Fund’s Returns Show Why ‘Buy-and-Hold’ Isn’t Dead
Even before last week's stock-market sell-off—the biggest losing streak in three years—large-cap stocks were getting thumped, despite analysts' and money managers' claims they're among the best bets.
But the record tells a different story.
The large-cap stock benchmark, the Standard & Poor's 500 Index , has lost an annual average of 0.2 percent over the past three years, including 5.9 percent so far in 2011.
Over the past decade, it's up 4 percent, less than bonds.
In making a case for large-caps, supporters say U.S. multinational companies can take advantage of fast-growing emerging economies to sell their products and services and, as a result, aren't handcuffed by America's slump.
They're seen as a good bet when inflation strikes because large companies are often leaders in their industry, which means they can raise prices and still keep customers, something smaller competitors can't get away with.
Charles Smith, chief investment officer of Fort Pitt Capital Group, who manages over $1 billion in mostly blue-chip stocks, said that "large-caps started off in the worst possible position in terms of valuation in the past decade, so the 10-year numbers look pretty bad." That's because of the lingering effects of the widespread technology bust.
Going back to 2000, technology giants such as computer network maker Cisco Systems , software firm Microsoft and chipmaker Intel were selling at 40 to 60 times earnings, and investors expected further gains in their shares, he said.
That proved dead wrong as the stocks soon came crashing down.
"When the tech boom ended, so did their outperformance and that set the table for the bad decade" that followed, Smith said.
It's been rough-and-rocky traveling since then.
Now, Smith says, given their low values and healthy dividends, "large-caps are better positioned now for a rally." But it's a hard sell as a lot of people are tired of hearing that argument and are clearly looking for greener pastures for their money.
Many investors are dumping stocks altogether. Stocks funds worldwide lost $92 billion to redemptions in the three months through August, more than the total amount put into those funds since equities bottomed in 2009, the Wall Street Journal reported today.
Smith hasn't lost his faith in large-cap stocks, but his investment approach is definitely old-school and not in the mold of many mutual funds that are typically larded with the same stocks, including the likes of iPad and iPod maker Apple or Internet search engine firm Google.
That may be why his Fort Pitt Capital Total Return, a large-cap blend fund, has been a top performer over the past few years.
The fund is down 2.2 percent this year, a performance that still ranks it in the top 5 percent of its peers, but it has gained 8 percent over the past 12 months, ranking it in the top 3 percent of funds in its category.
Over the past three years, it has an average annual gain of 0.8 percent, putting it in the top 15 percent of large-blend funds in terms of performance, according to Morningstar.
Smith's investment approach includes an ignore-the-pack stock selection process. It's based on researching long-term fundamentals, a buy-and-hold strategy, and a focused portfolio with miniscule turnover.
"We own businesses, we don't trade pieces of paper," said Smith.
His fund's holding period is typically "three to five years, minimum, and eight years, on average. Our ideal holding period is forever."
"We look at returns on equity as measure of corporate performance and compare that with the price-to-book multiple," seeking stocks with a low price-to-book ratio and a high return on equity, Smith said.
"We also look for as high a percentage of insider ownership as we can get," Smith said, "so that (we know) their financial interests are directly aligned with mine, as a shareholder."
But "screenings are not the hard part. The hard part is putting companies that oftentimes have warts on them into the portfolio. The data is cheap. You have to have the courage of your convictions." Smith currently favors the telecommunications and aerospace industries, for their long-term growth potential.
In telecommunications and in particular, he likes AT&T and Verizon Communicationsand has held each for at least five years because, he said, even in a recession their cash flows remain strong because "people give up everything but their TV remote and cell phones."
He also likes the aerospace industry, especially aircraft maker Boeing and avionics leader Honeywell International because "we see commercial air traffic continuing to rise and most of the aircraft fleets are very old."
Smith even thinks that the financial sector has the worst of its challenges behind it. That sector makes up 20 percent of the fund's portfolio.
"For the most part the banks are pretty much prepared for any calamity that comes alongl," he said. The (Federal Reserve) has stuffed them with cash and they're holding on to it." His top pick there is PNC Financial Services Group , at 3.4 percent of the portfolio.
