This guy is on the ball I'm in complete agreement with him.
<<Money Manager Q&A: Northern Technology Fund's John Leo
Chicago, July 22 (Bloomberg) -- John Leo, co-manager of the $2.7 billion Northern Technology Fund, has evaded bears of all kinds this year.
The 39-year old dodged two hungry black bears he encountered during a week-long camping trip on Alaska's Chilkoot trail, near Juneau.
``They made their way through the campsite and shook things up a bit,'' said the Evanston, Illinois, native. ``They ripped up a tent, but it wasn't ours.''
The same could be said for bearish investors who chewed their way through the Nasdaq Composite Index, which has fallen 37 percent from its March 10 peak. Leo, along with his colleague George Gilbert and a team of five analysts, steered the fund through the decline and have chalked up a 15.9 percent return in 2000. The index has gained only 0.6 percent this year.
Leo said his fund will keep a stock for as little as two weeks, as it did with Amazon.com Inc. immediately following the online retailer's initial public offering, or as long as three years. There are usually about 70 stocks in the portfolio.
The Northern Technology Fund has returned an average of 65 percent annually in the past three years through the end of June. This makes it the eighth-best performing fund out of 2,060 U.S. stock funds tracked by Chicago-based market research firm, Morningstar Inc.
In an interview from his Chicago office, Leo comments on his outlook for computer-related and telecommunications stocks:
Q. How have you managed to outperform the Nasdaq by about 15 percentage points so far this year?
Leo: We've got a focus that is purely electronics-based technology. Our pure emphasis on high-growth technology companies has paid dividends this year, as it has in previous years.
Q: What are some of the companies you're looking for?
Leo: Specifically, our search is for ultra-high growth companies that are focused on communications-oriented applications. We're looking at companies that are supporting the rebuilding of the telecommunications infrastructure, and wireless communications.
A good example of a company that is right in the middle of the telecom rebuilding, as the emphasis is shifting from electronics to optical transport, is JDS Uniphase Corp. They are a very rapidly growing company, consolidating that industry as they acquire other companies to round out their product offerings.
JDS provides optical networking components to the Lucent Technologies and Nortel Networks in the world that need to put together these systems for telecom carriers. It's a very lucrative business today, as telecom companies realize they need to make that leap to the optical transport world.
Another high-growth company that we've just been blown away by recently, in terms of their most recent earnings release, is Juniper Networks Inc.
We bought that stock when it went public last year and have continued to buy more and more shares as we've become just very enthusiastic about the growth potential for Juniper. They provide high-level Internet routers and switches that cause the Internet to operate at its highest functionality today, and I'm sure that future generations of Juniper products will help take the Internet to the next level.
Q: How do you measure growth?
Leo: We're looking first and foremost at top-line revenue growth for most of these companies. Juniper, as an example, posted incredible numbers. Just quarter-over-quarter growth was somewhere in the neighborhood of 80 percent, and that's not an annual growth rate, that's the last three months versus the three months prior, which is just phenomenal.
So top-line growth is a key element for us. In addition, we want to see companies able to take that top-line growth and translate it into bottom-line earnings. One of my favorite items to evaluate in a company's financial reports is a trend in operating margins. A company that can consistently improve its operating margins shows me that not only are they in a good space in the marketplace, but they have a management team that's executing well and making the business more valuable over time.
Q: What are some stocks that you've been buying?
Leo: PMC-Sierra Inc. is a great example of a company that is not only growing rapidly, but becoming more and more profitable, and that's one we consider a core holding in our fund. We've been buying more Altera Corp., which is a company that provides programmable logic devices, a type of semiconductor to communications-oriented companies. And they continue to raise the bar in terms of their growth potential and their profitability.
Q: Standard & Poor's just announced that JDS Uniphase is being added to the S&P 500. How does this change your view of the company?
Leo: It really doesn't mean a lot; it's a nice near-term pop in the stock price, as index funds or managers who are benchmarked to the S&P 500 have to go in and buy the stock. It doesn't change what the company is going to do going forward or the growth potential.
Q: What are investors' biggest concerns going to be in the coming months?
Leo: There are a couple things to keep close touch on. Number one, we need to monitor closely the health of the U.S. economy; the Federal Reserve has raised interest rates several times. And there's always the chance that those interest rate increases -- and they may continue to raise rates again, once or twice more -- those may have some slowing effects on the economy. If that slowdown proves to be a little more than investors are anticipating, we could see earnings growth begin to slow down, and that's a bit of a concern.
The other important concern is valuation. You simply can't argue effectively that stocks are cheap, especially in the technology area, after strong performance over the past handful of years. We're comfortable with the ones that we own and have identified as high-potential companies, but if the economy and earnings growth slows over the next few quarters, that could cause the market to be a little rocky.
Q: What does valuation mean to you?
Leo: We don't apply blanket valuation constraints or parameters over the technology industry, because each company and each niche of technology is different from the next. We evaluate the valuation of a given stock relative to its potential, its growth, historical growth that the company's delivered and what we think can be achieved going forward. We own stocks that are trading at lofty price-to-sales multiples.
JDS Uniphase is an example of a company that probably is trading in the 30-times-revenue range at this point. That, relative to historical figures, is high. But the company is in a multi-year, rapid-growth development phase, and they continue to surprise on the upside in terms of the growth that they're able to generate.
We see opportunities in their operations for incredible leverage if they're able to attack a couple of important manufacturing-related challenges over the course of the next two or three years. We're encouraged to think that the growth opportunity is large enough to justify the valuation today. And that's the process that we have to go through with every stock that we evaluate.
