Now, here's a value investor who likes, get this, CIEN and RBAK...
brill.com
Jerome Dodson
Parnassus Fund
by Marla Brill
MFI Publisher
Dodson Moves In
In late August of last year, Parnassus Fund’s huge cash allocation—at 62 percent of assets, over ten times the industry average--reflected manager Jerome Dodson’s concerns about high stock market valuations and a souring economy. As it turns out, this dash of conservatism paid off after the terrorist attacks of September 11 sent stocks tumbling. By the time the year had drawn to a close, the fund gained 7.84, compared to a loss of 11.89 percent for the S&P 500 Index.
"Some of the fund’s strong performance for the year was because of good stock-picking," says Dodson. "But much of it was because we had about half our assets in cash for most of the year."
Normally, mutual funds keep their cash positions well below 10 percent with the idea that shareholders pay stock fund managers to invest in stocks, not warm the bench. Until a couple of years ago, Dodson did that, too.
"There were two previous times in the fund’s history, in 1987 and in 1990, when I thought the market was greatly overvalued. But I didn’t have the confidence to act on that belief. And both years, I lived to regret it." By the time 2000 rolled around, his belief that the market was ripe for a tumble finally prompted him to move on his conviction and take some money off the table.
The main downside of a high cash stake, of course, is that a fund risks getting left behind if the market takes off. "I think that risk is outweighed by the reduction in risk you get when stocks are overvalued," says Dodson. "And at current levels, I don’t see much upside for stocks anyway."
For the rest of 2002, he predicts, "Either one of two things will happen. There could be a sharp correction that will pull valuations in line with business prospects. Or, we’ll just see minimal, single digit market gains. I don’t have too many concerns about the market running away from us."
And what about the potential fallout from financial advisors, whose asset allocation strategies come unwound when a fund moves into cash? "I’ve had a couple of advisors bring up that point," says Dodson. "But for most of our shareholders, the main priority is getting a good return."
Betting on Telecom
Dodson points out that while a heavy cash position certainly helped the fund last year, it was not the only factor behind its strong performance. Almost 6 percent of the fund’s nearly 8 percent gain came from the equity side of the portfolio. Big winners included PETsMART, up 242 percent for the year, and chip maker Adaptec, up 96 percent. "There wasn’t any one sector that led the market," he says. "It was more like a retailer here, a tech name there."
Today, Parnassus Fund’s cash position is down to about 30 percent of assets. After the stock market re-opened in late September, market levels were so low that Dodson used his cash stake to buy stocks at what he considered bargain levels.
Many of these stocks, which remain in the portfolio today, are in the battered telecommunications sector. "Telecom the only area of the market that’s still selling at bargain levels, yet has the potential for growth. Every other industry with growth potential is fully valued."
Dodson won’t buy a stock unless it’s selling below its five-year average for measures such as price/earnings, price/book, and price/sales. A stock’s price/earnings ratio must also be no higher than the company’s projected earnings growth rate over the next year.
He also looks at a company’s intrinsic value, which he bases on its future cash flows. He will only buy a stock when it is selling at two-thirds or less of what he considers its intrinsic worth.
The strategy often lands his picks squarely in the "fallen angel" camp—an inevitable result, he says, from shopping for growth stocks trading at value prices. "A lot of times our stocks will go down for awhile before they go up," he says. "No one rings a bell at the bottom."
If there were such a bell, it would certainly not be ringing yet for the fund’s telecommunications stocks, which have fallen about 7 percent so far this year. The drop in the sector is the main reason that the fund was down 5.14 percent in 2002 as of mid-April, compared to a drop of 1.59 percent for the S&P 500 Index.
Dodson attributes the downturn to continued cutbacks in capital spending by long-distance telephone carriers, which directly affect many of the telecommunications equipment companies in the portfolio. While the downturn has lasted longer than Dodson thought it would, he believes that an improvement in orders will help the stocks make a comeback by the end of the year.
Parnassus’s telecommunications plays, like the rest of the fund, represent a mix of small, mid-sized, and larger companies. His largest holding, Ciena, maintains a 60 percent share of the optical switching market. The stock, priced in the high sixties a year ago, has collapsed to about $9 a share. Dodson figures the stock will rise to $16 within the next twelve to eighteen months. The fund’s second largest holding, Redback, is a small telecommunications equipment maker whose stock has fallen to less than $3 a share, down from over $25 a share a year ago. Dodson calculates its intrinsic value at around $15 a share. |
