Nancy Tengler - New Era Value Investing (Wiley-2003) (pdf)
On February 27, 2001, the Securi-
ties and Exchange Commission
(SEC) approved amendments to
National Association of Securities
Dealers, Inc. (NASD®) Rule 2520
relating to margin requirements for
day traders (the “amendments”).
1
The amendments become effec-
tive on September 28, 2001 and
are substantially similar to amend-
ments by the New York Stock
Exchange (NYSE) to its margin
rules.
2
NEW ERA VALUE
INVESTING
RELATIVE VALUE DISCIPLINE
This book describes an innovative investment strategy called
“Relative Value Discipline,” which provides a framework for in-
vesting in traditional dividend-paying value stocks, as well as
undervalued growth stocks. The graphic below illustrates how
the stock selection process works step by step to winnow a
thousand large cap stocks down to a focused portfolio of
twenty to thirty holdings.
Investment Universe
• Large cap U.S. stocks
• Approximately 1,000 companies
• Market cap over $3 billion
Divdend-Paying Stocks Low-Yielding Stocks
in Traditional Value Sectors in Growth-Oriented Sectors
Screened using: Screened using:
Relative Dividend Yield Relative Price-to-Sales Ratio
(RDY) valuation model (RPSR) valuation model
Focus List
• Approximately 100 companies
• Low price versus historical company average
Twelve Fundamental Factor Analysis
Qualitative Factors/Quantitative Factors
• Buggy Whip (product obsolescence) • Positive Free Cash Flow
• Niche Value (market leadership) • Dividend Coverage and Growth
• Top Management • Asset Turnover
• Sales/Revenue Growth • Investment in Business/ROIC
• Operating Margins • Equity Leverage
• Relative P/E • Financial Risk
Portfolio Construction
• Rank each Focus List security based on both qualitative
and quantitative analysis
• Focused portfolio (usually between twenty and thirty holdings)
• Highest confidence picks
• Calculated sector bets versus S&P 500
NEW ERA
VALUE INVESTING
A Disciplined Approach to Buying
Value and Growth Stocks
NANCY TENGLER
John Wiley & Sons, Inc.
Copyright © 2003 by Fremont Investment Advisors, Inc. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada
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Limit of Liability/Disclaimer of Warranty: While the publisher and author
have used their best efforts in preparing this book, they make no represen-
tations or warranties with respect to the accuracy or completeness of the
contents of this book and specifically disclaim any implied warranties of
merchantability or fitness for a particular purpose. No warranty may be cre-
ated or extended by sales representatives or written sales materials. The
advice and strategies contained herein may not be suitable for your situa-
tion. You should consult with a professional where appropriate. Neither the
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Library of Congress Cataloging-in-Publication Data:
ISBN 0-471-26608-6
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
CONTENTS
PREFACE ix
ACKNOWLEDGMENTS xv
CHAPTER 1 Is It Really “Different” This Time? 1
CHAPTER 2 A Short History of Fundamental Analysis and the
Dividend 13
CHAPTER 3 The Development of Relative Dividend Yield 21
CHAPTER 4 The Challenges of the 1990s 33
An Historical View of U.S. Productivity 37
CHAPTER 5 The Twelve Fundamental Factors of RDY and RPSR
Research 51
Qualitative Appraisal 53
Quantitative Appraisal 61
CHAPTER 6 RDY Case Studies 85
Oil Stocks 86
Pharmaceutical Stocks 88
Classic Fallen-Angel Growth Stocks 90
Consumer Stocks 93
Bank Stocks/Financials 97
RDY Failures—Terminally Cheap Stocks 100
v
vi CONTENTS
CHAPTER 7 RPSR Case Studies 105
RPSR and the Technology Bubble 106
The Intersection of RDY and RPSR 120
CHAPTER 8 Constructing a Value-Driven Portfolio 129
Merged Companies Combining High-Growth and Slow-Growth
Components 141
New Companies with Too Short a History 142
CHAPTER 9 What Is Value Investing Today? 145
CHAPTER 10 Seven Critical Lessons We Have Learned as
Disciplined Investment Managers 153
1. Wall Street Tends to Take Current Trends and Extrapolate Them
Out to Infinity. 154
2. It Is Rarely “Different This Time.” 154
3. Market Workouts Are Often Great Investment
Opportunities. 156
4. At Turning Points, Go with Your Discipline—
Not Wall Street. 157
5. Investment Managers Need to Challenge Their Beliefs
Every Day. 161
6. Use the Availability of Data and the Always-On Financial Media
to Your Advantage. 162
7. It’s All Relative. 162
APPENDIX A New Era Value Composite 165
Disclosure 165
APPENDIX B Estee Lauder—Twelve Fundamental Factors:
Estee Lauder Companies, Inc. Valuation Factors 169
Qualitative Appraisal 170
Quantitative Appraisal 173
CONTENTS vii
APPENDIX C EMC—Twelve Fundamental Factors:
EMC Valuation Factors 181
Qualitative Appraisal 182
Quantitative Appraisal 189
APPENDIX D Walt Disney—Twelve Fundamental Factors: The
Walt Disney Company Valuation Factors 197
Qualitative Appraisal 198
Quantitative Appraisal 208
INDEX 215
PREFACE
Most books on equities investing are written during the ad-
vanced stages of bull markets when the public’s interest in the
subject is peaking. This book was written almost two and a half
years into a wrenching bear market by a portfolio manager
whose investment performance has not been particularly good
in this exceptionally challenging market environment. This
begs two questions: Why now? Why me?
