The Peter Lynch philosophy is great -- invest in stuff you can see, feel, and understand, and where you think there might be growth. Thats a good concept, but you need to couple that with some hard analysis of actual earnings progression, earnings numbers, and then watch the stock chart. -- Fritz Meyer
Meyer began his investment career in 1979. Prior to joining INVESCO Funds, he was an executive vice president and portfolio manager with Nelson, Benson & Zellmer in Denver, CO.
How does Meyer choose the most profitable stocks for INVESCO's Growth and Income fund? Jason Hutson of Working Money asked him on October 19, 2000.
The Peter Lynch philosophy is great -- invest in stuff you can see, feel, and understand, and where you think there might be growth. That's a good concept, but you need to couple that with some hard analysis of actual earnings progression, earnings numbers, and then watch the stock chart. -- Fritz Meyer
How long have you been the fund manager for INVESCO's Growth and Income fund? Since its inception. We started this fund in June 1998 and I was comanager with Trent May. We really work well together; he manages the blue-chip growth fund and I manage this one. There's a lot of overlap, but there are some key differences.
Was there any particular event that really got you interested in the financial markets? My interest in the markets and stocks goes way back. I always had an interest in them, even as a little kid. I come from a family where we talked stocks occasionally. My father and other people around me had an interest, which is probably true for a lot of people who get into this business. In the back of my mind, I always wanted to get into the financial business. The way I look at it, I'm getting paid to do something I'd be doing anyway. You can't find a better career than that, can you? I mean one you really like, where you come to work fired up every day.
How did you get started at INVESCO? I started in the money management business about 10 years ago. Before that, I was in investment banking, so I sort of went from the sell side to the buy side. But I've always had an interest in investing and common stocks, so I guess I've been involved in this business, in one way or the other, since the day I graduated from business school.
To be successful at investing, you have to take a keen interest in both companies and the market itself. If you don't have that, if you're not inclined to read The Wall Street Journal or Investor's Business Daily every day, then my advice would be to let a professional do the investing for you. You should go out and pick a good mutual fund. Having done this a long time, first informally on my own and then professionally, I realized you have to be nimble in the market.
Just buying and holding is probably not enough any more -- I don't know if it ever was. This year is a glaring example of that. For the year, the Standard & Poor's 500 index is down 7.4%. Yet with active management, we're actually up 4%. According to efficient market theory, that's not possible.
Why? You can't sit there with Procter and Gamble or Coca-Cola and watch it go down day after day, and just tell yourself it'll all be okay. Don't get me wrong; these are great companies. But a lot of individual investors are prone to do that. They know Warren Buffett owns a lot of Coke. They know he owns lots of Gillette. And yet, this year, if you had just sat there and done nothing in the markets, you would have watched your investment get cut almost in half. It pays to be either a very interested, active investor or find a manager who has demonstrated a positive record and go with that mutual fund. I don't think you need to overly diversify. Just find a five-star long-term growth fund and you'll do fine.
I've been told that when you choose a mutual fund, it's important to know how long the fund manager has been there. For example, if somebody was managing the fund for several years and it did really well, then switched management, that's something an investor should know. That makes sense. On the other hand, there have been instances where a successful fund has turnover at the top, but -- for one reason or another, typically on the strength of the organization -- the fund stays at the top of its class. I think Janus has a number of examples of that situation, and I think even here at Invesco we've had instances where we've changed managers, yet the fund has remained at the top.
I guess if the strategy stays similar you could maintain the performance. The strategy, and the organization. If you're buying a fund company that really believes in fundamental bottom-up research, then in part you're buying a host of analysts who work there and who feed ideas to the portfolio managers. So the fund manager doesn't do it all.
Generally, I think your point is important. If I were picking funds for my own account, I would definitely want to see a fund manager who has actually been with that particular fund for quite a while. If there was turnover at the top, I would watch the fund carefully. If the results started lagging, I would probably jump ship, because I would conclude that the previous fund manager had added all of the value to the fund.
You mentioned picking a mutual fund and letting someone else sweat over the positions for you. That's a pretty good idea for the average investor. People would probably end up doing better in the long term, and they wouldn't have to spend all their time and energy doing the actual investing. If there were a formula for doing this, everyone would know it, and everyone would be successful. But the fact is, something may work for a while, but markets are so efficient that pretty soon it doesn't anymore.
