Robert Millen is betting that this is one of those years that slow and steady investors have their day.
It’s also a year that Millen, co-manager of the $2.7 billion Jensen Portfolio, is hoping that large-cap stocks finally are recognized for consistently generating sparkling earnings growth. But that recognition may require investors to become less fixated on quarterly earnings results.
And there’s the rub.
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The past few years have been tough on large-cap stocks, defined as companies with a market capitalization–stock price times shares outstanding–above $10 billion. The 25-stock Jensen Portfolio, which carries many large-cap stocks, was down 1.4 percent in 2005.
While the Standard & Poor’s 500 index was up 4.9 percent last year with dividends reinvested, the operating earnings of S&P 500 companies have been expanding at double-digit growth rates for 14 consecutive quarters.
So, even as large-cap companies generate significant free cash flow and use it for classically shareholder-friendly causes like buying back shares and increasing dividends, in many cases their share prices are growing in the low single digits annually. That’s rather disappointing to investors, considering that the 10-year Treasury bond yield is at roughly 4.4 percent.
Though Millen, whose fund operates from Portland, Ore., counsels his investors to be patient, he complains that the market is unduly influenced by investors obsessed with short-term earnings results.
“We don’t have too many investors in the market anymore; we have traders,” he said. “Traders tend to go to the hot sectors. Last year, it was energy and utilities. We still believe the best way to invest is to participate in the success of the business over time rather than betting on short-term growth.”
But, as is demonstrated every earnings season, investors frequently buy or sell depending on whether a company meets the quarterly earnings estimates trumpeted by Wall Street analysts. For that reason, Millen said, the average length of time an investor owned a stock in 1980 was eight years. Today, it’s about 11 months.
The `whisper estimate’
Sometimes, even meeting analyst estimates isn’t good enough. Take the case of Genentech Inc., a San Francisco-based biotech company.
For its fourth-quarter earnings reported Jan. 10, Genentech had a 64 percent profit increase and a 44 percent rise in operating revenue over the same period in 2004.
But the market sold off Genentech shares, sending the stock down as much as 6.7 percent, before it finished the day off 4.4 percent.
Genentech failed to satisfy the “whisper estimate,” analysts’ expectations beyond the official consensus of estimates. Whisper estimates have been prominent among tech stocks, especially during the Internet boom.
So although Genentech met analyst forecasts by reporting earnings of $1.18 a share for full-year 2005, the fourth quarter marked the first time in a year that Genentech had failed to exceed an earnings estimate by at least 4 cents per share.
That same day, a Merrill Lynch analyst report stated that for Genentech to justify a price-to-earnings multiple of 51, it “needs to beat estimates.”
“That’s very frustrating, but earnings are still what it’s all about,” said Jeremy Siegel, a finance professor at the Wharton School of the University of Pennsylvania in Philadelphia. “Investors look at annual performance, and they’re not always patient to sit with a company for a long time.”
Hedge fund haste
Indeed, the advent of impatient hedge fund managers taking in increasing amounts of money has in many cases narrowed the length of time shares are held. Hedge funds often make very large bets on just a few stocks. Besides employing more complex tools such as derivatives, hedge funds will often short a stock, betting that its price will fall.
The upshot, of course, is a more volatile market.
But volatility, said David Fondrie, a fund manager at the Heartland Funds, a Milwaukee-based mutual fund group, can work to the advantage of a slow and steady investor. A big sell-off, as in the case of Genentech, may provide a buying opportunity for those who remain a believer in a company’s underlying value: its ability to generate cash and smartly reinvest it in the business.
“No one likes a 4 percent hit to their portfolio in one day, but if you have confidence about what that company can do over 12 months or longer, it’s best to ignore the vagaries of how it moves day to day,” Fondrie said.
For now, Fondrie and Millen see a large-cap sector with P/E multiples below the market average of 15, but with earnings growth in the double digits.
That, they say, makes for attractive prices, provided you’re willing to take the slow and steady approach.
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