Mutual Funds
Doing One Thing Well
General American Investors manages GAI, period. One of the original closed-end funds, GAI has harvested an outstanding record for nearly 80 years. Learn how manager Spencer Davidson does it.
By Manuel Schiffres, Executive Editor
From Kiplinger's Personal Finance magazine, March 2006
Advertisement
Do you make decisions on big-picture thinking, or do you assemble your portfolio on a stock-by-stock basis? It's a combination of the two. Within the top-down call on energy, we've been highly selective, emphasizing domestic natural-gas companies and oil-well-services companies.
How about an example of an energy stock you like? A good one is Weatherford International (WFT). We started paying attention to it about a year ago, when the company announced it would buy the energy-services and international-drilling businesses of Precision Drilling. We've owned Halliburton (HAL), a big energy-services player, for some time, so we know that many of the countries that own oil are starting to take on more projects on their own. In order to do that, they need more support from the service companies. The deal with Precision Drilling gives Weatherford the assets and technology to offer one-stop shopping internationally.
What's your favorite gas stock? It's hard to pick a favorite. We rank stocks on the basis of price to free cash flow [the cash that's left after making the capital expenditures needed to maintain a business], and we view $1 of free cash flow as the same, whether it's generated by Microsoft (MSFT), which we own, or Weatherford -- or Apache Corp. (APA) and Devon Energy (DVN) in exploration and production. Apache's got more oil and Devon's developing heavy oil, so we're not religious about owning natural gas only.
How long do you see this energy cycle lasting? My view is that we're not running out of oil and that there's plenty of it. But energy companies have underinvested for quite some time, and it's probably going to take three to five years before supply catches up with demand.
How will you know when it's time to sell your energy stocks? I think the signal will probably come from excessive developments in the stock market rather than from the fundamentals of the companies. In other words, we'll sell when the stocks get overpriced.
You also have a big stake in financial stocks. It's our largest sector, and it's mostly in specialized insurance companies, such as Everest Re (RE) and PartnerRe (PRE), Bermuda-based reinsurance companies. These are companies with established long-term records and excellent credit ratings, and we felt that they were undervalued. Interestingly enough, the reason we got involved with Halliburton had nothing to do with oil prices or rigs. Its stock had fallen because of concerns over asbestos exposure. Our insurance analyst put us into Halliburton after concluding that the company's liabilities were so overly discounted that you could essentially buy Halliburton's entire energy business for free.
To switch gears, you own a fair amount of Pfizer, which has been a miserable performer. We've owned Pfizer (PFE)for years. Our continuing to hold it represents our value shoes. The stock yields a lot. It's one of only eight industrial companies in the S&P 500 with triple-A bond ratings. We like management, and everyone knows what the bad news is, particularly all the patents that are expiring. What we don't know is what $7 billion a year in R&D will generate in the future. But at these levels, we're willing to bet that it's more likely than not that all that spending will generate some good things.
And talk about a blast from the past. What's the case for Xerox, one of your most recent purchases? For starters, Xerox (XRX) has solved some operational problems and we expect its bond rating to be upgraded from non-investment grade to investment grade. That will lower Xerox's borrowing costs. On the product side, we expect a big increase in sales of color copying machines. By 2007, the growth in color machines is likely to offset declines in black-and-white copier sales. Profit margins on color products will be higher than on black-and-white products and, because this is a classic razor/razor-blade business, the gross profit margins on the ink and the paper and on servicing will be much higher than the margins on the machines themselves. So Xerox has an improving financial structure and a new product cycle. We've got an attractive entry price for buying the stock, and again, because of our closed-end structure, we don't have to worry that we're a quarter or two early.