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The Pros and Cons of Three 2005 Chart Toppers
Jennison Value PBEAX
This offering currently ranks a close number two in the huge large-value category. Of the three funds mentioned here, it's probably the one most worthy of serious consideration--or perhaps it is better to say that it is least likely to be a big disappointment.
On the positive side, we have a high opinion of the fund's advisor, Jennison Associates, which does a good job of training and keeping a stellar group of analysts. The fund also had a fine 2004. One reason for its 2005 success is that it has scored nicely with several energy picks. And unlike some chart toppers--the next one on the list is an example, although not the most extreme--its year-to-date return of 14.1% isn't so high that you'd feel hesitant to buy it at this point.
The main downside here is that both of the fund's managers are fairly new--one began his tenure in 2003 and the other in 2004. One of them does have nice track records at other offerings, and the Jennison connection raises confidence, but it obviously makes sense to be cautious in assessing a fund whose managers have such brief tenures.
Driehaus International Discovery DRIDX
With a 30.6% gain, which leads the foreign small/mid-growth category by nearly 3 percentage points, this one has the highest year-to-date return of the three offerings mentioned here. That can turn some heads--but make sure to check the details. For one thing, the current manager hasn't even been in charge all year. Lynette Schroeder took over in March 2005, coming from American Century. That in itself, however, is not a concern. She's a talented manager who had success running American Century International Opportunities AIOIX, and she had been at Driehaus before going to American Century in 2001, so this isn't an entirely new situation for her.
There are plenty of other reasons for caution, though. First, in the international realm (unlike in the
Finally, this fund is expensive: At 1.70%, its expense ratio is above the median for no-loads in its category. In short, its strong performance this year is impressive--Schroeder has made some solid choices, particularly among consumer stocks, and her history argues in her favor--but the fund is not one to buy lightly. (By the way, the number-two fund in this category is none other than American Century International Opportunities--Schroeder's old charge.
Merrill Lynch Global Value MDVLX
This one's the least appealing of the three. Not that it should be off-limits: Its managers, who took over in 2002, amassed a decent record prior to this year and deserve credit for making some impressive choices in 2005, particularly in the energy sector and the surging Korean market. However, their three-year tenure is not long enough to give us great confidence in the fund. And it's worth noting that this year's stellar 28% gain--tops in the world-stock category by a long shot--has a catch. The fund reaped a substantial one-time gain from the resolution of litigation in October: That alone added about 10.8% to the fund's net asset value, according to a statement from Merrill Lynch. The fund was having a good year before getting that extra boost, but not this good.
On the positive side, this fund's 1.50% expense ratio is reasonable for a broker-sold offering in this category, and the managers did serve as analysts here before taking the helm, so they have more experience than their managerial tenure implies. Still, it's hard to get too enthusiastic about this offering right now.
Health-care stocks haven't gotten a lot of love lately. This sector significantly lagged the market over the past three years, returning only 5% compounded annually (as measured by the Health Care Select Sector SPDR XLV) while the S&P 500 returned 12% on an annualized basis. This underperformance is no surprise given the intense scrutiny health-care companies have been under, especially since the Vioxx saga. Safety, legal, and regulatory risks abound in health care, and the Vioxx case continues to highlight those inherent risks. Combine those risk factors with drying pipelines and blockbuster patent expirations on the horizon for some industry titans, and many investors have run screaming for the exits when presented with these stocks.
We think turning a blind eye to this highly profitable industry is a mistake. In fact, many of our favorite health-care companies are currently on sale. When performing a screen of health-care firms with wide moats, average or below-average risk ratings, and trading at or near our consider buying price, we were presented with a list of heavyweights. These companies may not be immune to the risks of this industry, but their abilities to generate economic value over the long term remain intact.
Our favorite health-care companies exude the enviable advantages that often lead to long-term success in this industry. These include a record of innovation, a diversified product portfolio, and marketing prowess.
1. Record of Innovation
Patents form the foundation of most health-care moats. Almost any company can get lucky once by introducing a product that generates substantial returns on invested capital for a patent's duration. However, the most successful health-care firms show an ability to introduce novel products again and again, allowing them to replenish revenue streams when old products face patent expiration. The ability to continually discover new products that treat unmet needs, usher those products through clinical trials, and receive regulatory approval in a timely fashion remains highly valuable in the health-care industry.
