March 2, 2004  Email this  Print this
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Large-Caps for the Long Haul
by Steven Goldberg  As investors in such once great companies as Eastman Kodak and Xerox have discovered, much to their chagrin, there simply are no buy-and-forget stocks. But Bob Smith, manager of T. Rowe Price Growth Stock (PRGFX), has come up with the next best thing -- stocks that you can buy and hold for a long time.
Smith, 42, has about half his fund in what he calls "core holdings," stocks that probably will be in his fund five years from now. Not that Smith will ignore these stocks, but unless the companies stumble badly, or their stock prices get bid up to stratospheric levels, these blue chip companies will remain in Smith's fund.
These stocks, says Smith, "are big, steady growers." Finding companies that will produce 10% to 15% earnings growth over the long term is the heart of Smith's investment process.
A simple philosophy
"The philosophy we have is pretty simple," he says. "Stocks over time move with earnings and free cash flow."
Free cash flow is defined as earnings plus depreciation, taxes and interest minus the costs of keeping the business running, including capital expenditures. Many of the best fund managers use it nowadays in place of earnings, because they say it gives them a picture of a company's true earnings power.
Very few companies, says Smith, can compound earnings or free cash flow at double-digit rates. Over time, the stock market's earnings tend to grow about 6% to 7% annually. "If you can find companies generating twice those earnings over a sustainable period and buy them at fair prices, you'll get 12% to 14% even if the P/E never changes."
Smith's approach isn't new. Indeed, it's not all that different than the teachings espoused by T. Rowe Price (the man, not the firm), who launched this fund in 1950.
It's the execution that's difficult. Here Smith has done well. Over the seven years he's been running this fund, it has finished in the top 10% among large-cap growth funds with substantially less volatility than its peers. He tends to lag in bull markets, such as 2003's, but he makes up for it in flat and down markets. That makes this an ideal fund for people who want a growth fund, but don't care for speculative fare. Low expenses of 0.73% add to the fund's appeal.
Five core holdings
Among Smith's favorite long-term holdings:
American International Group (AIG), the global insurance powerhouse, has a huge and growing presence in China. Yet it sells at a P/E of just 17 based on 2004 consensus per share earnings estimates of $4.48. Smith likes financial firms in general, because he says the market tends not to fully value them.
Amgen (AMGN), the biotech giant, boasts a strong pipeline. It trades at 27 times consensus earnings per share estimates of $2.38 for 2004. But earnings are expected to rise to $2.83 in 2005, which would push the P/E down to 23.
Citigroup (C) sells at a P/E of just 12 based on $3.85 per share earnings estimates for this year. The diversification of this company makes it less prone to dips than competitors, Smith says.
Microsoft (MSFT), now considered a tech blue chip, has recently gone through one of the market's periodic but unaccountable devaluings. The stock sells at just 23 times estimates of $1.19 for this year.
Pfizer (PFE) is back from the dead, but it still sells at just under 18 times 2004 estimates of $2.10.
These blue chips lack the sex appeal of some tech company you've never heard of. But if you're investing to earn steady returns -- rather than trying to get rich overnight -- they are well worth looking into.
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