Don't Get "Railroaded" by Growth vs. Value

By DAVID MOON, Moon Capital Management
May 21, 2006

Every so often, I run across a nugget that proves the silliness of trying to classify investors or stocks as 'growth stocks' or 'value stocks.' A Wall Street Journal article provides a recent example.

The Journal reports that large growth funds have returned an average of negative 0.92 percent a year for each of the last five years, are underperforming most mutual funds in 2006, and, as a result, are looking for ways to catch up with the rest of the investment pack.

So where are the growth-fund managers turning? To construction-equipment manufacturers and railroad operators. Do those sound like traditional growth stocks to you?

Here is a little test. Which of the following companies would you classify as a 'growth stock' and which as a 'value stock?' My answers are at the end of the column.

' Company A has a price-earnings ratio of 16.47, a five-year average dividend yield of 2.9 percent, a large cash position and no debt. Because of its industry's high barriers to entry, it has enjoyed almost an almost monopolistic competitive position for decades.

' Company B pays a current annual dividend of 1.6 percent. Its stock price has declined 8 percent in the last year and 60 percent in the last six years. All recent transactions by company insiders have been sales. It often overpromises about its ability to deliver new products.

' Company C has 15 percent annual earnings growth and 13 percent annual revenue growth. It regularly introduces new products, buys aggressive start-up companies and funds new, risky technologies.

* * *

Most of the funds described in the Wall Street Journal article have dramatically reduced their exposure to technology stocks. The Merrill Lynch Focus Twenty Fund, for example, dropped from 60 percent in technology to only 7.6 percent at the end of March. Tom Marsico helped build what was once known as a growth empire at Janus Capital. He now runs his own shop, where his Marsico 21st Century Fund has a mere 5 percent of its assets in technology.

Instead, this growth guru owns railroads and FedEx. Where are the semiconductors and pharmaceuticals?

My suspicion is that Marsico has these companies on his list of stocks not to own at today's prices. He's probably not too concerned about whether or not some financial planner, adviser or consultant classifies stodgy old railroads as a growth industry. He's buying things he thinks are attractive and will make him money. Labels probably don't influence his decisions.

Those labels do influence many people, however, who need to justify advice about market timing. Consultants and others have convinced us that you need them to determine when to change between value and growth funds. Or how much of your portfolio you need to have allocated to each of these styles. Who do you want making these types of decisions? You, some consultant-adviser, or someone like Marsico who knows the companies and has a track record in determining what they are worth?

I know where I'd put my money.

* * *

Answers: I don't know whether Companies A, B and C are growth or value stocks. All three of them, however, are Microsoft.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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