Wall Street Week With Fortune; 0103

Why good earnings haven't been enough to salvage the sinking stock market. If you'd invested with one of this evening's guests a year ago you'd have doubled your money by now and that may explain why the rest of the market is tanking and we're going to show you how to protect yourself from companies that cook the books that and oh so much more coming up on Wall Street Week With fortune. Wall Street I mean good fortune is made possible in part by going to gets an automated wired digitized zero for more options which. Can help business make sense of it all. For professional services the answer is that people don't wait until. And by contributions to your PBS station from viewers like you. Thank you.

I'm Karen. And I'm Jeff called and welcome to Wall Street Week With fortune. And what a week genuinely historic for Wall Street. The president tried to rebuild investor trust by proposing changes in how companies are governed and how wayward executives are punished. Congress then tried to outdo him. Investor trust didn't see much improved by it all. Stocks fell to their lowest levels in years. But maybe investor trust wasn't the whole problem. Stocks fell. Yet some experts believe the market still may not be cheap enough. Well if it makes you feel any better consider this the great bull market began almost exactly 20 years ago on August 13th 1982. The market opened that day with the Dow at 777 even after the past two and a half years of declines from that great day till this. The Dow has risen at an annual rate of twelve point eight percent well above the long term average. Or look at it this way. If stocks had returned their historical average of 11 percent a year the Dow would be

only around 63 hundred today. Well that definitely does not make me feel any better. But it times like this I try to remember what Warren Buffett says he likes it when the market falls because it means you can buy more for your money. Well that actually doesn't make me feel any better. OK how about this. Barton Biggs chief global strategist for market Stanley and a notorious bear finally said on Thursday it's time to buy. Well now that will make me feel better Karen I must say. As you tell us the grim story of what happened this week. Well Jeff caught in a freefall from accounting scandals and profit worries. The major market averages tumbled to post-attack lows. Sticking it investors cross more federal investigations this time telecom giant quest and drug maker Bristol-Myers Squibb. The S&P 500 Index down almost 7 percent for the week. Good news from General Electric on the heels of positive pre-announcement from Eastman Kodak and Wal-Mart were offset by fuzzy math at Merck. And worries over General Motors pension

policy leaving the Dow down more than 7 percent for the week after hitting nine and a half month lows. Dell upped its second quarter earnings estimates while internet Titan Yahoo reported a second quarter profit after six consecutive losing ones. But the Nasdaq still lost 75 points for the week. And we want to update you on a stock recommended by one of our guests last week deems a lot in the car. Why it lost more than 21 percent after the government found problems with the torment pill for menopausal women. Despite the bad news. But Dean is still bullish citing the company's great pipeline and now an even lower stock price. Tonight our two market guests see things quite a bit differently from the average stock picker. And we're glad they do. John Maria they are Morning Stars international fund manager of the year last year. Thanks P E ratios are a Wall Street invention just an attempt to obscure what really counts which is free cash flow. That belief has paid off big as has a kind of investors insurance he favors we'll hear

all about that. And Howard Charlotte is the man all those Wall Street masters of the universe and Harvard MBA types turn to when they need to figure out which companies are cooking the books. The Sherlock Holmes of accounting will tell us what's keeping him up at night right now. Thank you both for joining us. Marie's funds have had an exceptional run and so he has the bragging rights this evening for sure his gold fund. The number one rated morning star fund is up over 100 percent this past year up almost 80 percent year to date. His global fund another winner up over 12 percent over the past 52 weeks rising almost 9 percent this year alone. John most investors are on the verge of tears right now you're smiling. What's your secret. Jeff I was in the village fifty three years ago when everybody else was going great guns right. So this is a cyclical business.

But you have come through even on long term averages looking extremely good. How do you do. Well I think we take a basic of a value of taking from both Ben Graham and Warren Buffett Kaun mansion. And over time it has we're now in the Hundred percent gain that we mentioned was in your gold fund. What happened there. Well the price of gold started going up again but it didn't go up 100 percent. No but the gold mining securities or was always provide tremendous leverage. And so what you buy is not gold. That's why we buy gold mining security which all sort of calls on gold options will always be there and they always go up more than the metal itself or down when the board don't know exactly but I mentioned the investors insurance and what I was talking about was gold Tell us how that works when we look at it as insurance against bad things happening.