So it's an intellectual challenge to find the next direction. What part of the market is relatively undervalued? Where will the momentum go next? Where will the most attractive earnings momentum pop up next? Which sector of the S&P will it be? It's challenging and it's a lot of work, because in this business history never repeats.
So there's no pattern? No. There's no formula, nothing stock. There are no college courses or graduate school courses that can teach this, in my opinion. I went to business school and I didn't learn anything there that helps me in this business, except for basic accounting. In school, you really only learn the basics of how a company works and how to keep track of bookkeeping. You're on your own when it comes to figuring out how to make money in the market.
I think the single most useful publication for the average investor is Investor's Business Daily. Few people in this business even read the thing. I don't know why that is, because everyone reads The Wall Street Journal. For the average person trying to pick stocks or even pick mutual funds, Investor's Business Daily is a very valuable publication.
One thing that distinguishes IBD from The Wall Street Journal is the fact that IBD has always used charts. It gives people a different perspective. Do you use technicals or look at stock charts? William O'Neil, the founder of Investor's Business Daily, has made a fortune in stocks, so immediately that publication has credibility in my mind. There is a lot of emphasis on charts.
If you read it long enough and closely enough, you will realize O'Neil believes -- and so does his staff, evidently -- that successful stockpicking has two basic elements. First, you have to do your fundamental homework. Second, the money flow embodied in a chart is very telling, and you have to pay attention to those elements. I picked that up later in my career, and it has become so useful.
You can think you know everything there is to know fundamentally about a company, yet the stock doesn't work or it lags. That's not going to do an investor any good. In my case, if I own too many of those stocks, I'll be looking for a new job real quickly. So I concluded there must be more to this than just thinking you understand all the fundamentals. That's really the market aspect of stockpicking that Investor's Business Daily highlights so effectively.
I've always thought a chart is a culmination of all the data from all market aspects at a given time. That's the efficient market at work. A lot of times the stock price chart tells you something that's counterintuitive. Obviously, one of the fundamental reasons is that somebody knows something, and they're selling stock. Or accumulating stock. Only later do you find out why the movement occurred. If you pay attention to those charts, you can save yourself a lot of heartache on the sell side. Conversely, you can identify buying opportunities well before they are common knowledge.
Can you explain the steps you go through to rate your stock selections? The core philosophy is to own and invest in the stocks and the sectors of the economy that are going to sustain better than average growth in both sales and earnings. In this case, "better than average" means comparing earnings growth for our portfolio companies with, say, the S&P 500 earnings growth.
How does that work? For the sake of illustration, if you think the S&P is going to grow earnings 10% next year, then it would be nice to own a portfolio of stocks that, on average, are growing earnings at 15-20%. The theory is that over the long term, stock prices follow earnings at roughly the same rate of growth, so over the long term, you would outperform the S&P 500 if you were consistently in stocks that could sustain strong earnings growth.
At INVESCO Denver, we focus a lot of our analytical energy on sales and earnings and in the growth sectors of the S&P, starting with technology, telecom, health care, certain segments of financials -- these are really the growth sectors of the economy. That's where we tend to concentrate our investments. Unlike most competing firms, this firm has always had sector funds, meaning portfolios concentrated in a particular sector like technology, telecom, or health care. That's catching on in the business, but not too long ago we were one of the only fund companies with sector funds.
How does that work? I listen and watch what the sector funds are investing in and I try to construct my diversified growth portfolio based on what I think are the best ideas in the shop. I exercise a lot of my own biases and prejudices, and then I overlay a sector discipline.
How? For example, maybe the telecom guys still love WorldCom for fundamental reasons, yet I've known for six months that the sector is going down the drain. So even though they're recommending the stock, I probably wouldn't touch it. The point is, to outperform you have to be right on individual stock selection and you have to be right on sector allocations within a diversified growth portfolio. Try to overweight the sectors that are really working and underweight those that are lagging.
How do you find the sectors that are working? What steps do you go through to find the ones that are doing best? That gets back to day-by-day market feel and close observation of the market. For example, on my screen I have the top S&P 500 stocks listed by sector. It's amazing what I can tell just by looking at the colors on my screen in the morning. Over time, you develop a sense for the direction of the various sectors versus the market as a whole.
