Where a Top Fund Manager Is Finding Opportunities
So many fund managers seem to sparkle in one market cycle and then fade away. And then there is the incomparable Will Danoff, manager of Fidelity Contrafund (symbol FCNTX), a member of the Kiplinger 25. Since Danoff took the reins of Contrafund in September 1990, it has returned an annualized 13.2%, an average of nearly four percentage points per year ahead of Standard & Poors 500-stock index. And Danoff, who mainly invests in large, growing companies, has consistently beaten the index while shouldering less risk than the market.
We recently caught up with the maestro to learn what he thinks about the big picture and where he is finding the best investing opportunities. What follows is an edited version of our conversation.
KIPLINGER’S: What’s your take on the economy?
DANOFF: U.S. companies have cut costs very well and have remained disciplined in capital spending and inventory control in reaction to the economy’s collapse in the fall of 2008 and early 2009. That discipline, coupled with growth in emerging markets and stabilization of the U.S. economy, has led to growth, particularly in the export sector.
Americans in the lower and middle part of the economic spectrum are still concerned about their jobs, and their houses are under water. The top 10% of income earners in the U.S. are feeling better. They’re spending more now, and we’ve seen some of the higher-end consumer companies report good numbers. We’ll eventually see better job numbers, but overall the consumer is still not a particularly strong part of this economy.
Interest rates have probably bottomed and are backing up now. Investors in the stock market have to fight a modest headwind of higher interest rates, but better-positioned companies can still grow. And emerging-markets economies appear to be back on track.
What do you look for in a stock?
I’m interested in finding multi-year growth stories, companies that are going to gain market share over time and are positioned in front of a mega-trend. That’s what I’ve done for 20 years. I like companies that can triple earnings over five years and have above-average returns on investment. I prefer to own great businesses, but I also look at lesser companies run by exceptional business people.
You have nearly one-third of Contra’s portfolio in tech stocks. Why such a large bet?
My strategy has been to own technology as a play on a recovering economy. More than half of all capital spending is now IT-related. Companies have cleaned up their balance sheets and reduced capital spending, but they continue to buy more computers and other technology.
One of the biggest trends right now is the emergence of smart phones. It’s not new, but it’s relatively early in the product cycle. Apple (AAPL) has been well-positioned for that trend. Apple now has four stores in China, and these are now their most productive and most heavily trafficked stores in the world. (Apple was Contrafund’s largest holding as of December 31.)
The Internet continues to grow and change everyone’s lives. More and more people will carry a computer in their pocket. That will require a lot more memory and other chips in the technology chain. Electronics are growing in everyone’s lives -- toasters now contain semiconductor chips.
Are you in front of any other megatrends?
When it comes to the consumer, companies in the U.S. and other developed countries must offer exceptional value. TJX Companies (TJX), an off-price retailer of apparel and home fashions, has offered its customers great value.
The growth of emerging markets is a continuing megatrend. Many companies are seeing their emerging-markets businesses become more meaningful, and those businesses continue to grow. The ability to execute in emerging markets is important for global brands. For instance, Americans consume 400 eight-ounce servings of Coca-Cola (KO) beverages a year. Mexicans drink 650 to 700 servings a year, while in China annual per-capita consumption is only 25 eight-ounce servings. Coke is betting that it will be able to increase per-capita consumption in China profitably.
I’m interested in companies that can sell products -- whether branded goods or technology -- to billions of people in Asia and the rest of the emerging markets. Nike (NKE) fits this theme. McDonald’s (MCD) and Coke are also doing a nice job in emerging markets (McDonald’s, Coke and Nike were all top-ten holdings as of December 31).
How do you assess the stock market’s current valuation, and where do you still see value?
If earnings for Standard & Poor’s 500-stock index come in at $95 a share in 2011 and $105-$110 in 2012, then the index’s price-earnings ratio -- 14 on 2011 estimates and12 on 2012 numbers -- isn’t especially demanding, especially after you deduct companies’ cash holdings from the numerator -- the P in P/E ratio. Companies are doing a nice job. So from the bottom- up, from the perspective of individual companies, things look good. The big picture, the top down, is a mess, with governments running record budget deficits. But macroeconomic issues tend to bounce around. I just try to stay focused on good to great companies that will be bigger in five years.
At the margin, I’m finding better opportunities in bigger-capitalization names. It wouldn’t surprise me if the bigger cap companies perform a little better than the rest of the market. Some of the large, blue-chip companies are cheap relative to where they’ve been in the past 15 years, and their businesses are getting better. They have a weaker dollar on their side, strong profit margins and free cash flows, dominant positions and the necessary human resources to execute and grow in emerging markets.