An Interview With Richard F. Aster Jr., Portfolio Manager, Meridian Growth Fund
by Maria Crawford Scott
What investment philosophy and approach do you use in managing the fund?
The growth fund invests in small- and medium-sized growth stocks. We try to find companies that we believe can grow earnings per share by about 15% annually. We look for companies that are in a market thats conducive to growth, have an important market share in the area theyre in, have good return on equity, and are well-managed.
We also pay close attention to valuations, which distinguishes us from a lot of other growth managers. Many growth managers will simply buy every company that they like. But when we like a company, we ask: What should we pay for the shares so that we can realistically expect a good return? We are looking for reasonable valuations on our growth companies.
We are also long-term investors. On average, our turnover is less than a third, which means we typically hold our stocks for three years.
Generally, when we purchase a company it will have a market value of $2 billion or less. We dont necessarily sell when the market cap appreciates above that, but that is our selection universe.
Probably about 15% to 20% of the portfolio is in companies with market caps under $700 million. In those kinds of companies, you do have a little bit more risk involved, so you want to make sure that youre investing in a really stable business.
Generally, we look for the growth rates and we dont care where they are. However, over time we have usually been more heavily weighted in technology, health care, retail and restaurants. Thats where we tend to find the most growth stocks.
Basically, the process I use is to monitor around 100 to 200 companies that I think are of interest—they are companies that are in our universe and I think theyre interesting for one reason or another. Usually they have one characteristic in common: They can show good growth for the next three, four or five years.
By monitoring these companies, Ill go to research conferences, listen to conference calls and Webcasts, read SEC documents and, in some cases, talk to the companies on the telephone.
Ive found that if I monitor these companies and Im patient, at some point I usually get a chance to buy them for some reason. For instance, maybe something has changed in the business that I was concerned about. But most of the time the change involves the valuation coming into line. At that point, I try to get it into the portfolio. Thats an ongoing process for me for finding the companies that we invest in.
We certainly know all the major valuation measures for all the stocks we are examining. We know the price-earnings ratios, the price-to-sales ratios, the price-to-earnings-growth rates, all those things. But we dont really have any hard and fast rules. The things that would really determine what we would pay would be not only the growth rate but what we believe is the sustainability of the growth rate based on the companys balance sheet, management, cash flow and so forth. For me, it really isnt a quantitative decision, its more of an intuitive feel.
No. To be blunt, I think those things are a joke. Each time you analyze a company, youve got to examine it at that one point in time. For example, if you buy a company and then you look at it four months later, things will have changed. It doesnt make sense to say I set a target, now it is at the target and Im going to sell it because it may be worth more now. Or maybe its worth less—who knows? Youve got to examine it at that later point in time and determine what its worth then. So, I dont believe in targets, and I dont believe in rules such as if it declines 20%, sell it.
I have a rule that never fails: A bad management will wreck a good business every time. You check them out the best you can: You examine their track record and background, and you hear their plan and program.
At that point, you can make a decision. However, its an ongoing process—you have to continue to monitor the management and the decisions they make. You also have to determine if theyre building all of their bases: Are they building their financial base? Are they bringing in good people? Are they building their systems and controls? Are they making the right strategic decisions? You have to monitor this and judge as you go along.
Thats actually a good example of our approach.
Obesity is becoming a major issue in this country. It is now considered the major medical problem in the country, ahead of smoking. So we know theres a huge demand here.
In the weight-loss industry, Weight Watchers is by far the leading company. The others have really faded away as a factor—companies like Jenny Craig, Diet Center and so forth.
Weight Watchers is a franchise. And not only is it a franchise, but it has tremendous financial characteristics in terms of cash flow versus capital expenditures. It is a great business line.
So thats the growth story. In terms of valuations, I think the opportunity is here now because the company is somewhat controversial. Their North American business is suffering modestly right now—their comparable store sales are declining between 1% and 3%. The reason is that everybody is crazy about the low-carbohydrate diet—thats a big deal now and it is hurting Weight Watchers business somewhat.
My view is that those diets and the interest in them will peak and then decline. When that happens, I think Weight Watchers business will do much better and, at that point, stock investors are going to be more comfortable with the shares and they will go up substantially.