The answer to the first query is easy. As a died-in-the-wool
value investor, I believe in buying cheap and selling dear. Rela-
tively few stocks are truly cheap during the latter stages of a
bull market, whereas there are plenty of great fundamental
bargains toward the end of a bear market. Bear markets are a
perfect time for investors to pick off great companies at low
valuations. What better time to introduce a value-driven in-
vestment discipline to investors?
The answer to the second query is a little trickier. I’ve spent my
entire seventeen-year career as a value manager for large compa-
nies, municipalities, mutual funds, and individual investors. My
quest for value has resulted in a focus on discipline both from a val-
uation and fundamental research standpoint. The Relative Price-
to-Sales Ratio (RPSR) strategy detailed in this book has not been
especially effective over the last eighteen months. Is this a cause
for concern? We think not. The most important thing when em-
ploying a discipline is consistent implementation. RPSR has
identified cheap high-quality companies, and the market will
eventually follow. The discipline works because the market cy-
cles; if investors remain constant it will come back our way. Rel-
ative Dividend Yield (RDY), our original valuation discipline, has
ix
x PREFACE
produced results over the long term but has struggled during pe-
riods when growth investing ruled. But, by their very long-term
nature, both strategies will identify stocks that will not outper-
form each and every year. However, they will outperform over
the long term, which should be the time horizon of most in-
vestors. The disciplines this book will discuss have produced ex-
cellent long-term track records, which I believe will help readers
target the stocks that will produce the most generous returns in
the years ahead.
There has been a long-running debate on whether growth-
at-a-reasonable-price methodologies such as mine qualify as
value investing. This debate has intensified over the last year,
as traditional value portfolios have outperformed and value-
oriented growth stock investing has underperformed. Indeed,
“absolute value” investors, with low price/earnings ratio port-
folios concentrated in the most defensive market sectors, have
had considerably more success than anyone else as the stock
market has plummeted over the last few years, which is how it
should be. I believe in traditional value stocks and hold some
in my portfolios, but with the flexibility of the discipline this
book will be introducing to you, I am able to identify stocks
that trade at value-investor valuations, with growth-investor
earnings potential. Coming out of a bear market, this is where
investors want to be. Over the long term, I believe buying in-
dustry “Cadillacs” when the dealer (the market) is offering big
incentives is a better definition of value than buying more
cheaply priced, but much slower and poorer quality “Yugos.”
Put another way, “cheap” is not a synonym for “good value.”
Warren Buffett, the most famous value investor of our time,
is what I would call a growth-at-a-reasonable-price investor.
Mr. Buffett has earned his well-deserved reputation as a con-
noisseur of value by buying high-quality growth companies
when they are experiencing temporary difficulties or, for what-
ever reason, have lost favor in the market. Although over the
short term, Mr. Buffett’s portfolio of “fallen angel” growth
stocks has periodically underperformed, over the long term
PREFACE xi
they have made Berkshire Hathaway (Buffett’s holding com-
pany) shareholders an enormous amount of money.
As I write (October, 2002), the Dow Jones Industrials and
S&P 500 are at four-year lows and the NASDAQ Composite is
off almost 77 percent from its March 2000 peak. Naturally,
some commentary about this wrenching bear market is in or-
der. At this stage, I think the most important thing to under-
stand is that as investors approach bull market peaks and bear
market bottoms, they develop an almost total disregard for
fundamentals. Back in late 1999 and early 2000, investors
didn’t care about P/E ratios. They simply wanted to buy stocks
because they were going up. Wall Street was bending over
backwards to justify sky-high valuations and their nearly unan-
imous buy recommendations. Today, investors are equally
oblivious to fundamentals. The S&P 500 is trading at about fif-
teen times next year’s earnings estimates—near its historical
P/E average and lower than one might expect given today’s his-
torically low bond yields and inflation, as well as improving
economic and earnings trends. But investors seem to be ignor-
ing the improvements, waiting for what they call visibility. This
reflects doubt that earnings will be as good as anticipated.
