Friday, October 14, 2005

Value v. Growth

Over the past several months I have come across a number of articles discussing the increasing popularity of the forgotten growth stocks, especially amongst professional money managers. I suppose historically, value investors have in general favored sectors such as financial and industrial stocks while shunning typical growth sectors such as healthcare, consumer staples and technology.

I find all this talk about value versus growth somewhat confusing. Sure, when value investors are loading up on their favorite value stocks, growth stocks are most probably trading at multiples outside their comfort zone. Inevitably though, value stocks begin to outperform while growth stocks go through a rough patch, period of underperformance or a correction. Value investors then change their tune and begin considering purchase of traditional growth sectors. You get the picture. I think Bill Nygren of the Oakmark Fund put it very eloquently at a recent conference when he said that Wall Street is now "an upside down world" and that "buying above-average businesses at average prices is just as much value investing as is buying average business at below-average prices."

This is in effect what Buffett has been doing ever since he took a position in Coca Cola - Growth at a Reasonable Price. In his book titled Money Masters of Our Time, John Train notes that Buffett dismisses the distinction between Grahamian value investing and buying prime growth stocks, "saying that both techniques involve analyzing the present value of the future cash flows you expect to receive."

Incidentally, I recently finished reading Train's book. It was interesting to learn about the different investment styles of some of the most successful investors including T. Row Price, Philip Fisher, Soros and Lynch. The book is full of valuable insight and advice. I found the chapter on Soros fascinating - talk about a high pressure, high risk investment style. Train does a good job summarizing the philosophies and investment styles of these investors and ends the book with a chapter titled Lessons from the Masters.

It is interesting that whether they are value investors, growth investors, emerging market gurus or currency speculators, they all have common attributes necessary to make any investor successful. Here are a few attributes to note:
  1. Remember you are buying a share of a business. Make sure you understand the business.
  2. Buy stocks when they are unpopular. My brother and I recently added Wal-Mart (NYSE: WMT) to our portfolio. Talk about a stock that has been hammered and a company under scrutiny. Another recent addition to our portfolio is Anheuser-Busch (NYSE: BUD). Let's just say beer is not in with the crowd right now.
  3. Do not be spooked by market fluctuations. Let the story play out. I think in the immediate after-math of a purchase, I have almost always lost money. Always remember why you bought the stock in the first place. My Pier 1 holding recently hit $10 a share. Five years ago I may have sold. But this time, I am waiting for the story to play out.
  4. Buy stocks when they are cheap. Don't buy Intel (Nasdaq: INTC) when it's trading at a historically high multiple and every analyst on Wall Street is upgrading the stock. Speaking of above-average businesses at average prices, I have continuously added to my Intel and Cisco (Nasdaq: CSCO) for more than a year. It was comforting to see Bill Miller at Legg Mason's Value Fund recently added Cisco to his portfolio as well.
  5. Be flexible. The Money Masters have all had the uncanny ability to change with the times. Buffett evolved from a pure Grahamite and slowly incorporated qualitative measures into his approach. Others such as Soros are ready to switch directions on a moment's notice. Train's epigraph to his book is one worth remembering: "Times change and we change in them."

Sunday, October 02, 2005

Eddie Lampert

You may have heard of Eddie Lampert if you shop at Kmart or Sears. Actually, he has been around for a while and is considered one of the most successful value investors around. He founded his private investment fund, ESL Investments Inc., in 1998 with $28 million of seed money from another legendary investor, Richard Rainwater. ESL now has $9 billion under management and Lampert’s net worth is believed to be around $2 billion. Since 1988, ESL has earned 29% a year – compare that to Berkshire’s 25% a year return since 1965.

Lampert has successfully invested in undervalued companies and, unlike Buffett, is not afraid of to consider companies run by sub par management teams. His rational is that those situations offer an even larger potential reward.

Most recently, Lampert was in the news for emerging as one of Kmart’s largest shareholders following that company’s bankruptcy proceedings. Kmart’s stock has rocketed from $15 in 2003 to a high of $160 back in July. It is now sitting at around $120 post-Katrina.

A few important things to note about Lampert’s Kmart foray. Not long after emerging as a controlling shareholder, he made a bid for Sears and merged the two companies into Sears Holdings Corporation (NYSE: SHLD). The company has in excess of $3 billion in cash and is cash flow positive. More importantly, the Board of Directors has given him free rein on the use of cash. This is pretty much what Buffet did with Berkshire. He milked the textile mill for cash and turned Berkshire into an investment vehicle. A la Buffett, Lampert is not giving guidance to the street and instead opting to update matters through his shareholder letters available on Sears’ corporate web site.

For now, Lampert is intent on turning Sears and Kmart around and in August announced that he will be taking a more hands on role in the marketing department. Regardless, his focus is on transforming the culture at Sears, profitability and cash flow generation. He has made it clear that top line growth does not interest him.

Estimates vary as to the Sears’ intrinsic value. I have seen estimates as high as $190 a share just on the basis of the company’s real estate assets. You could also argue that the shares are overvalued and that you are paying a Lampert premium at these levels. The fact is that the shares have come off their peak and have been under more pressure, going as low as $115 recently, as Katrina and Rita have wreaked havoc in the South, hammering many retailers’ operations. I was too slow to pull the trigger when the shares were at $100. This time, my brother and I agreed to get in at $130 before the hurricanes hit.

Let’s call it the Lampert experiment. He has the track record and manages money for a number of well-known wealthy individuals including Michael Dell. It is also comforting to know that successful value investors such as Legg Mason’s Bill Miller and Third Avenue Fund’s legendary value investor Martin Whitman own Sears in their portfolios. In fact, Whitman partnered with Lampert during the Kmart bankruptcy proceedings. Whitman is quoted as saying. “There is no question he will turn Kmart into an investment vehicle like Buffett’s. That is what I am valuing into the stock.”