[This Rule Maker column originally ran June 26. Enjoy!]
You don't have to look hard to find great investing content on the Web, but it's worth digging beneath the topsoil, past the better websites and solid publications such as Fortune and The Wall Street Journal.
A little deeper, in the mineral-rich layers of cyberspace, lies a great source of investing wisdom: The annual reports of top-flight mutual fund managers, investors such as Bill Ruane and Bob Goldfarb of Sequoia Fund (Ticker: SEQUX), Ralph Wanger of Wanger Advisor Trust, and John Spears and Chris Browne of Tweedy, Browne (Ticker: TWEBX).
It's a big mistake to assume all mutual fund managers are cut from the same underperforming cloth, or that money managers have nothing to offer. More than a handful of professionals have a lot to teach the willing investor, and the annual report is a useful platform since the manager isn't forced to field questions from MoneyLine's Willow Bay about the next market bottom.
Besides, it's rare you'll see an interview with an investor like Bill Ruane, who keeps a low profile -- unless it's in Outstanding Investor Digest -- so take advantage of the annual report content. It's all archived at websites such as FreeEdgar. Just find the fund's ticker symbol, type it in, and look for the N-30D form -- the mutual fund's equivalent of a 10K and 10Q (annual and semiannual reports). Alternatively, you can run a Google search on the Fund's name to locate the website, and then download the annual reports.
The topic of the last few years, of course, is the Internet bubble and, recently, the subsequent collapse of dot-com, telecom, and Internet infrastructure companies. Many of these reports offer more than just "I told you so commentary," though there's plenty of finger-wagging. Rather, the investors offer history lessons from previous bubbles, a strong dose of their own investment strategies, and, more often than not, enough humor to make the reports a good read. Here's a sampling of investment wisdom that's pretty hard to find on TV:
Wanger Advisor Trust
Manager: Ralph Wanger
2000 Annual Report
"The Internet stocks were a spectacular example of a market mania followed by a debacle. While this latest cycle was dramatic, it was not unique. In 1980, the number-one growth stock was oil service company Schlumberger (NYSE: SLB). From 1968 to 1980 energy stocks went from 14% to 27% of the S&P 500. During the period, every portfolio manager was an amateur geologist, with a four-color map of the Overthrust Belt pinned to his wall. Private investors lined up to buy tax shelter drilling partnerships from good ol' Bob in San Antonio because we all knew crude oil would be $100 per barrel in 2000.
"This seemed like a good idea since oil and gas was a giant, profitable, necessary industry. Energy consumption increased steadily between 1980 and 2000. However, crude oil prices didn't go up as hoped; oil stocks were a bad idea for the next 20 years. By 1999, energy stocks dropped from 27% of the S&P 500 to a measly 5%."
Tweedy, Browne American Value
Managers: Christopher Browne, John Spears
2000 Annual Report
"In past letters, we have half-jokingly said that a course in history may be a better requirement for someone in the money management business than a course in finance. Bubbles occur only every 10 or 20 years, which is a good thing and a bad thing. It is good that they occur infrequently because usually a great deal of money is lost when the bubble bursts. It is bad because memories are short and when the next one begins to inflate, many investors will either say, 'It's different this time,' or simply have no recollection of the last one.
"Unfortunately, the pattern of bubbles is strikingly similar throughout history. Bubbles seem to begin with some new technology that is predicted to revolutionize the way we do things. This time it was the Internet, but in years past it has been biotechnology, or computers, television and radio, electricity, cars, railroads, etc., etc. Each time the new technology did have a significant impact on the way we live or do business, and each time investors' urge to participate led to significant losses. Traditional business valuation models are deemed irrelevant because we are in uncharted waters...."
"True, sustained long-term growth is difficult to achieve, as the success of so few companies will attest. Buying shares in start-up companies, companies with business plans or products that can be rendered obsolete before they even reach profitability, is not, in our opinion, growth stock investing. It is speculating. Ignoring this lesson, which has been taught many times over the years, can be expensive...."
"Jeremy Siegel, professor at the Wharton School of Business... observed that in March 2000, nine technology stocks with market capitalizations greater than $90 billion also carried price/earnings ratios in excess of 100. In Professor Siegel's opinion, no large company in history has ever justified such a high earnings valuation. He observes that, a year later, this group has fallen an average of 60%, and their P/E ratios are all below 50.
"However, he believes they are still overvalued. High price/earnings ratios are usually reserved for companies with above-average growth rates that are highly predictable. For a variety of reasons, technology companies historically have not had highly predictable earnings. Of the 500 companies in the original Standard & Poor's 500 Index in 1957, only 74 remained on the list in 1998, and only 12 outperformed the Index over that period. The conclusion we draw... is that predicting corporate performance well into the future may be a task beyond the abilities of the average stock analyst.
"In our opinion, investors should always invest assuming the next bear market is about to begin tomorrow. Bear markets occur infrequently and, at least for us, are impossible to predict. Therefore, we always assume the next one starts tomorrow."
Sequoia
Managers: William Ruane, Robert Goldfarb
Annual Reports
1999
"We find it extremely daunting to analyze businesses characterized by rapid technological change with their resultant shorter periods of predictable competitive advantage. And generally these companies trade at very high valuations which implicitly assume that dramatic growth and very high profit levels will continue uninterrupted in almost flawless perpetuity, in sharp contrast to almost all economic history. That requires a sense of certainty that we simply cannot muster."
1999
"We do not make any attempt to mirror the market in the composition of our portfolio, and in a focused portfolio like ours, deviation from the norm is highly probable. In making decisions to buy and/or hold stocks, we put almost all of our analytical focus on the particular company's long term economic prospects, with little emphasis on shorter term factors. The facts are that in today's inflated stock market we continue our search for attractive equity values but have found little we want to buy with deep conviction."
1998
"During 1998, we sold some Sequoia portfolio positions primarily on the basis of valuation, including our long-time holdings in Walt Disney (NYSE: DIS) and Johnson & Johnson (NYSE: JNJ). With these sales, we entered 1999 with just over 20% of the Fund's assets in cash. As always, we remain humbly agnostic on the likely future course of the market, but would rather hold cash than invest in equities with valuations we believe are over-enthusiastic relative to underlying fundamentals. In the words of Warren Buffett, "It's only when the tide goes out that you learn who's been swimming naked."
Have a great day.
Richard McCaffery, co-manager of the Rule Maker portfolio, doesn't own any shares mentioned in this report. The Motley Fool is investors writing for investors.