All in all, it is a great example of a company thats growing at around 15%, it has good return prospects, and there is a controversy thats creating the opportunity.
Weve had that for about a year and its been a fantastic stock—it has just about doubled. I thought back then that the growth stocks—which they specialize in—have really had a difficult time, and I thought they did a good job. Obviously I know the industry very well. They are a good company, theyve had good returns and I thought that for the next several years, with the financial markets coming back and the leverages they had, they would show substantial growth.
In terms of valuations, what really helped was when a lot of the other fund families got into trouble with the controversy over market timing and that kind of thing. But T. Rowe Price hasnt had any problems. (Nor have we, for that matter.) So that helped their valuations.
Now theres a small-cap stock—its got a $600 million to $700 million market value. Advent is the leading company providing portfolio management software to the industry. We have used their product for probably 10 or 15 years. The company is a market leader, and they suffered during the past two years due to the decline in the equity markets, but as the financial industry is getting healthier and better, Advent should benefit from that. In addition, the founder and long-time chairman recently returned as CEO, and I like that.
The main reason would be if the fundamentals broke down—if we buy a company and we believe it can grow at a certain rate, and then something changes that outlook for whatever reason. Maybe the industry changes, maybe the competitive landscape changes, or maybe the company isnt making strategic decisions. If that breaks down, we usually sell the company.
As long as I believe the long-term outlook remains intact, I will hold on—Im not concerned if the company misses the quarter by two or three cents.
The other reason I would sell is if a company became overvalued. I usually dont sell if companies become modestly overvalued, but if they become excessively overvalued I will sell.
I also limit the number of names in the portfolio, and that may result in a sale. A lot of times, if I want to buy a stock, I will go through the portfolio and sell something. Thats a good discipline because if you own 45 to 50 stocks, there are always going to be a few in there that you dont like as well as the others.
Our largest positions range from 1% to 3½% of the value of all fund holdings. As a rule, if I buy enough shares so that it is about 2% of the fund, and the share price rises so that it becomes a 4% to 5% position, Ill probably cut it back to 2½% to 3%. By the same token, if I buy a 2% position and the price then drops so it goes down to a 1% position, Ill check things out to make sure my original outlook still holds, and if everything is okay, I will bring it back up to 2%.
Over time, I think that that kind of approach has helped our performance and reduced our risk.
Limiting our positions is one thing. The other thing that eliminates risk for a growth stock manager is being realistic about valuations and not owning a lot of companies selling at 100-times or infinite-times earnings.
If you look at our record, I would bet it shows that our relative performance does better in difficult times.
We try to keep cash at less than 10% as a rule.
The only thing I can think of that would make us go heavily to cash is if the entire market got extremely overvalued and you couldnt find any companies at valuations that made sense. Fortunately, that hasnt happened yet. For example, in the late 1990s, the Internet and the telecomm companies didnt make any sense, but there were a lot of other areas that were ignored—whether it was retail or restaurants or what have you.
In the later 1990s, we made money for our clients but we lagged the small- and medium-sized high-growth funds and the Nasdaq. This was because I didnt own the telecomms or the Internet companies. The valuations, in my opinion, were just unacceptable.
It was an awful time. There was a tremendous amount of pressure on me to own those stocks. The ultimate pressure was that we were losing assets to those funds that were invested in those stocks!
But eventually, we were proven correct. From the end of 1999 till the end of 2002, we were up over 20%. During the same period, the Nasdaq was down about 70% and the small- and medium-sized high-growth funds were obliterated.
In 2002, we did increase our exposure to technology even though the companies still werent doing well, because there were a lot of companies that I followed that really became attractive on a valuation basis. This certainly helped us in 2003, when we were up over 47%!
I think the outlook is OK. First of all, nobody can really predict the market. But we know that the market averages about 11% a year, and we know that one out of every three years is down.
Current valuations certainly are not as attractive as they were a year or two ago, so its a little more difficult now to find attractive valuations. I would guess its going to be hard to get the big returns like you did last year. But I think thats OK. You learn not to pay attention to that, and you just plug away.