Normally, low bond yields combined with relatively good
economic and corporate earnings news would buoy the stock
market. But not this time. The financial press and politicians
gearing up for mid-term elections are placing most of the
blame for the market’s dismal performance this summer on the
“crisis in confidence” spawned by accounting scandals and
corporate malfeasance. This makes good copy and provides
politicians airtime and ammunition to use against their oppo-
nents in the upcoming elections. However, the turmoil and
volatility is likely to continue for some time. For times like
these, the valuation disciplines are made to order.
In my view, one of the benefits of this bear market is that it
has seasoned a whole generation of investors. Healthy fear and
respect of the bear is a good thing and will result in prudent,
intelligent investors. In our family of mutual funds, Fremont
xii PREFACE
Funds, individual investors have been doing exactly what they
should be doing: averaging into a diversified portfolio of funds.
Outflows have been modest.
I wrote this book because I believe passionately in the virtues
of discipline in investing. If you find our valuation discipline of
interest—great! If not, find a discipline that appeals to your ap-
petite for risk and your long-term return objective. But whatever
your investing profile, be disciplined. A consistently applied dis-
cipline will ensure success. I will leave you with two of my own
experiences that illustrate why discipline is so important. The
stories have been told before, to Allen Clarke for his book Ad-
ventures in Investing, but bear repeating because they illustrate
the importance of investment discipline so perfectly.
Best Investment: In the spring of 1999, Oracle Corporation be-
came attractive on a valuation basis. According to the way we
look at the world, the stock had rarely been cheaper. The mar-
ket was discounting slowing growth in application software.
But Oracle was focused on Internet computing and the trend
away from personal computers to servers. Oracle’s commit-
ment was articulated best by founder and CEO Larry Ellison,
who believed that the best way to demonstrate the value of the
Internet to Oracle’s customers was to become an Internet-
centric company centered around their own products—a bril-
liant move that served not only to lower the company’s oper-
ating expenses but also to stimulate demand for new Internet
applications. Oracle proceeded to beat estimates and “wow”
the Street. Of equal importance to us was the quality of man-
agement and the fact that Larry was “engaged” in the com-
pany once again. Using the Larry Ellison indicator has proven
to be a successful way to buy the stock—it performs better
when he is in charge and not so well when he is sailing around
the world in his yacht. The results? We realized about a 600
percent return from our acquisition price.1
Oracle is a classic example of how RPSR can be used to
profitably invest in value-oriented growth stocks.
PREFACE xiii
Worst Investment: Ignoring one of my long-held tenets of
never taking stock tips from friends, I did something worse: I
took a stock tip from a stranger of sorts. He wasn’t a strange
stranger; after all, I met him in first-class on a cross-country
flight. He was CFO of a company that was in the midst of an
IPO road show. We didn’t talk about the deal, but we did talk.
And after the IPO I would watch the stock from time to time.
It took off and produced exponential returns for the invest-
ment bankers and early investors. After about six months the
stock pulled back about 50% and I jumped in, breaking all my
own rules. I knew nothing about the fundamentals of the com-
pany beyond what business they were in and I knew nothing
of the management except that the CFO was a very funny guy.
I bought 200 shares of Smartalk Services (SMTK) for each of
my kids’ college accounts. “A little speculative growth can’t
hurt,” I told myself. I purchased the stock at around $16 per
share after an earnings disappointment. The first warning is
rarely the last. The stock was eventually delisted and the com-
pany filed for bankruptcy. When I can get a value for my
shares it shows a price of pennies per share.
I did just about everything wrong in that transaction, but
the most critical error was buying stock in a company I knew
nothing about. I didn’t follow my discipline and I gambled with
my hard-earned money. Although I will never salvage the loss,
the shares remain in the account as a painful reminder of my
error.1
NANCY TENGLER
NOTE
1. Allen Clarke, Allen Clarke’s ADVENTURES IN INVESTING, How to
Create Wealth and Keep It (Key Porter Books Limited 2000).
ACKNOWLEDGMENTS
The acknowledgements section of a book always reminds me
of 8th grade graduation. The part where the principal stands up
and tells the graduates that they will be sorely missed since
“you are the best class to ever pass through these halls.” Yeah,
right.
The traditional thanks to all who dedicated so much of
their time to this manuscript falls flat. I would like to raise the
bar for all future authors who drain the time and intellect of so
many to achieve so little.
First and foremost I want to thank the founding fathers of
this great country for one of the most successful experi-
ments in free trade and capitalism ever ventured. To all the
investors who every day take their hard-earned money and
invest in the future of this country and their own retirement
while fighting the hangovers of insider trading and corporate
accounting fraud and terrorist attacks and economic slow-
down, you are the real heroes of capitalism—you have my
enduring respect.
