Beating the Street (21 page)

Several Wall Street analysts were touting Chrysler throughout its descent. My most bullish estimate for Chrysler's earnings, which I thought might be hopelessly optimistic to begin with, was far below the most bearish estimate on Wall Street. My best guess was $3 a share, while some analysts were predicting $6. When your best-case scenario turns out to look worse than everybody else's worst-case scenario, you have to worry that the stock is floating on a fantasy.

The winning stocks in the post-Correction turned out to be growth stocks, not cyclicals. Fortunately, I was able to take money out of the autos and put it into companies with high-quality operations and strong balance sheets, including Philip Morris, RJR Nabisco, Eastman Kodak, Merck, and Atlantic Richfield. Philip Morris became my biggest position. I also bought enough General Electric to make it 2 percent of the fund.

(Two percent was not enough. The market value of General Electric was 4 percent of the value of the market overall, so by having only 2 percent in Magellan I was in effect betting against a company
I loved and recommended. This anomaly was pointed out to me by my successor, Morris Smith.)

Here is another example of how foolish it is to stereotype companies by putting them into categories. General Electric is widely regarded as a semistodgy blue chip with cyclical elements, and not as a growth company. But look at
Figure 6-1
. You could easily imagine this could be a tire track left in the road by a steady grower like Johnson & Johnson.

FIGURE 6-1

From the bargain bin, I'd also begun to scoop up the out-of-favor financial-services stocks, including several of the mutual-fund companies, which were pummeled in the market because Wall Street worried about a mass exodus from equity funds.

Magellan had a 22.8 percent gain in 1988 and a 34.6 percent gain in 1989, beating the market again in 1990 when I resigned. It also had beaten the average fund for all 13 years of my tenure.

On my last day at the office, Magellan had $14 billion in assets, of which $1.4 billion was in cash—I'd learned from the last Great Correction, don't leave home without it. I'd built up the holdings in big insurance companies with stable earnings: AFLAC, General Re, Primerica. I'd built up the drug companies, and also defense contractors such as Raytheon, Martin Marietta, and United Technologies. The defense stocks had been pummeled in the market because Wall Street worried that
glasnost
would bring peace on earth, a fear that was highly exaggerated, as usual.

I'd continued to downplay the cyclicals (papers, chemicals, steels), even though some of them appeared to be cheap, because my sources at the various companies told me that business was bad. I had 14 percent of the fund invested in foreign stocks. I'd added to hospital supply, tobacco, and retail, and of course Fannie Mae.

Fannie Mae took over where Ford and Chrysler left off. When 5 percent of a portfolio is invested in a stock that quadruples in two years, this does wonders for a fund's performance. In five years, Magellan made a $500 million profit on Fannie Mae, while all the Fidelity funds combined made more than $1 billion. This may be an all-time record for profits for a single firm from a single stock.

The second-biggest gainer for Magellan was Ford ($199 million from 1985 to 1989), followed by Philip Morris ($111 million), MCI ($92 million), Volvo ($79 million), General Electric ($76 million), General Public Utilities ($69 million), Student Loan Marketing ($65 million), Kemper ($63 million), and Loews ($54 million).

Among these nine all-time winners are two automakers, a cigarette and food company, a tobacco and insurance conglomerate, an electric utility that had an accident, a telephone company, a diversified financial company, an entertainment company, and a company that buys student loans. These weren't all growth stocks, or cyclicals, or value stocks, but together they made $808 million for the fund.

Although I couldn't possibly have bought enough shares in a small company to have it affect Magellan's bottom line, 90 to 100 of them put together could and did make a difference. There were many 5-baggers
and a few 10-baggers among the smaller stocks, and the ones that did the best in my last five years were Rogers Communications Inc., a 16-bagger; Telephone and Data Systems, an 11-bagger; and Envirodyne Industries, Cherokee Group, and King World Productions, all 10-baggers.

Table 6-1. MAGELLAN'S 50 MOST IMPORTANT STOCKS (1977–90)

King World is one of those companies whose success was obvious to millions of Americans—everybody who watches TV. It owns the rights to “Wheel of Fortune” and “Jeopardy!” A Wall Street analyst told me about King World in 1987, and soon afterward I took my family to see a taping of “Wheel of Fortune” and to watch Vanna White. There have been a lot of silent movie stars, but Vanna is the only silent TV star I can think of. King World also had rights to a popular talk show hosted by somebody whose name I thought was Winfrah Oprey.

