Buying stocks that are lagging the market may seem like a questionable strategy, but investors willing to hold on for a couple of years can profit, says Ron Sloan a mutual fund manager at Invesco.
Sloan, a 15-year veteran at Invesco, is the lead manager of the firm's Charter fund (CHTRX), which invests in large multinational companies, and is designed to give investors a more consistent, less volatile ride than the overall market. He also co-manages a portfolio of medium-sized companies with the same objective.
Both funds look for opportunities among stocks that have fallen out of favor by assessing whether those companies are in terminal decline, or if they have problems that can be solved.
A company's revenue growth can provide an important indicator. If a stock is slumping because the company's profit margins are deteriorating, it can often recover as long as sales are still growing, says Sloan. "It's much harder to get your hands round a company that is having sales difficulty."
The key to this kind of investing is being prepared to be patient and to hold a stock for a couple of years, rather than just a few quarters.
Q: The major market indexes are up sharply this year. Is it harder to follow this type of investment strategy and find undervalued companies in this market?
A: You just have to think longer term. If you're managing for the next quarter or two, it is tough.
If you're willing to take a little bit of a longer-term view you can continue to do what we do, and that is buy into disappointments. If we think that it's a temporary situation and the company will have an opportunity to show much better results, with a lower valuation, it's an opportunity for us.
Q: Health care companies account for almost 20 percent of the Charter fund. What do you like about the sector?
If you are willing to focus more on the pipeline that these companies have, I think you will tend to become a lot more excited about the businesses. In a world where GDP growth is pretty small, the relatively modest growth in pharmaceuticals doesn't look nearly as bad.
We were able to pay a below market valuation for very good companies. Very solid financial companies. And when we did a sum of the parts analysis on many of them, what you saw was that the market really wasn't paying anything for something to come out of their R&D pipeline.
Some of our biggest weightings are actually in European pharmaceutical companies. Whether it's Sanofi or Novartis, as examples. We also own Pfizer and Merck and a lot of Gilead, a large cap bio-pharmaceutical company.
So there was really very little that you had to pay for the promise of faster growth. We were intrigued by that.
Those are companies, where we like the business models, we like where they are in terms of new drug introduction possibilities and we don't think the market is paying for it.
Q: Will the focus of investors increasingly turn to company earnings if the Federal Reserve starts to wind down its economic stimulus this fall, as many investors and analysts expect?
A: I think it has, and I think it's a positive thing long term.
Earnings have been flat for a long time. The market has been going up on valuations. People have been willing to pay more for that flat level of earnings.
If we take away the fuel for this valuation move, which really has been quantitative easing, then all of a sudden you're not going to have a valuation-led market and it has to become an earnings-led market.
When do we see some better vibrancy for earnings? I think, we begin to see it with some of the fourth-quarter numbers, but certainly we begin to see better earnings growth next year.
Q: What's your soap box issue?
A: It's people blathering on about earnings beats and earnings misses. I mean, come on, grow up! Companies are guiding analysts literally at the 11th hour to pull in their numbers. So, they set it up so they can "beat" a forecast that is lower than the forecast maybe a month before that. But then they get credit for saying they beat estimates.