Another good example would be Ariba Inc., in the Internet software area. This is another niche that we find very attractive, the e-commerce enablement companies. Ariba is a leader there in their online procurement software.
This is a stock that is very expensive by traditional measures in terms of price to revenue. But they had one of the most unbelievable quarters ever this past quarter, and we think that the opportunities for Ariba are enormous over the next few years.
Q: Can you quantify that?
Leo: Ariba is just breaking into profitability in terms of bottom-line numbers, so a price-to-earnings figure is not a very meaningful number. We look at the ability of this company to grow in the triple-digit range, probably as much as 200 or 300 percent over the course of each of the next two or three years. Looking at our five-year forecast for Ariba, you can justify the lofty price that you seem to be paying in today's revenue run rate and earnings run rate.
Q: What are some of the stocks you're trimming?
Leo: We have done a little trimming in the semiconductor sector of late. There have been some concerns about exposure to various elements of the wireless business where, for instance, the CDMA wireless market has slowed down a little bit relative to expectations.
Another area that we are avoiding and have taken some money out of over the past few months is the hardware segment of technology. We are not too enthused by either the PC makers or the mainframe-type companies, and we find there's less value added in that portion of the technology universe than was the case two or three years ago, so we've significantly cut our exposure in that segment of the market.
Q: Which companies are you expecting to lag in those industries the most?
Leo: Hewlett Packard Co., for one. They are trying to become a bigger player in the server market and a more effective player in the storage market, but they are just not catching up to either Sun Microsystems Inc. or EMC Corp. in those respective markets.
We're kind of lukewarm in what we see happening in International Business Machines Corp. and we don't own the stock even though they reported what seemed to be a decent quarter relative to expectations. We aren't inclined to step into that stock because we have concerns about continued slow progress in the mainframe market.
Q: What about Intel?
Leo: We've been out of it for a little while. Frankly, it's done a little better than we expected it would. But we're not stepping in at this point; we want to see more evidence that the progress they're making on manufacturing efficiencies and competitiveness with Advanced Micro Devices ramps up over the course of the next quarter.
Q: What's a buy signal to you?
Leo: When we see demand expanding at a rapid clip for the products that a company is providing, and consequently an improvement in the market positioning of that company, that's a clear signal to us that we probably ought to own that stock or at least get to know the company better.
Q: What are some examples?
Leo: There are a handful, probably six to eight software providers, that have percolated up to the top, each of them leading the charge in terms of their niche within this overall Internet-enablement software business.
BEA Systems Inc. has become, in many ways, the primary provider of a certain type of software that ties together disparate systems within an organization and makes e-commerce functionality achievable at a reasonable price, and there simply isn't any other independent company that does the job as well as BEA does. IBM has had some success in this, but that software business sort of gets lost among all of the other pieces of IBM.
Q: What's the best investment advice you've ever gotten, and who gave it to you?
Leo: If you can identify a company that has an opportunity that appears to just be huge over the next three to five years, and a management team that appears to have the savvy and know-how to exploit that, you've gone a long way to identifying a good opportunity. I usually use this as the first cut in terms of evaluating companies.
George Gilbert, my co-manager on the fund, has always espoused this.
Q: When has that advice worked particularly well for you?
Leo: The best example over the past three years is JDS Uniphase. When we first began kicking the tires of this company, it was simply Uniphase Corp., probably late 1997. Not too many people were thinking much about the optical networking space because it really had not caught on. Telephone operators, telecom companies weren't spending money aggressively in this space, yet telephone companies are notoriously slow for picking up the ball and making these kinds of investments. But to us, it appeared that this was going to have to happen over some period of time.
Actually, we're in the middle of that process today, probably the fourth or fifth inning of this optical networking revolution, and I would imagine that our initial purchases of Uniphase stock are probably up 20-fold or 25-fold in three years.
That's a good concrete example of how important it is to identify the size of the market opportunity, and then getting the market leadership question answered is probably the next important step.
Q: Where else are you looking for market leadership?
Leo: I think that from a U.S. and worldwide business analysis, we are very early in the ballgame in terms of the use of the Internet as a business proposition, and I think that Fortune 500 companies and large global companies, and medium- sized and small companies, are all going to have to incorporate the Internet as a critical delivery mechanism for their business.
There are a handful of big name-brand companies like Cisco Systems Inc., Oracle Corp., Sun Microsystems and newcomers like Exodus Communications Inc. that are Internet-infrastructure dominators. These companies should continue to see demand for their product and service offerings probably outstrip expectations for several more years. These are companies that we are comfortable having at the core of our technology portfolio.
Q: I understand that you've taken up hiking as a hobby and you spent some time in Alaska. What did you take away from that experience in terms of risks and rewards?
Leo: Well, aside from being thankful that I survived the experience and didn't tumble down the mountainside or get eaten by a surly bear, the comparison that I found interesting was that rarely was the terrain flat. There were a lot of ups, a lot of downs.
I thought a lot about the comparison between investing in the technology market, especially this year, and the hiking we were doing. It was a challenge, as is investing, but a rewarding one, and I think volatility is something that we all need to continue to expect in the technology marketplace.
But I think over time, the climb will be rewarding, and if we continue to identify good, strong investment performers, we'll enjoy being along for the ride.>>
Greg->I own JDSU, JNPR, ORCL, EXDS, CSCO I'm looking to add SUNW on weakness. |