And I think in the 80s in the 90s we were sort of spoiled because it was powered by financial assets about no bad news. And over the past two years well we've had the building of the bubble September 11 and then we had an oil. And gold today I think is insurance against possibly bad things happening in the future. You're also looking at some of the raw material some particularly talking about one of your holdings Rainier forest products company. Tell us about that. Why do you have that. Well Jeff was saying that before that you know price earnings ratios do not matter where you are to us and why India cannot be analyzed on a price to earnings ratio basis. You know basically it's the ownership of timber and timber has been a good asset over the years indeed over the decades it's one of the few commodities that has kept up with inflation. It generates tremendous cash flow. And if you and I care and we went out and tried to buy a forest somewhere in the U.S. we would have to pay 10 times cash and in the securities market with Alania we have the ability to buy. An owner of Timberland out about seven times cash. So it's

a good asset at a discount to what we would have to pay in the private market. What is that discount you're looking at now. Talk about the cash value right now versus intrinsic value. Right. The stock is at about forty eight forty nine and our analyst figures that the intrinsic value of the security intrinsic value that's also from the intrinsic value of the securities something between 65 and 75 dollars per share. So at forty eight forty nine dollars it's a decent holding. Can you tell me why you focus on cash value. Because if you and I we own the business. What we would worry about is the amount of free cash which the business generates. And at the end of the year either we would take the cash home or we would use it to reduce the debt or we would invest it to reinvest it in the business in order to generate even more free cash in the future. That's what's truly important is it was more important than say the earnings per share that everyone talks about

focus on one particularly today where shares seem to be not to be overnight upon then I suppose. Howard will have something to say about it. So we ourselves we never take the reported numbers at face value. We try to figure out what the true economic profit of the business. We don't necessarily coincide with the accounting. Numbers and come up with the free cash flow number or salary on that basis you like a stock that many people would consider a little controversial which is Tyco. What's the justification for buying it now. We have no interest of 40 50 60. We can't keep an eye on that on the company because it own what we believe are attractive businesses in the two industries somewhat cyclical but extremely profitable. What we could not understand is how Kozlovsky could pretend that the company was going 20 percent a year and not with mature businesses. Right. And still big when the stock came down

to twenty one pilots took a look at it. None and then the next performance point of view because that's what cause or cause you was playing along with. But from the sum of the parts point of view in other words what would you buy your left pay for cleaning security business. All the other businesses I did all up deducted that and we came up with something like 30 dollars. OK Howard Sherlock Charlotte runs the Center for Financial Research and Analysis I've got to think Howard that you have taken a look at Tyco. Have any thoughts. We haven't been to a large extent I agree with John re that. Wall Street fell in love with a company that. Was growing largely by acquisitions. The growth of the business really was not coming from producing more products themselves as they were making the acquisitions they had a habit of taking big restructuring charges and it was very difficult for the

investors to really know what was real and what was not. Now where I agree specifically with John Reed today is I think Tyco could represent an incredibly exciting turnaround business with the right senior management coms coming in who are not tainted by any kind of scandals and that's what worries everyone right now and I know you have some thoughts Howard on what the ordinary investor can look at. You're a Ph.D. in accounting and almost frightening concept. But you know how ordinary investors can look at things and possibly start possibly spot trouble. And if I've got this right the three things that you would advise are one know how the company makes money. To look at the cash flow versus reported profits and three read the proxy statement. Now those sound like pretty basic things I know how the company makes money. How would that have told you something might be wrong.

Well a good rule of thumb is try to keep it as simple as possible so for example let's let's look at Enron and Ron had an operating business for about 10 years until mid 90s and 90s and changed their business model on the fly where it became a trading business like a Wall Street firm and these were not people who were schooled in risk management. And it became a business way to so much of the revenue coming from one time gains that should make investors nervous cash flow versus reported profits What specifically do you want to look at what what's what. One of the most valuable documents that any investor you mentioned I'm a Ph.D. in accounting. You don't even need a an an undergraduate degree in accounting to simply look at the cash flow statement. They show you the company's reported profits. They show the company's cash flow from operations. They're both measuring the same thing right. If you see a disconnect if you see that can you know. That's right if you see a company's net income growing 20 percent a

year like clockwork and the cash flow starting to head south dramatically that should make you nervous. And finally read the proxy statement what might you find out if you read it. Well what you're trying to find there is about the people you know and when everything is said and done. You want to invest with people who you can trust. So the proxy gives you the background related party transactions is one section where they talk about related party transactions and whether members on the board of directors are getting a special fee for ranging from investment banking deals as was the case in Tyco. So you know if somebody stops you on the street and said We'd like you to invest a buddy of yours said there's a private partnership we'd like you to invest in. You want to know these good people the people who are these people. You see opportunities now the prices have come down so dramatically. But you're also not just looking at stocks you're looking at some corporate bonds and of some companies that raise quite a few eyebrows in fact some of the red flags that Howard was talking about. Let's look at the Lucent bonds at the level 3

