ALEXANDRIA, VA (Oct. 14, 1997) -- The past two decades have been the best in the stock market's history. Investing isn't always so profitable.
Two decades is a long time, and it's likely that many people are getting comfortable with consistent gains. The last long slump in stocks has been erased from the memory of many investors. Logically, then, several of the valuations now given to leading stocks are a little hard to swallow -- and the justification for the valuations are weak. Many stock prices are demanding that you pay now for five years -- or more -- of earnings growth down the road. But what is the current value of that future cash flow? Next, remember the uncertainty of that cash flow, and then what is the current value? What price will you pay for a company's earnings that could be earned five years from now, given a good economy and a strong business?
Many leading companies have several years of little but good news already built into their stock prices. We have a twenty-year goal of beating the market, and though DRP investing allows for more mistakes because you're dollar cost averaging, if we want to beat the market and grow such a small amount of money into something significant, we need to be extra careful about where we invest our money. Once we begin dollar cost averaging into a stock, it's hard and costly (in time and dollars) to stop. Years can be lost by dollar cost averaging into a poor choice.
Some people are anxious for decisions, though in two months we've already made two twenty-year investment choices -- a good start. We're beginning to invest in both INTEL (Nasdaq: INTC) and JOHNSON & JOHNSON (NYSE: JNJ). We feel that the stocks of both companies hold enough current value and represent strong enough businesses that both have a good chance of beating the market over the next twenty years, if business at each remains solid. Twenty years is, after all, only 7,300 days. We'll be cautious with our next buy decisions, too.
If we could simply buy the biggest names and the current leading stocks (which also means, in most cases, buying the stocks with the highest valuations compared to their projected earnings growth) and still expect to beat the market, we would be lazy and simply do so. But investing with the goal of beating the market over a period of twenty years (only 80 quarters of business) isn't quite that easy. We do pay less attention to valuation due to the dollar cost averaging process, but if we were blindly just buying leading companies we'd easily have our eight stocks by now -- and we'd be demanding that some of these companies have market caps in the trillions of dollars by the year 2017 if we were to expect continued market outperformance from them. That type of growth is not likely to happen for the current market darlings.
Success in long-term investing comes at the front-end of the process -- the decision making process. We already decided the back-end of our investment approach, and it's a great one: we're buying and holding, and we're adding to each position steadily for twenty years. Now, of course, we're deciding what to buy -- the front-end decision -- and this process will determine our success. Of course it's going to take time, and it should take everyone time. These are close to life-long decisions, though twenty-years is only an intermediate span of time when it comes to investing (a fact which does makes current valuations more important).
Before we get to Randy's part of the recap on valuing stocks, it's worthwhile to note that both Johnson & Johnson and Intel reported earnings today. We'll cover the earnings in detail when Randy is finished with his articles on KSU. For now, Johnson & Johnson reported earnings per share growth of 14%, matching estimates, while third quarter revenue grew to $5.58 billion, up only 3.4% due to a strong dollar impacting international sales. In the U.S., pharmaceutical sales grew 14.9%.
Intel reported earnings of $0.88 per share, below estimates of $0.90 to $0.91, but up 18.9% from last year's third quarter results. Revenue rose 19.7% to $6.1 billion. Gross margins held steady at 57.6% from the year ago result of 57.1%, but down slightly from recent gross margins as the company suggested would happen. We'll look closely at Intel's earnings at our earliest opportunity, as well, and we'll be sending more money to Intel as soon as we receive the DRP enrollment form.
Now Randy continues with his series on valuation. Fool on!
Valuing KSU, Part 4
by Randy Befumo
Although the Fool spends a lot of time calling mutual funds into question because of their typically subpar performance, I personally believe that if run properly the fund business is a great business. This is why I am so excited about looking at the Financial Asset Management (FAM) business of KANSAS CITY SOUTHERN (NYSE: KSU) in today's column, as I have been meaning to get to this for weeks. On September 29th, I wrote an article called "Hate Funds, Love Fund Companies" that discussed why I thought that the next few years would be good for mutual fund companies. The ongoing corporate transition from defined benefit pension plans to defined contribution 401(k) plans continues to drive assets into mutual funds. Even with more and more people start managing their own money, for the vast majority of Americans mutual funds continue to be an important part of their retirement planning. Mutual funds are very efficient vehicles for retirement plans.
Although revenues and earnings are important, the way to measure the worth of a fund company is to first look at its assets under management. Revenues and earnings come from assets under management. For a mutual fund company to grow the bottom line, its management needs to increase assets under management, increase the average fees being garnered from the assets under management, or some combination of the two. With equity funds having the highest asset management fees in the mutual fund universe, this means that the real growth will come from large companies with a robust lineup of market-beating equity funds. These are the companies that will continue to grow assets at a record pace as they steal market share from their competitors, driving both revenues and earnings growth.
