An Interview With Richard F. Aster Jr., Portfolio Manager, Meridian Growth Fund

    by Maria Crawford Scott


    CATEGORY: Mid-Cap Stock


      1Yr 3Yrs 5Yrs 10Yrs
    Fund 59.6* 16.0* 17.3* 14.1*
    Category 43.9 5.6 7.3 11.4

    TOTAL ASSETS: (as of 4/15/04) $1.85 billion

    CONTACT: Meridian Fund Inc. (800) 446-6662

    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 that’s conducive to growth, have an important market share in the area they’re 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.

    What are the typical market capitalizations that you focus on?
      Generally, when we purchase a company it will have a market value of $2 billion or less. We don’t 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 you’re investing in a really stable business.

    Do you start with a universe of stocks and then simply search for growth, or do you start with themes and look for stocks in areas that typically have the type of growth you are looking for?
      Generally, we look for the growth rates and we don’t care where they are. However, over time we have usually been more heavily weighted in technology, health care, retail and restaurants. That’s 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 they’re 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, I’ll go to research conferences, listen to conference calls and Webcasts, read SEC documents and, in some cases, talk to the companies on the telephone.

      I’ve found that if I monitor these companies and I’m 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. That’s an ongoing process for me for finding the companies that we invest in.

    How do you value a growth stock?
      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 don’t 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 company’s balance sheet, management, cash flow and so forth. For me, it really isn’t a quantitative decision, it’s more of an intuitive feel.
    Do you set any return or price targets?
      No. To be blunt, I think those things are a joke. Each time you analyze a company, you’ve 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 doesn’t make sense to say ‘I set a target, now it is at the target and I’m going to sell it’ because it may be worth more now. Or maybe it’s worth less—who knows? You’ve got to examine it at that later point in time and determine what it’s worth then. So, I don’t believe in targets, and I don’t believe in rules such as “if it declines 20%, sell it.”
    How do you evaluate management?
      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, it’s an ongoing process—you have to continue to monitor the management and the decisions they make. You also have to determine if they’re 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.

    One of your recent purchases was Weight Watchers. What attracted you to that company?
      That’s 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 there’s 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 that’s 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—that’s 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 that’s growing at around 15%, it has good return prospects, and there is a controversy that’s creating the opportunity.

    You also have a holding in T. Rowe Price—the holding company for a number of competitor funds. How long have you had that holding?
      We’ve had that for about a year and it’s 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, they’ve 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 hasn’t had any problems. (Nor have we, for that matter.) So that helped their valuations.

    Another of your purchases that seems to play on a similar theme—the investment business—is Advent Software, although I suppose that is also in the technology industry.
      Now there’s a small-cap stock—it’s 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.
    What would prompt you to sell a stock?
      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 isn’t 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—I’m 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 don’t 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. That’s a good discipline because if you own 45 to 50 stocks, there are always going to be a few in there that you don’t like as well as the others.

    How concentrated are your holdings?
      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, I’ll 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, I’ll 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.

    What other actions do you take to control the risk of the portfolio?
      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.

    Are you always fully invested in stocks? Is there anything that would cause you to move to a heavy cash position?
      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 couldn’t find any companies at valuations that made sense. Fortunately, that hasn’t happened yet. For example, in the late 1990s, the Internet and the telecomm companies didn’t make any sense, but there were a lot of other areas that were ignored—whether it was retail or restaurants or what have you.

    The last five years have been a challenging investment environment. How has your fund fared—were you fully invested over that time period, and were you able to find growth companies with reasonable valuations?
      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 didn’t own the telecomms or the Internet companies. The valuations, in my opinion, were just unacceptable.
    Was that a difficult time?
      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 weren’t 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%!

    What is your outlook for the markets over the next several years?
      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 it’s a little more difficult now to find attractive valuations. I would guess it’s going to be hard to get the big returns like you did last year. But I think that’s OK. You learn not to pay attention to that, and you just plug away.

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