In the development of this tutorial on our approach to
“skinning the cat” I would like to thank the beyond-the-call-of-
duty efforts of Bill Fergusson and Michelle Swager of Fremont
Investment Advisors. In addition to the creative demands and
deadlines of running the marketing activities for a mutual fund
complex, Bill and Michelle devoted hours of their personal
time to fact-checking and editing this book. They made strate-
gic contributions and added to the overall interest and edito-
rial content of what you are about to read. In her spare time
Michelle got married and Bill went to Fiji.
xv
xvi ACKNOWLEDGMENTS
Steve Kindell assisted in developing much of the content in
the book. Steve is an incredibly bright and lively contributor.
After this mundane project, I recommend that Steve write the
definitive history of the world—if anyone can do it, he can. His
seemingly endless knowledge and turn of a phrase was a great
help and was sincerely admired.
The analytical team at FIA should be awarded hazard pay
for devoting enormous effort to navigating through a bear mar-
ket and then having the annoyingly pesky task of responding to
my requests for data . . . and more data. Harshal Shah,
Joe Cuenco and Matt Costello provided historical perspective
for the companies they cover and important analytical
insight—not to mention all of the charts!
Noel DeDora and I have worked together since 1984. It’s
been a load of fun and Noel continues to be the single smartest
individual I have ever met. (He is also the perfect straight
man.) Noel has contributed a lot to my view of the world and
my education of the capital markets. His early adaptation of
RPSR as a way to identify value outside the dividend paying
pool of stocks we had fished in for so many years was revolu-
tionary at the time. After thirty years in the business, he has
seen it all and made a ton of money for our clients. When he
does decide to leave behind the “old stock and bond place” as
he calls it, he will be greatly missed indeed. Luckily the invest-
ment business doesn’t require heavy lifting, and I am hopeful
he will remain involved for decades to come.
I would also like to extend my thanks to Ed Sporl, a well-
regarded investment professional who graciously took the
time to provide insight and factual confirmation for parts of the
book. Dan Stepchew interned with us during the writing of this
manuscript and was given the unending job of checking
data of all sorts. Let’s hope that experience has not deterred
him from pursuing a career in the investment management
business—we need fresh, young minds, Dan!
Deb McNeill and Cathy Smart added research elements
that reflect their unique skills. Kathy Ribeiro assists me on a
ACKNOWLEDGMENTS xvii
day-to-day basis with the business of running the business I
oversee at Fremont Investment Advisors. If I could come back
with the ideal disposition and attitude—it would be Kathy’s.
My sincere thanks to KR for keeping things moving in a calm
and determined manner.
Many thanks to Nicole Young for the excellent advice she
gave us as we embarked on this project, and for referring us to
Gail Ross, whose services as lawyer and agent are much ap-
preciated. And thanks to Bill Glasgall, Editorial Director of In-
vestment Advisor magazine, for referring us to Jeanne Glasser,
Senior Editor at John Wiley and Sons.
Jeanne Glasser has provided valuable direction and en-
couragement. Jeanne’s vision to take an “out of the box” view
of the world like the one outlined in this book is a tribute to the
quality of the team at Wiley that continues to turn out interest-
ing and thought-provoking financial books. I am very grateful
for Jeanne’s guidance and patience.
Lastly, I would like to thank my old friend, Al Krause, who
had nothing directly to do with this book, but everything to do
with bringing a constantly provocative view of the world that I
find endearing, amusing, and personally challenging. Thanks
for continuing to stoke the desire to learn and improve, Al.
NANCY TENGLER
2002
1
IS IT REALLY
“DIFFERENT” THIS TIME?
“In Wall Street the only thing that’s hard to explain is—next
week.”
Louis Rukeyser
“It’s different this time” is a phrase impressionable young value
investors are taught to challenge from the moment they decide
to walk the value-investing path. As students of history and the
markets know, any given situation is rarely “different this
time.” Value investors make a nice living for their clients and
themselves by thoughtfully betting against those who say that
it is difficult, if not impossible, to make money on stocks that
are out of favor. For example, successful value investors were
able to profit on oil stocks purchased in the early 1980s, after
oil prices plunged from their late 1970s highs. They were able
to profit on health care stocks when the Clinton Administra-
tion’s failed attempts to reform health care in the early 1990s
severely depressed equity valuations in the sector. And they
were able to position themselves to later profit in defense
stocks as investors during the mid- to late 1990s temporarily
lost confidence in an industry undergoing wholesale consoli-
dation after a period of severe cutbacks in defense spending.
1