Even if the mutual fund industry could not keep up the rate at which it is bringing in new assets, it could get a good decade's worth of growth just by getting more people into equity mutual funds. Equity mutual funds, particularly aggressive growth and overseas funds, typically have management fees in the 1.0% to 3.0% range compared to 0.50% for bond funds and index funds and 0.10% or lower for money market funds. With 24.2% of the money in mutual funds sitting in money market funds as of August, simply moving this money to equity funds would increase earnings at any of the major equity fund providers. In my opinion, any fund family with good domestic and international equity funds will outperform its peers.
Kansas City Southern's Financial Asset Management business, better known as Janus/Berger Associates, ranks fifteenth in the world of mutual funds according to the Investment Company Institute, with $71.3 billion in assets. Janus accounts for most all of those dollars, with $67.3 billion in assets under management according to a recent press release from Kansas City Southern. Janus/Berger Associates is currently larger than familiar names like AIM, Alliance Capital, American Century, and Scudder, to name a few. Although the assets under management don't even come close to the $489 billion that Fidelity Investments manages, the company is one of the largest mutual fund families in the world and is well-known for its domestic and international equity funds. With very little in the way of bond funds, Janus/Berger Associates is a heavyweight in the sweet spot of the mutual fund business.
Even with the recent departure of portfolio manager Thomas Marsico, one of the top equity managers at Janus, Janus has had a spectacular year. The company still has a remarkable lineup of domestic and international stock funds, as prior to his departure, Marsico did an excellent job of filling out the portfolio management team. To date, it appears that none of his proteges are following him -- particularly Helen Young Hayes, who manages both of the prized international funds. Over the past year, Janus has grown faster than almost any other fund family. This growth has been primarily focused in the Janus Worldwide and Janus Overseas funds -- the reason why many pundits were concerned that if she bolted with Marsico, Janus could be really hurt. Last week's Barron's had a very detailed article on the internal politics of Janus that is a must for anyone thinking about investing in this company. With Hayes staying put, Janus now ranks second in prestige in overseas funds, with only FRANKLIN TEMPLETON (NYSE: BEN) beating the company. Janus also reminds me of T. ROWE PRICE (Nasdaq: TROW), another fast-growing no-load fund family, although T. Rowe's expertise is more in line with the second core competency at Janus -- domestic equities.
Berger Associates has been a more disappointing story. The company's flagship Berger 100 fund, which holds nearly 50% of the total assets under management, has underperformed the S&P 500 Index since 1994 -- when Kansas City Southern bought the darn thing. Recently some very savvy marketing has started to turn the company around. The Berger Emerging Growth and Berger Omni Small-Cap Value fund have both been tearing up the charts in a year when very few companies are beating the indexes. Management's timing when it came to releasing these funds was impeccable -- they blanketed CNBC with advertisements at exactly the time Wall Street had become unanimous in its adoration of small-caps. Although I certainly don't think chasing mutual fund trends is any way to invest, I am very impressed with management's recent moves to turn the company around. In many ways, Berger reminds me most of American Century (45% owned by J.P. MORGAN (NYSE: JPM)) and Pilgrim Baxter (a unit of UNITED ASSET MANAGEMENT (NYSE: UAM)). All three fund families had dismal performances over the past year or more, but seem to be turning things around with smart marketing and a renewed focus on beating the market.
With a better understanding of Janus/Berger Associates, the next step is to develop a peer group of companies we believe are substantially similar to the Janus/Berger Associates combination. Obviously Franklin Templeton and T. Rowe Priceare no-brainers to include. Just to make sure we don't populate our comparison valuation with overvalued companies, though, we will also take into account the current market values of some underperforming mutual fund families. Specifically, LIBERTY FINANCIAL (NYSE: L), EATON VANCE (NYSE: EV), and privately held American Century, which sold 45% of itself off to J.P. Morgan this summer, are the ones I think will work the best. Tomorrow we will get to work on analyzing the valuations of the peer group companies and try to price the Financial Asset Management (FAM) part of Kansas City Southern.
Stock Close Change Intel $91 7/8 -11/16 Day Month Year History Drip: +0.00% 0.00% 0.00% 0.00% S&P: +0.00% 0.00% 0.00% 0.00% NASDAQ: +0.00% 0.00% 0.00% 0.00% Rec'd # Security In At 9/8/97 1 Intel $94.69 Base: $700.00 Expenses: $ 55.50 (Moneypaper) Purchases: See above Cash: $549.10 Total Value: $652.00 apprx.
The portfolio began with $500 on July 28, 1997, adds $100 on the 15th of every month, and the goal is to have $150,000 by August of the year 2017.