Once you've concluded that, for whatever reason, health care is generally outperforming or large-cap pharmaceuticals are generally outperforming, then pay special attention to that sector. I try to overweight the portfolio in that sector. In order to do that, I have to study all the stocks in that sector. Then I go to our health-care guys and I ask, "Which stocks do you like best?" And you know what?
What? Money talks and bullshit walks. I talk to my coworkers in charge of each sector, then see what they're actually buying and what they own and what stocks they don't necessarily like. So I get a clear picture. First, I make my own sector judgments, then I rely on the people around me and these sector funds to help with stock selection.
Do you track that analysis day by day? Do you have a spreadsheet or anything like that? I track the analysis, but I don't really write it down anywhere. In our software tools -- Baseline, for example -- I frequently run the S&P 500 and then sort by sector. I can tell you what the best-performing and worst-performing sectors were within the last week, month, and so on. You can get a good feel for the sectors that are working and aren't working.
How do you decide? Here's how I make buy and sell decisions. Every day, I go through every one of the stocks I own. I use a system called WANDA, which is William O'Neil's software package. It has just about any information you could ever want on a stock, right on the screen. Then I make a judgment as to whether the fundamental earnings progression is intact and whether the stock is rolling over. I do that every day. I comb through every one of my holdings and couple that with the sector overview I was just talking about. With that, you will quickly see if a sector is starting to roll over, and you will see that in all the stocks you own in that portfolio. They're all starting to roll or look extended or something like that. Then a red light goes on in your head. It becomes very intuitive.
How often do you evaluate your portfolio based on your criteria? Every day.
What are the main things you take into account? Make sure the expectations for earnings growth for your portfolio companies, or anything you're looking to buy, haven't changed or remain robust. Any downward revisions or general assumptions as to your stocks' earnings progression for 2001 on out will dramatically and quickly affect the stocks. So you want to be sure you're remaining invested in companies where earnings growth exceeds 15%. In our case, I like to see earnings growth at 15% going out as far as I can reasonably project. That's compared to, say, a baseline for the S&P of 10%. So if the earnings growth estimates come down from 16% to 14% based on some changing circumstance, the stock's going to get hit. Then the question is, how serious is that, and should I stick around?
So the two software packages you use to determine all that are WANDA and Baseline? Yes. WANDA, Baseline, and for a large portion of our fundamental data, we use First Call. That's a way to get instant analyst notes on any company. Our Bridge system is Stock Quotes Plus, which provides instant news on any company. The access to information in this business is phenomenal. There's nothing we can't find if it's on the wires.
How often do stocks change within your fund, and why do they change? My portfolio turnover has gone up dramatically this year in contrast to previous years, when the market generally was on an upward path. Then it was pretty obvious -- if you took a buy and hold approach, you were probably going to do fine. This year, the market has gone a little sideways, meaning the S&P has actually gone down 7% year to date, with a lot of volatility. There has been some wreckage. A lot of the higher-flying stocks are down 70-80%, which explains why turnover has gone up. You want to constantly stay in the sectors that are making progress and avoid sectors that you believe are heading down. There's been so much money moving from one sector to another in the last 12 months that I've been forced to change the stocks in my portfolio frequently. For example, earlier I was loaded up on competitive local exchange carriers. The stocks had doubled and we had a good ride. Then, suddenly, they were cut more than in half.
That must have been brutal. What do you look for? You can do very well for yourself if you catch the upleg of something like that, but sticking around for the downleg is pretty counterproductive. That's just one example of industries within sectors that have done a Roman candle routine -- they go up and then they crash. In some cases, there is no obvious fundamental reason. Often, you find out the reason later. So turnover has gone up. Where the turnover comes out for the year depends on what kind of market conditions we experience. It's best to be careful in a sideways market like this, with huge volatility inside. I think that's where active management and hiring a good fund manager will pay off the biggest.
In the last five or 10 years, it's been easy for the average Joe to just index and do great. Those days are gone, at least for now. From roughly 1994 to 1998, indexing was the way to go because the nifty 50, the biggest 50 stocks in the S&P, were outperforming. That's no longer the case. Those indexes actually have negative returns this year.
