Baker 500 Growth Fund
Author: Manish Shah
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I make sure that I am well diversified throughout the sectors. The S&P consists of 59 industries, and if I am represented in 20-25% of those industries, that is a reasonable degree of diversification.
Right now I am more heavily weighted in healthcare. I think that healthcare is an industry that will continue to grow. If you select the right stocks, you should be rewarded. During the recent correction, healthcare has been beaten down, but I am pretty optimistic about the future of the industry.
That is my approach and it has been substantiated by Milton Friedmanís analysis that suggested that if you had thirteen stocks in thirteen industries, you really are diversified. Most portfolio managers that have 40 to 50 stocks donít agree with that, but everyone has a right to their own opinion.
Q: What are some examples of the stocks on your top-ten list?
A good example of a stock that I had for a long time is Dell Computer. It was a stock that had excellent growth and earnings path. Today, I think International Game Technology may follow a similar cycle. They are the market leader in the gaming equipment industry.
While that stock has been volatile lately, individual stocks have behaviors similar to the overall markets. They behave like a pendulum, and once they start to move they often take on a life of there own and continue in the same direction. Once they reach an extreme, they often become volatile.
I have been doing this since 1982 and what I have found is that I can find 4-5 winners, 3-4 dogs that I have to get rid of during the year. Then the rest of the stocks seem to hover around the S&P 500 performance.
I donít follow analysts. When an analyst downgrades a stock, I look to see if it might be an opportunity to buy; alternatively, an analyst upgrade may be a reason to sell. What I look at is the reason for the change. If it is due to something the company announced, then Iím usually out. But if it is due to the analyst opinion, and my analysis would suggest continuing to hold the stock, I am more inclined to retain the stock and add it to my alert watch list.
In general, company statements are more likely to trigger a trade than the earnings numbers themselves. I am more interested in whether the business is continuing to grow on track and whether the momentum is still in place.
Q: With regard to Dell, what were two or three characteristics that made it attractive?
In general, I am looking for the momentum of compound earnings growth. I focus on both top-line growth and cash flow, because the companyís ability to support the growth is very important. Dellís market share was an important factor, as well as their inventory management approach.
They did not believe in building inventory and letting it collect dust; instead, they would build on order. They are now doing the same thing in the server market and I think they will be successful. But the most attractive thing about Dell was their proven ability to grow their business.
Home Depot and Loews are two more good examples of companies that fit this mold. I owned both, but when it was clear that Loews was outperforming Home Depot, I sold Home Depot in favor of Loews.
Q: Why do you like Medtronic, it has been flat for a year?
Medtronic is a Minneapolis based company, so that I am more familiar with it than most of the stocks in my portfolio. I had not held this stock since 1988, but I added it to the portfolio again this year. In the late 1990ís they made a lot of acquisitions, but for various reasons, the company never made it through my screens again until this year.
In the 1980ís, it was a high growth stock and it is still the worldís largest manufacturer of defibrillators. I had the stock in my personal portfolio. They have apparently done an outstanding job of integrating their acquisitions form the late 1990ís into the company and into Medtronicís way of doing business.
Buying another company can be a real challenge particular when there are cultural issues at stake. Companies, like Wells Fargo, that learn how to do it can be very successful. I think that Medtronic has also figured it out. Their approach to management and the entire culture brings out the best in people. As a result, management turnover is very low.
I also like the areas of research they are focusing on like the spinal area and diabetes. The company has some pretty exciting acquisitions in those two fields and it is well positioned in most of its markets. Even so, the stock is not performing well relative to St. Jude. It is currently on my watch list and it may be one that needs to be replaced.
Q: You mentioned that you rarely hold stocks as long as two years. Why is that?
Itís not that I donít like to, it just seems to happen that way. Dell Computer was one exception, but they are rare. Given that I have a 75% turnover rate and 20 stocks in my portfolio, 15 may turn over during the year.
I donít view myself as a high turnover manager, but yet I am not a buy and hold manager either. Iím certainly not reluctant to act on a surprise coming from one of the companies I am holding, or news of changing conditions in an industry.
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