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INVESTING: Quarterly Review & Outlook

Weighing the Opportunities

A Good Time for Funds That Focus on Fundamentals

July 05, 2001|JOSH FRIEDMAN | TIMES STAFF WRITER

To make money in the first half of this year, some stock mutual fund managers found it helpful to have an open mind--and to know how to read a balance sheet and income statement.

Though many funds shot the lights out in the late 1990s with a "momentum" strategy that entailed simply owning what was going up, this year fundamental stock analysis once again ruled on Wall Street.

The Times singled out four stock fund managers who posted gains for their shareholders in the first six months--a period when the average U.S. fund fell nearly 6%--to look for a common thread.

The four: Robert Olstein of the Olstein Financial Alert fund, which surged 20.1% in the half; Peter Trapp of Needham Growth, up 18.1%; John C. Thompson of Thompson Plumb Growth, up 8.8%; and Ira Unschuld of Schroder U.S. Smaller Companies, up 7.4%.

Each of the four men has his own approach to stock picking and portfolio management, but they share at least two key traits that have helped them shine: They stress fundamental stock valuation that includes, but also looks beyond, price-to-earnings ratios, the most widely followed "value" measure; and they play defense, striving to avoid big mistakes that can blow a portfolio to shreds.

Here's a closer look at the four funds and the strategies their managers employ:

* Robert Olstein, Olstein Financial Alert (toll-free phone: [800] 799-2113; initial minimum investment: $1,000 regular, $250 IRA).

Olstein has managed the $472-million, Purchase, N.Y.-based fund since 1995. With an annualized return of 24.4% over the last five years, the fund has beaten 98% of its mid-cap value stock fund peers, according to Morningstar Inc.

But Olstein, a longtime self-appointed watchdog of Wall Street who published the Quality of Earnings Report newsletter before launching his retail fund six years ago, would prefer that investors look behind the numbers, as he tries to do.

"We're getting a lot of attention now, but there's too much focus on our performance and not enough on our discipline," Olstein said.

His discipline is one of "buy the numbers" rather than spend time hobnobbing with company management. "I'd rather spend one night with a financial statement than two days with management," he said. "Management is never going to tell us where we can lose."

And though most investors focus on searching for winning stocks, Olstein said, "the avoidance of losers is what leads to good long-term performance."

Case in point: telecom giant Lucent Technologies (ticker symbol: LU), which he sold at $60 a share in 1999 because his balance-sheet and income-statement analysis showed management straining to make the numbers look good.

Since then, Lucent has seen its stock price collapse to under $7, weighed down by heavy debt amid sinking demand for telecom equipment and by controversy over its accounting.

Not surprisingly, balance-sheet analysis also leads Olstein to stocks he likes. Among the positive signals he looks for in the fine print of company filings: high inventory turnover, improving cash flow, low debt, conservative cash reserves, forthright management and earnings reported to the Securities and Exchange Commission that match those reported to the IRS.

Olstein calls cash flow "the engine of any company," saying many investors focus too heavily on bottom-line earnings per share. Cash flow measures the money generated by a business in a given period, before deducting such noncash charges as depreciation.

Though Morningstar labels his fund mid-cap value, Olstein scoffs at such labels. "We don't pick stocks by size," he said. "We go anywhere that cash flow takes us."

This year, he has reaped the benefits of a contrarian bet that he began making late last year on battered semiconductor stocks.

Lately, he also has been buying cigarette makers R.J. Reynolds Tobacco Holdings (RJR) and Philip Morris (MO), along with PNC Financial Services Group (PNC) and Bank of America (BAC) in the financial sector.

But no matter how much he likes a stock, Olstein spreads his bets around, typically holding 100 or more names in the fund to limit risk, he said.

"Remember, if you're up 80% one year and down 50% the next, you're down 10% [for the two years]. That's what a big loss does to you," he said.

Olstein's efforts don't come cheap: The fund's annual expense ratio is about 2.2%, well above average for a U.S. stock fund.

* Peter Trapp, Needham Growth ([800] 625-7071; initial minimum: $5,000 regular, $1,500 IRA).

Trapp, who has managed the $231-million New York-based fund since January 1998, has generated an annualized return of 35.1% in the last three years. That was better than 99% of his mid-cap growth stock fund peers, according to Morningstar.

Trapp hunts for small and mid-size stocks selling for price-to-earnings or price-to-cash-flow ratios of half the company's projected earnings growth rate for the next three years, he said. He focuses on sectors he knows best: Tech makes up

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