NEW ERA VALUE INVESTING RELATIVE VALUE DISCIPLINE This book describes an innovative investment strategy called “Relative Value Discipline,” which provides a framework for investing 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 in Traditional Value Sectors Screened using: Relative Dividend Yield (RDY) valuation model Low-Yielding Stocks in Growth-Oriented Sectors Screened using: Relative Price-to-Sales Ratio (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 No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-7504470, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201748-6008, e-mail: permcoordinator@wiley.com Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations 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 created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993, or fax 317572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books Library of Congress Cataloging-in-Publication Data: ISBN 0-471-26608-6 Printed in the United States of America 10 CONTENTS PREFACE ix ACKNOWLEDGMENTS CHAPTER xv Is It Really “Different” This Time? CHAPTER A Short History of Fundamental Analysis and the Dividend 13 CHAPTER The Development of Relative Dividend Yield 21 CHAPTER The Challenges of the 1990s 33 An Historical View of U.S Productivity 37 CHAPTER The Twelve Fundamental Factors of RDY and RPSR Research 51 Qualitative Appraisal 53 Quantitative Appraisal 61 CHAPTER 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 RPSR Case Studies 105 RPSR and the Technology Bubble 106 The Intersection of RDY and RPSR 120 CHAPTER 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 What Is Value Investing Today? 145 CHAPTER 10 Seven Critical Lessons We Have Learned as Disciplined Investment Managers 153 Wall Street Tends to Take Current Trends and Extrapolate Them Out to Infinity 154 It Is Rarely “Different This Time.” 154 Market Workouts Are Often Great Investment Opportunities 156 At Turning Points, Go with Your Discipline— Not Wall Street 157 Investment Managers Need to Challenge Their Beliefs Every Day 161 Use the Availability of Data and the Always-On Financial Media to Your Advantage 162 It’s All Relative 162 APPENDIX A New Era Value Composite Disclosure 165 165 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 advanced 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 Relatively 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 investment 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 companies, municipalities, mutual funds, and individual investors My quest for value has resulted in a focus on discipline both from a valuation and fundamental research standpoint The Relative Priceto-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 employing a discipline is consistent implementation RPSR has identified cheap high-quality companies, and the market will eventually follow The discipline works because the market cycles; if investors remain constant it will come back our way Relative Dividend Yield (RDY), our original valuation discipline, has ix .. .NEW ERA VALUE INVESTING RELATIVE VALUE DISCIPLINE This book describes an innovative investment strategy called “Relative Value Discipline,” which provides a framework for investing. .. 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... 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 What Is Value Investing Today?