Tech and Healthcare Offer Growth at a Discount - Barron's Interview

Barron's interviews boutique money manager Jeff Coons, Co-director of Research at life-cycle portfolio firm Manning & Napier Advisors. Coons says he focuses on absolute value, comparing stocks returns as a premium to risk-free bonds, rather than the popular stance of finding stocks that trade at a relative bargain to peers.

Barron's asks Coons: How does this market look in terms of investment opportunities?

When we look at stocks, especially in the U.S., and compare them to the alternative of a 4.5%-5% bond yield, we really see a lot of value out there. We never buy the market, so we don't have to worry about whether the market is cheap or expensive. But we are certainly finding individual companies trading at discounts of 30%, 40%, 50% of their fair value. That's very compelling when the alternative is a 4.5%-5% bond yield.

He says his firm is heavy in tech and healthcare, which both offer high-quality growth, without a premium to more cyclical companies. Here are some of his picks:

• Google (GOOG): "A great growth company is one that sells into a growing consumer market with a dominant brand." He sees long-term growth of 30%, and says shares trade at a 40-50% discount even using the most conservative assumptions.
• Medtronic (MDT) is the 800-pound gorilla of the medical-devices market - one that's not tied to discretionary spending. Earnings growth should be 15-17%. Great pipeline and free cash flow. Shares trade at a 30-40% discount to fair value.
• Southwest Airlines (LUV) and Continental (CAL): Focus on companies that are "well down the line in terms of bankruptcy risk" that, if they survive, will emerge much, much stronger.
• Lowe's (LOW) and Home Depot (HD): The two will gain market share from local retailers as a result of the housing downturn. ROE tends to be high-teens to low-20s, and they trade at 1.5-2x book value.

Comments

[mwswi:]

I agree with Eli Hoffman especially when it comes to MDT. This is further supported in a 09-14-07 Morningstar article:

Three Once-in-a-Decade Stock Values
These HealthCareInvestor stocks haven't been so cheap for more than 10 years.

The author, Curt Morrison, MD, FACC, CFA states:

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"My investment theses for HealthCareInvestor portfolio holdings Pfizer (PFE), Johnson & Johnson (JNJ), and Medtronic (MDT) share common themes and depend on the following assumptions:

1. The companies' historic economic advantages are stable and durable.

2. Stocks are fairly priced over long-run horizons.

3. Ten to 20 years is a long-run horizon.

If these assumptions are true, then the companies' future growth and returns on assets will be similar to past results, and the historic average valuation is the correct valuation. I'll discuss these points in this HCI issue before presenting data highlighting the value of entrenched economic advantages, and then closing with comments about portfolio construction and performance evaluation.

Mature, Stable Growth Companies

Medtronic was founded in 1949, Johnson & Johnson in 1885, and Pfizer in 1849, and their trailing 20- to 30-year earnings and dividend growth rates were both stellar and steady, supporting the notion that all three were mature, stable growth companies several decades ago.
Each company posted double-digit growth in every decade-plus period listed, and I think the consistency of their results is the most telling feature of the data. It suggests that these companies enjoyed persistent economic advantages and reinvestment opportunities that showed no signs of deterioration even many decades after the companies were founded. Because these were not young companies in the unsustainable rapid-growth phase of their life cycles, it should be reasonable to expect similar growth rates in the future as long as their economic advantages endure.

Economic Moats Intact 

A company's return on its assets is a good measure of its economic strength, and I've listed the Pfizer, Johnson & Johnson, and Medtronic 1997-2006 averages below:

Pfizer: 14.7%


J&J: 15.9%


Medtronic: 15.4%

Most U.S. companies earn returns in the 4%-8% range, so the performance above is outstanding. The HCI portfolio companies have grown rapidly while earning returns well above their costs of capital, and they've done it for decades. That isn't typical in a freely competitive economy; most companies eventually earn no more than their cost of capital because rivals are attracted to above-market returns like sharks to blood.

First and foremost, I think their economic moats are based on technological innovation. Technological change is a threat to small companies with one or two cutting-edge products but limited resources to help them stay ahead of the curve. However, for companies with diversified product portfolios, an extensive R&D infrastructure, and a long history of new product development, technological change is a barrier that protects excess returns."

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The article continues in-depth, but I think the author, Dr. Curt Morrison's, points quoted above are well made. If you've been thinking about investing in health care, and you don't yet own these companies or are thinking about extending your current holdings, then now may be an opportune time to do so.

2008 Aug 02 06:14 PM