Value Added
In Search of the Next Coke
Money manager Robert Hagstrom is looking for a new economy stock to give him the same kind of success that Coca-Cola gave Warren Buffet.
By Steven Goldberg, Contributing Columnist, Kiplinger.com
December 7, 2004
Advertisement
Robert Hagstrom is best known as a Warren Buffett chronicler. In three books, Hagstrom has laid out the methods of the greatest investor of our time in language anyone can understand. His new edition of The Warren Buffett Way is as good as anything he's written.
But there's another side to Hagstrom. At his day job, he manages a mutual fund, Legg Mason Growth (LMGTX). And after years of toiling in the shadows of Bill Miller, his better-known mentor at Legg Mason, Hagstrom is demonstrating that he, too, is a first-class money manager.
Look at the record: Over the past five years, Hagstrom's fund has returned an annualized 2%. That doesn't sound impressive, but it puts the fund in the top 3% among funds that specialize in stocks of large companies with (supposedly) fast-growing earnings. Bear in mind that the average large-company growth fund has lost an annualized 15% during those five years. What's more, Growth has done that well despite a whopping 1.88% expense ratio.
Following Buffett's principles
Not surprisingly, given his writings, Hagstrom, 48, credits Buffett's work with inspiring and guiding his work.
Hagstrom, who loves technology companies, says that he, Miller and others at Legg Mason "have taken Buffett's principles into the New Economy." In Growth fund, he says, "We're trying to find the next Coke." Coca-Cola, of course, was one of Buffett's best stock picks.
These stocks -- stocks that can go up five-fold or ten-fold if given time -- are largely involved in the Internet, though there are some in health and entertainment, and even some in telecom, Hagstrom maintains.
Hagstrom looks for two main things: The first is the durability and sustainability of free cash flow. Free cash flow is earnings per share minus the costs of keeping the business running, including capital spending, plus depreciation and amortization. Simply put, it's what a business generates to spend on new ideas, pay out to shareholders or pay down debt.
The second thing he looks for is return on capital. This is a measure of a firm's profitability.
If a company is generating tons of free cash, and it has a high return on capital, it can grow into even the highest P/E-given surprisingly few years.
Stocks that pop
Amazon.com (AMZN) is Hagstrom's biggest holding. While Amazon's P/E is at nosebleed levels, it trades at a semi- reasonable 21 times free cash flow. Plus, it has a 40% return on capital-double or triple that of most good companies. As more retailing moves to the Internet, Amazon's path to success seems clear to Hagstrom.
Electronic Arts (ERTS), the king of the video gaming industry, is another Hagstrom favorite. "Interactive games are growing faster and earning more revenue than Hollywood makes in movie tickets," Hagstrom says. What's more, the complexity of the games makes it nearly impossible for others to compete. The company should earn $2 in 2005, making its P/E 25.
Other favorites include Nokia (NOK), which he thinks will benefit as cell phones finally move to advanced 3-G systems; AIG (AIG), the insurance giant that's increasing earnings 15% annually; and Citigroup (C), the world's pre-eminent money center bank.
Most of Hagstrom's favorite stocks look awfully pricey to me. But it's tough to argue with his results.