If you're holding Microsoft, Dell, and Intel, you probably aren't doing too well this year. Exactly. From 1994 to 1998, those tech icons were outstanding. A lot of average investors who really don't follow it day to day would tell you, "Come on, don't tell me Microsoft isn't going to go back to its old highs."
Maybe five years from now. In my view, that isn't going to happen. At a minimum, let the stock put in a bottom and start up before you get renewed interest. But don't stick around from 100 to 50.
Are there industry sectors you think will outperform? Do you think they're still going to be technology, telecom, and health care? Yes, I do. We have a firm conviction on that. When you look at macrotrends in the economy, the big driver in technology is the buildout of e-commerce infrastructure. That's one of the most significant macrotrends this country has ever seen. It compares with the industrialization and rollout of railroads in the 19th century, or automobile-based economy coming on strong in the 1920s, which took with it steel, rubber, and glass.
What's the key? The key is to be invested in the servers, the switches, the software, the storage, the security, and the semiconductors that are behind the e-commerce infrastructure buildout. From a macro standpoint, this is going to be a multiyear phenomenon. The growth rates are going to be spectacular for a long time. The increasing need for greater bandwidth is going to continue for as far out as I can see. Different companies come and go, but the demand for these products is going to remain robust. The trick is to identify the winners and stick with them.
What about health care? The same type of thing. The underlying progress is growing, not only in gene research, genomics, and so forth, but even among the major pharmaceuticals with traditional drug research. That growth is driven in large part by demographics in this country and worldwide. As they age, the babyboomers spend more and more of their disposable income on more and more drugs. The supply shortage created by demographics, coupled with scientific advancements, is driving strong growth rates in pharmaceuticals.
Any other trends you can see? Some other trends are here for at least the investable horizon. There is one in my fund now I like. It is energy related, but not just oil and gas or drilling; it stems from deregulating the utilities in this country. A host of companies now have recognized that if they can sell power or gas on a deregulated basis, they can make some good growth strides. Companies like Enron, El Paso, Duke, Dynegy, and Constellation have all rushed to embrace a deregulated environment for selling both electric power and gas. That market, when you think about it, is huge. I've forgotten the statistic, but it's like $100 billion a year in sales of power and gas. It's basically reorganizing that entire infrastructure here in the US to make it more efficient. There will be clear winners and a lot of losers.
Any others? Another trend with very strong growth characteristics is entertainment. Companies that are creating content for entertainment will continue to show strong growth because we've become an armchair society. People with more disposable income will continue to buy content through one channel or another, such as video content, movies, and music. Over time, people will be willing to pay more, particularly as boomers approach retirement. It will become a leisure economy.
How often do you contact individual companies? All the time. That is one of the things we sell in terms of marketing our expertise. We spend a lot of money to make sure we have enough people in constant contact with all the portfolio companies we own, as well as the ones we don't own but we're interested in. We don't leave it to Wall Street to talk directly with companies. In fact, we take pride in the fact that we oftentimes don't even listen to Wall Street analysts. We like to do our own research.
How do you deal with smaller, more volatile companies? For some of these companies where the expectations are subject to rumor or changing fundamental demand, our people talk to some managements as often as weekly. We want to be sure we're on top of it so we can clearly identify weakness before anyone else does.
What are some of the main economic factors you keep your eyes glued to? First, let's agree on what drives stock prices. Earnings. That is, the outlook for earnings growth. Price/earnings ratios, which are driven by two things, earnings growth expectations and inflation expectations. And finally, liquidity. Market liquidity and longer-term liquidity.
So what are the indicators? For earnings, it's basically the outlook for Gross Domestic Product (GDP) growth, and whether you see things underneath the economy's surface that will cause corporate margins to expand or contract. Basically, if you see healthy GDP growth, it's the same as healthy top-line growth, which we were just talking about. GDP is a measure of the economy's total sales. If you think the US is going to continue to have healthy GDP growth, that means companies are going to keep having good top-line growth. If you see GDP growth turning down, meaning we're headed for a recession, then the whole market probably gets whacked. You want to go for the most defensive sectors you can find, or go to cash.
