while it might be
recognized to some degree by one or two of the analysts, it's something
that in the aggregate is under-appreciated as a growth driver by the
street." And he says when it plays out, it leads to analysts "raising their
estimates, price targets and multiple targets."
He says that's happening with EMC Corp (EMC), a high-end data
storage company that deals in main-frame data storage. " I think what
people are missing, at least to a considerable degree, is this
re-centralization trend among corporations," says McCall. He notes that
earlier in the decade, there was a de-centralization trend at many
companies, moving computing capability from mainframes to client/server
and desktop systems. Great for individual worker empowerment. But a
nightmare for information technology managers.
"And what they discovered was that their data, which is becoming an
ever-increasingly important strategic weapon, was out of control." Some
managers who needed access to key data couldn't get it. So McCall says
"there's been this trend toward buying large data storage systems, both
hardware and software, like that supplied by EMC, to centralize the data
and give the IP managers control of it, make it secure and make it
accessible when it's needed."
McCall says EMC's growth rate was 52 percent last quarter and 44
percent the quarter before that. " We have expectations going forward of
growth in the high 30s to mid 40 percent area for the next few quarters."
He also likes Worldcom (WCOM) and
thinks '99 will be a year in which synergies
from the MCI merger will come through
better than most people are expecting.
"They've got the largest competitive local
exchange carrier, they're the second largest
long-distance carrier in the U.S., they're
very large now with MCI internationally in
the long distance area, and in the world,
they're the largest Internet service provider.
So they can offer a business the whole soup
to nuts telecom solution, whether it be
voice, data, or video."
Another favorite is Cardinal Health (CAH).
" They have been buying smaller businesses
that are higher margin service providers to
compliment their drug distribution business."
McCall says they bought a company that
provides automated drug dispensing
equipment for hospitals. It's a high margin
business and very complimentary to their
base drug distribution business. And, he
says, they also picked up a specialty
manufacturer of packaging and dosage
forms for medications, also higher margins
and very complimentary. Plus, they
acquired a company that distributes other medical supplies to the same
customer base Cardinal already serves.
All of that, says McCall, "gives them the ability to offer a one-stop-shop
approach to these hospitals, so that they can buy all of their medical
supplies and pharmaceuticals from the same company, and reduce
paperwork costs."
McCall says the Cardinal Health story is one of profit margin expansion
that's going to surprise people. "The operating margin has been around
4.3 percent and I would see that gradually moving up over 5 percent over
the next 4 or 5 years. Maybe it doesn't sound like a lot, but in a low
margin business like that, it can really drive the EPS number."
For McCall, the ideal growth company is one that "has, in addition to a
logical business model and good management, a technology that's
proprietary, or a service that's very difficult to duplicate, that's allowing
them to gain market share from their competitors."
"If they're operating in a segment of the market that in and of itself is
growing quite rapidly, then that's kind of a double kick to the bottom line.
And we like the companies to be of such a size that they're starting to
benefit from economies of scale such that their margins are expanding,
which leads to acceleration in earnings growth."
Don Scott writes for CBS MarketWatch.
|