2. Diversified Product Portfolio
The principles of portfolio diversification are not limited to stocks. Health-care companies that rely on diversified product streams often fare better and definitely exhibit lower risk profiles than counterparts that put all their eggs in one basket. We like companies that are able to excel in more than one discipline of the health-care industry, which includes pharmaceuticals, devices, and biotechnology, among other fields. Even if the company's prowess lies in only one area, its ability to draw on many products for revenue rather than only a few products increases our confidence in its long-term staying power.
3. Marketing Prowess
While marketing is overlooked in many industries, salespeople bring enormous value to health-care companies. They can make or break a product, so health-care companies spend a lot of time and money to get the right message in the right physicians' ears. Many upstarts lack this vital link in the industry's value chain, which creates a barrier to entry. Until they can establish their own salesforce, newcomers often give away most of their products' profits in exchange for help from a larger partner to get treatments into patient hands. So even when an established health-care company doesn't discover a product, its sales and distribution capabilities often allow it to grab a large share of partnered profits.
Five of our favorite health-care companies:
Abbott Laboratories ABT
Morningstar Rating: 5 Stars
Economic Moat: Wide
Risk Rating: Below Average
From the Analyst Report: The backbone of Abbott's business model is its diversified revenue base. High-margin pharmaceutical products constitute 60% of sales, and the nutritional and diagnostics segments make up 22% and 18% of sales, respectively. The prescription drug business is one of the most profitable around, but it can be risky if patents expire and pipelines dry up. Abbott's diversified business segments provide a steady stream of cash that shields investors from bearing the full brunt of pharmaceutical product cycles.
Johnson & Johnson JNJ
Morningstar Rating: 5 Stars
Economic Moat: Wide
Risk Rating: Below Average
From the Analyst Report: We like J&J's global leadership positions in three attractive healthcare business lines: pharmaceuticals, medical products, and consumer products. Each line has excellent long-term growth prospects driven by favorable demographic trends or structural shifts in the
Eli Lilly LLY
Morningstar Rating: 4 Stars
Economic Moat: Wide
Risk Rating: Average
From the Analyst Report: Lilly offers investors exposure to best-in-class new drug discovery. The company consistently spends 18%-19% of sales on drug research and development, at the top of the range for the industry. Furthermore, Lilly has attracted some of the most talented academicians and clinicians in medicine. As a result, the firm has shown an ability to pump out new drugs more consistently than any other company.
Pfizer PFE
Morningstar Rating: 5 Stars
Economic Moat: Wide
Risk Rating: Average
From the Analyst Report: Pfizer's massive size and scale give it significant competitive advantages. Its formidable salesforce is the largest in the industry, providing vital muscle in penetrating the vast global physician network. Pfizer's existing drug portfolio is first-rate. Ten products hold dominant market positions in such key therapeutic classes as cholesterol control, anti-infectives, and erectile dysfunction.
Sanofi-Aventis ADR SNY
Morningstar Rating: 4 Stars
Economic Moat: Wide
Risk Rating: Average
From the Analyst Report: Sanofi has one of the strongest drug pipelines in the industry, including some potential superblockbusters. We particularly like antiobesity drug Acomplia. Clinical trial results have shown excellent efficacy, and the drug could serve a global market of potentially millions of patients. The firm has filed for approval with the Food and Drug Administration, and we expect a market launch in 2006. We think Sanofi's high-octane branded drug portfolio will generate high-single-digit sales growth for the next several years.
Part-Time Investing
By Chuck Saletta (TMF BigFrog)
Advisor, Motley Fool Inside Value
There's a tradeoff all investors have to make. On one hand, we know that the market can be beaten, as it has been by masters like Warren Buffett and his tutor, Benjamin Graham. On the other hand, it takes a lot of work to research, analyze, value, and buy companies trading at the right prices to potentially beat the market. It can be a full-time job and then some. Worse yet, even if you're eventually proved correct, the old saying attributed to John Maynard Keynes -- "The market can remain irrational longer than you can remain solvent" -- is as true today as it was back then.
