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It’s not enough that value investing is suddenly in vogue. Howard Morris, a 15-year veteran of the money management business, still takes a “play-it-safe” approach to picking stocks. “We’re looking for companies that are trading at a 40% discount to what we feel they’re worth,” says Morris. “If we buy stock below a company’s intrinsic value, we get an automatic margin of safety.”
That kind of thinking comes in handy for Morris, 41, who helps manage $80 million as co-chief investment officer for Lakefront Capital Investors, a Detroit firm that invests pension money for clients such as First Energy (formerly Ohio Edison) and the Ohio Bureau of Workers’ Compensation. Lakefront’s mid-cap funds averaged a total return of 19.9% in 2000 and 29.9% in 2001. By comparison, the Standard & Poor’s 500 delivered no more than -9.1% in 2000 and -11.8% in 2001.
Lakefront’s success has been with large-cap stocks, with a market capitalization of $2 billion to $8 billion. Since he is after stocks that sell below their intrinsic value, Morris examines share prices using “price to earnings” or P/E, a ratio of a stock’s market value against a company’s profits per share. He looks for companies that are trading at 60% of the market’s average P/E.
Morris also uses “price to book,” a measure of a stock’s value in comparison to the worth of a company’s hard assets, such as office space, factories, and equipment. He likes candidates whose price to book is under the market’s average. Morris quips: “We aim to buy Nieman Marcus goods at Wal-Mart prices.”
Often enough, Morris finds the best bargains among companies that are in the middle of a turnaround. Case in point is Office Max (NYSE: OMX). The No. 3 office product retailer, behind Office Depot and Staples, Office Max has been busy remaking itself. It trades at a 40% discount to its book value, yet has prospects good enough to warrant a climb in its share price. Xerox (NYSE: XRX) is another turnaround story. While the company has had financial woes, efforts to pay down debt and streamline operations have gone unnoticed. Morris says Xerox could lift earnings back to $1 a share this coming year, compared to the -$0.44 the company reported in 2001.
IMS Health (NYSE: RX) is also a firm on the rebound. A supplier of market data to pharmaceutical makers, IMS had accounting concerns in 2001 and had to swallow large charges to its earnings. Morris thinks those problems are resolved now that the new management has adopted a more conservative approach to reporting financial figures. Morris also likes the company’s tie-in to the pharmaceutical industry’s growth prospects.
Savings and loan operator Washington Mutual (NYSE: WM) is one company Morris thinks has been unduly ignored. The money manager sees Washington Mutual’s acquisition of New York’s Dime Bank as a boon. Finally, Morris sees AT&T (NYSE: T) as an undervalued player in telecommunications. The company’s sale of cable television assets is well publicized, but Morris is convinced that its long-distance business deserves more