Two things drive the market P/E multiple. First, earnings growth expectations. Again, multiples can stay high if people believe we have really strong earnings growth ahead. Second, inflation expectations.
How do you gauge inflation expectations? The bond market is a pretty sensitive barometer of future inflation. If interest rates seem as if they've plateaued and are heading back down, that's probably a good indication of subdued inflation expectations going forward. Today, for example, we'd say the market multiple is clearly intact and probably not vulnerable. But if you had a sense that inflation was about to pick up, look out below, because the market will sell off. Nothing will kill the market quicker than a whiff of inflation.
Finally, liquidity. The Federal Reserve holds the levers to liquidity. When the Fed is tightening, you can bet the market will either go sideways or down. The most recent experience is so true to form. For the 12 months ended May 2000, the S&P went absolutely sideways. We were fortunate just to go sideways and not go down precipitously when the Fed was tightening.
Dig down even deeper. For example, housing in this country has been strong. Even the construction of second houses has been red-hot for the last number of years. I think that's because people have made a lot of money in stocks and they're feeling wealthy enough to make such a huge expenditure. Along the lines of your cycle theory, housing filters through many sectors of the economy, many industries, many supplies. That's a good way to get the economy going. If you can get housing going by dropping mortgage rates on the part of the Fed, or in this case with the wealth effect, you're going to have a great economy. And that's exactly what's been going on. What you don't want is to get that going in reverse. If you cut off growth in housing starts, you'll have a recession real quick.
How would you measure that? The only way you can measure expected growth and sales is to look at the recent history and quarter-over-quarter growth and sales. I start with sales because that's the definitive measure of whether this company is selling something in increasing demand. And that's how you really make money in stocks over time. Find a good or service that is in increasing demand, and earnings, of course, will follow. When earnings follow, stock price follows. So look at the most recent quarter-over-quarter record and ask enough questions or do enough research to satisfy yourself that yes, this trend will probably continue, at least for the foreseeable future. Chances are, even if you pay a ridiculous multiple for that stock, you're going to do fine.
If you look at growth and sales, Amazon.com looks good, but they're so far from making any money. How do you evaluate that? That's a good point, because you asked what would be the best measurement for potential. Well, having negative earnings is the exception. In that case, it won't matter in the end whether they can keep compounding their sales growth if they can't make any money. If they lose money on every sale, it's not going to do them much good.
What's the first thing you would tell someone who wants to start investing in the markets? I told my nephew, who has always been interested in the markets, to get a subscription to Investor's Business Daily. That's the simplest thing I can think of. If you have an inquisitive mind and you read that paper, you will get a good feel for how the market works and how to identify individual stocks and build a portfolio. People learn a good set of trading rules along the way. Again, I'm not hung up on rules, because they don't always work and they change over time. You must stay on top of your fundamental education, accounting principles, and read about companies, businesses, and trends. For that, Investor's Business Daily is the best suggestion I can make.
The Peter Lynch philosophy is great -- invest in stuff you can see, feel, and understand, and where you think there might be growth. That's a good concept, but you need to couple that with some hard analysis of actual earnings progression, earnings numbers, and then watch the stock chart.
One of Working Money's goals is to encourage young people to save. Do you have a personal example that might show people the importance of investing early? In my own case, I recognized quite a while ago that in order to send my kids to college, I was going to have to start saving early. It worked out beautifully. I'm pleased I won't have trouble sending our kids to the fanciest colleges they can get into. I'm 50, and I started at age 26 when I got out of graduate school. I worked at it, put money away whenever possible. Really, I was 100% invested in common stocks from the get-go. I withstood a lot of heartache along the way due to market volatility, but it paid off.
Set your money aside and invest it so it's compounding at a reasonable rate. When your kids get to college, there's no way you're going to be able to pay $25,000 or $30,000 a year for college out of your current income. Even people on big salaries can't afford that, so you have to start saving early.
What's your favorite aspect of investing? It's the intellectual stimulation. It's coming to work every day knowing you're going to be facing something new -- either a new stock idea or a problem in your portfolio that you have to deal with. It's constantly dealing with a new flow of information each day and making judgments based on that. And you get a report card at the end of the day, too.
Sometimes that's good and sometimes that's bad. Exactly. Sometimes you need a martini at night.
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