Here are six stocks among the largest holdings in the Fort Pitt Capital Total Return Fund portfolio:
AT&T is the fund's largest holding at 4.8 percent of the portfolio. The company is the dominant phone service provider in 22 states, serving about 41 million phone lines, 16 million Internet users, and three million television customers. It is also the second-largest U.S. wireless carrier.
Smith said the fund has owned it for at least five years. He said it's attractive because of its consistent strong cash flow in any type of economy and near 6 percent dividend yield.
AT&T owns its wireless subsidiary, and it should generate strong, steady profits as more consumers migrate to it as one of the most dependable carriers. AT&T shares are up 2.6 percent this year and 7 percent over the past 12 months, giving it a $168 billion market valuation. Over the past five years the shares have a 2.8 percent average annual return.
Loews has been a holding since Smith started managing the fund. It is a diversified holding company, with a big bet on the insurance industry, and is in the same mold as Warren Buffett's Berkshire Hathaway .
Its subsidiaries consist of a 90 percent stake in the insurer CNA Financial , the seventh-largest U.S. commercial insurer and the 13th-biggest U.S. property & casualty insurer; a 50 percent stake in Diamond Offshore Drilling , an oil industry contract driller; a 66 percent position in Boardwalk Pipeline Partners , which owns three interstate natural gas pipeline systems; and is the parent company of Loews Hotels, a luxury resort hotel chain, and HighMount Exploration & Production, an explorer for and producer of natural gas.
Smith said he likes it because Loews owns 80 percent of the big insurance firm CNA. He said insurance, although cyclical, is a great business, because a company can use money from premiums for investing, "so you get free money for years." The company has been run by the Tisch family for decades and "they are what I call interested owners because the family is still its largest shareholder. And their stock is owned outright; there are no options agreements."
Loews shares are down 9 percent this year and 6 percent over the past 12 months, resulting in a market valuation of $14 billion. Over the past 10 years, they have an average annual return of 10.4 percent.
Honeywell International, the third-largest holding at 3.9 percent of the fund, represents another play on aerospace as its avionics division is a supplier to major aircraft manufacturers as well as to companies that refurbish older planes.
Honeywell International is a diversified manufacturer that operates four major business segments: aerospace (32 percent of sales); automation products for process controls, sensing instruments, and safety and security products (41 percent); specialty materials (14 percent); and transportation products (13 percent).
That diversity helps mitigate downturns in any particular industry and therefore smoothes out earnings. Its shares are down 10 percent this year, but up 9.5 percent over the past 12 months, resulting in a market valuation of $36 billion. Its shares have a 10-year annualized return of 7.3 percent and carry a projected dividend yield of 1.74 percent.
Comcast , the second-largest fund holding at 4.2 percent, is the biggest operator in the TV cable industry. Its networks reach 52 million households and it recently combined its cable networks with NBC Universal, CNBC.com's parent, to create a new 51 percent-owned venture early this year.
Smith said its huge cash flow is reliable as people are not apt to give up the TV remote control, and by proxy, cable TV service, even if they're being pinched financially. Early this year it committed to buying back $2.1 billion of its stock in 2011, a 75 percent increase from last year.
Comcast's shares are up 1 percent this year and 23 percent over the past 12 months, giving it a market valuation of $58 billion. Its shares have a 2.06 percent projected dividend yield.
Verizon Communications provides communication services to about 25 percent of the U.S. population. The firm owns a worldwide long-line network and a 55 percent stake in Verizon Wireless. Its partner in the venture is Vodafone Group , the second-largest wireless phone company in the world.
The wireless business serves about 94 million customers nationally and dominates the industry.
It has a steadily growing customer base, which helps it post some of the best operating margins of any U.S. carrier. Verizon's shares are up 4.3 percent this year and 17 percent over the past 12 months, resulting in a market valuation of $100 billion. Its shares have a projected dividend yield of 5.5 percent.
Boeing, the world's largest airplane manufacturer, is in the fund’s top 10 holdings at 3 percent of the portfolio, an investment that is consistent with Smith's belief that the aerospace industry is going to grow throughout the pending recession.
Boeing's sales are split equally between the commercial aircraft and defense industries. The firm generated $64 billion in sales in 2010. Its shares have a 2.75 percent dividend yield.
Boeing's shares are down 4.6 percent this year and 2.4 percent over the past 12 months, resulting in a market valuation of $34 billion. But over 10 years, it has a 9.3 percent average annual return.
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