With all the effort that it takes to beat the market, many investors are simply better off following an indexing strategy. With a portfolio that consists of Vanguard's Total Stock Market (FUND: VTSMX) fund and its Total Bond Market (FUND: VBMFX) fund, weighted to suit your risk tolerance and time frame, you can come within a tiny expense ratio of matching the market, without much more work than writing periodic investment checks. It's a great, low-impact strategy, and for 90% of current and potential investors, it really is the best way to build wealth over time.
While indexing is great for the vast majority of investors, it simply cannot beat the market's benchmarks over the long haul. If you want to be one of the 10% who has a legitimate chance of doing that, then you have some work to do. It's up to you to determine how much of your time you're willing to put toward the effort. The learning curve can be both steep and expensive to climb on your own, but with the right mentor, you can dramatically streamline the process. If you don't want to make investing your full-time job, the guiding hand of an expert can help get you moving in the right direction.
Getting started
To begin your journey, start by defining your strategy for success. You need a plan, a philosophy, a way of thinking that you can use to build your portfolio. While building that plan, you need to ask yourself the all-important question of "Why?" -- as in, "Why should this strategy work, when so many that have come before it have failed miserably?"
At Motley Fool Inside Value, our strategy is based on the timeless teachings of Graham and Buffett, two of the greatest market-beating investors of all time. Our strategy is simple. We start by determining a business's true worth, regardless of what the stock market says at any given time. Once we've got that pretty well in hand, we compare the company's true worth to what the stock market thinks. If the market thinks the company is worth far less than we do, we buy. Then we wait for the market to catch up to our way of thinking. Just as it has for generations of market-beating investors before us, that simple strategy is still working for us today.
Why follow a strategy?
If you really want to be a successful part-time investor, you need to limit your actions to those things that really help push you closer to your goals. Defining and living by the rules of a strategy takes time and effort, but it is effort well-spent. As Graham said, "In the short run, the market is a voting machine, but in the long run, it is a weighing machine." Without a rational strategy to guide you, you increase your risk of letting negative, short-term voting machine results scare you away from the long-term potential successes as the weighing machine kicks into play.
Take Inside Value selection AutoZone (NYSE: AZO), for example. This leading auto-parts dealer recently sunk below its recommended price as some short-term operating weakness, driven by spiking gasoline prices,?eant that more of the company's growth was coming from its share buybacks than from improvement in its operations. Yet because high gasoline prices appear to be with us for a while, folks are starting to realize that it just may be cheaper to keep, repair, and operate an existing car than it would be to buy a newer one, even if the newer one is a fuel-efficient model like the hybrid Toyota Prius. As a result, supported by the solid results and 10% same-store sales growth turned in this most recent quarter by AutoZone's big competitor Advance Auto Parts (NYSE: AAP), the auto-parts business looks to be on the mend.
Short-term worries drove AutoZone's stock below where it was already value-priced. In the longer term, reality helped it recover, to a point where it is now a positive performer for the service. Without the value strategy as your guide, it would have been simple to panic-sell into the decline in an attempt to preserve some of your cash. And that short-term thinking would have meant long-term pain, since early sellers of the stock did not participate in the rebound.
OK, now what?
Once you've decided on your strategy, the next step is to list companies you'd love to own if the price were right. High on my list right now is beverage and snack-food giant PepsiCo (NYSE: PEP). Pepsi is an extremely well-managed business with the No. 1 or No. 2 brands in nearly every category in which it competes. If its shares would just do me the favor of dropping into my buy range, I'd be more than happy to snap some up. Also on my list is newspaper and television juggernaut Tribune (NYSE: TRB). Thanks to a general slowdown in newspaper ads and television advertisers scared away by digital commercial-skippers like TiVo (Nasdaq: TIVO), business is tough for the Tribune media empire. Its stock is starting to reflect that, and if it gets much cheaper, I may soon find myself faced with an offer I simply cannot refuse.
With a solid strategy to guide your investments and a list of companies that you'd be willing to own at the right price, successful investing then becomes the art of waiting. Waiting for a company to fall in price to where it's worth buying. Once you've bought your stake, it's simply a matter of waiting again until its price is so high that the business is no longer worth owning. And waiting is something that anyone can do on a part-time basis.