I did some research and learned that game shows generally have
a 7- to 10-year run. This is actually a very stable business—a lot more stable than microchips. “Jeopardy!,” another King World production, had been around for 25 years, but was only in its 4th year of prime-time syndication. “Wheel of Fortune,” the highest-rated show on TV, was in its 5th. Winfrah Oprey was on her way up. So was King World stock.

Table 6-2. MAGELLAN'S 50 MOST IMPORTANT BANK STOCKS (1977–90)

There were hundreds of losers in Magellan's portfolio, to go along with the winners I've just described. I've got a list of them that goes on for several pages. Fortunately, they weren't my biggest positions. This is an important aspect of portfolio management—containing your losses.

Table 6-3. MAGELLAN'S 50 MOST IMPORTANT RETAILERS (1977–90)

There's no shame in losing money on a stock. Everybody does it. What is shameful is to hold on to a stock, or, worse, to buy more of it, when the fundamentals are deteriorating. That's what I tried to avoid doing. Although I had more stocks that lost money than I had 10-baggers, I didn't keep adding to the losers as they headed for
Chapter 11
. This leads us to Peter's Principle #13:

Never bet on a comeback while they're playing “Taps.”

My top loser of all time was Texas Air: $33 million worth. It could have been worse if I hadn't been selling into the decline. Another
stinkeroo was Bank of New England. Obviously, I had overestimated its prospects and underestimated the effects of the New England recession, but when the stock fell by half, from $40 to $20, I started to take my losses. I was completely out at $15.

Meanwhile, people from all over Boston, many of them sophisticated investors, were advising me to buy Bank of New England at the bargain price of $15, and then $10, and when the stock got to $4 they said it was a stupendous opportunity that couldn't be overlooked. I reminded myself that no matter what price you pay for a stock, when it goes to zero you've lost 100 percent of your money.

One of the clues to the bank's deep trouble was the behavior of its bonds. This is often a tip-off to the true dimensions of a calamity. That the value of the Bank of New England's senior debt had fallen from par ($100) to below $20 was a big attention getter.

If a company turns out to be solvent, its bonds will be worth 100 cents on the dollar. So when the bonds sell for only 20 cents, the bond market is trying to tell us something. The bond market is dominated by conservative investors who keep rather close tabs on a company's ability to repay the principal. Since bonds come before stocks in the lineup of claimants on the company's assets, you can be sure that when bonds sell for next to nothing, the stock will be worth even less. Here's a tip from experience: before you invest in a low-priced stock in a shaky company, look at what's been happening to the price of the bonds.

Also near the top of my losers list are First Executive, $24 million; Eastman Kodak, $13 million; IBM, $10 million; Mesa Petroleum, $10 million; and Neiman-Marcus Group, $9 million. I even managed to lose money on Fannie Mae in 1987, a down year for the stock, and on Chrysler in 1988–89, but I'd reduced my Chrysler holdings to less than 1 percent of the fund by then.

Cyclicals are like blackjack: stay in the game too long and it's bound to take back all your profit.

Finally, I note with no particular surprise that my most consistent losers were the technology stocks, including the $25 million I dropped on Digital in 1988, plus slightly lesser amounts on Tandem, Motorola, Texas Instruments, EMC (a computer peripherals supplier), National Semiconductor, Micron Technology, Unisys, and of course that perennial dud in all respectable portfolios, IBM. I never had much flair for technology, but that didn't stop me from occasionally being taken in by it.

What follows over the next 160 or so pages is a chronicle of the phone calls, speculations, and calculations that led me to the 21 stocks I recommended in the 1992
Barron's.
The fact that this section is as long as it is is evidence that stockpicking can't be reduced to a simple formula or a recipe that guarantees success if strictly adhered to.

Stockpicking is both an art and a science, but too much of either is a dangerous thing. A person infatuated with measurement, who has his head stuck in the sand of the balance sheets, is not likely to succeed. If you could tell the future from a balance sheet, then mathematicians and accountants would be the richest people in the world by now.

A misguided faith in measurement has proved harmful as far back as Thales, the early Greek philosopher who was so intent on counting stars that he kept falling into potholes in the road.

On the other hand, stockpicking as art can be equally unrewarding. By art, I mean the realm of intuition and passion and right-brain chemistry in which the artistic type prefers to dwell. As far as the artist is concerned, finding a winning investment is a matter of having a knack and following a hunch. People with a knack make money; people without it always lose. To study the subject is futile.