bonds or even the Liberty Media or Vivendi stock why would you be interested in any of those. With the case of the loosened bonds and Level 3 bonds we've concisely picked the bonds because we're not very comfortable with the business. I mean there is less waste. But if you nation with a man with a stock with a bond you know you need a company to survive. While talking yields of 18 20 percent 24 25 percent we think both companies are in a race against time. But I think both companies have a good odds of surviving. That's terrific. Gentlemen this has really been illuminating at a tough time for investors. Howard thanks for being with us here. Well before we learn about rising stars from Don Philips I want to thank all of our viewers who have taken the time to write us with their thoughts and insight. Thank you. One of the most frequently asked question so far has been who the heck are we. Well let me tell you about my co-host Jeff. He's been with Fortune magazine for over 23

years now editorial director of Fortune magazine for the past seven years and he writes the value driven column in every issue. True enough. Now let me tell you something about Kara. She was the first woman hired by the Chicago Board of Trade. A senior futures strategist with a major brokerage house and for the past 10 years has been a leading business television journalist. You've asked some other good questions as well Peter. Well from Spokane Washington writes How can I be sure that Company X Y Z is expensing stock options. It's a very hot question right now is a company reflecting in its financial statements the cost of the stock options and awards to its executives and other employees. Well Peter right now it's a very simple one to answer. Boeing and Winn-Dixie are the only two companies in the S&P 500 that expense stock options. Whatever a company does it must report it in the footnotes to its financial statements that's where you'll find the answer. And if a company doesn't expense stock options it must disclose in that footnote

what its profits would have been if it had expense them. And so for example General Motors reports that profits last year were six hundred one million dollars but if it had expensed its stock options its profits would have been only two hundred twenty seven million dollars. We do love to hear from you please send us your questions and comments to Wall Street Week With Fortune Owings Mills Maryland 2 1 1 1 7. Or e-mail us at WSW or. Care. Well nothing has more cache in the mutual fund business than Morningstar is famed five star rating system so ingrained in the investing culture that few people buy a mutual fund without checking the ratings first. So you can understand the nervousness when Morningstar trains the way they rate the more than 10000 funds. But there's good reason for the change. The folks at Morningstar know something you're probably not aware of about the rating systems ability or inability to predict future performance. You may be shocked to learn that one star funds have outperformed

five star funds. Forty five percent of the time since 1995. Confused saying stars. Let's get help from Don Phillips managing director of Morningstar. Don thanks so much for joining us. Sure Karen. Well why the change and what do you hope to bring about by one of the major changes rather than raising funds and broad groups say all domestic stock funds together. We're going to rate them across much more narrow groups a bit more of an apples to apples comparison. You know in many times in the past the ratings worked exceptionally well but you get times you get huge changes in the market where you move from growth being very much in favor to value being very much in favor. And then you end up with oddities for example back in 1999 75 to 80 percent of the large growth funds received four and five star ratings simply because large growth it had better returns over the last decade than had value and now will be doing is looking just at within the large growth category or just within the small value category and assigning ratings within them. We really hope the upshot of this is that it'll make investors more willing to step up to the plate and buy a quality fund out of favor part of the market but won't it make them even more

confused now. More categories switch. How are you going to deal with that confusion. I think this actually eliminates confusion what we've had is a lot of advisors over the years have said I love Morningstar I tell my clients great things about Morningstar but I put together a truly diversified portfolio for them. Say it's 1999 and the say the client see the five star rating on the growth fund and say absolutely I'll buy that but then they'll see a three star rating on the small value fund. I don't know about that. They'll see a two star rating on a gold phone for example say absolutely not. And yet it's the quality funds in the out of favor areas that really oftentimes are what bring the most value like Mary's gold fund coming back so strong. You know that's a great gold fund even at times when it's out of favor that's maybe when you most want to add it to your portfolio. Under the new system we think will encourage investors to do that more. Well let me see if I got this right. So that means that a fund that's in a sector that in general hasn't done well would still get a high rating if it has performed better than the other funds in that sector. That's exactly right so some areas have been very out of favor right now like high yield bonds or especially

communications funds. Now we'll be giving 10 or five star ratings to 10 percent of those funds four star ratings to twenty two and a half. And we really hope we want to get to this issue of helping people put together better portfolios. You know I look at the fund landscape the problem isn't that people buy bad funds today but they buy a series of good funds that happen to do the same thing. And because of that they assemble a bad portfolio. What we want to do is elevate the debate away from good fund bad fund towards appropriate or inappropriate use of a given fund for a given investor with a given goal. So if I've got this right your new system. Would among other things encourage investors to take a more long term view. Well because they'll buy funds that may have not performed from a sector that may not have performed well in the past. But in the cyclical nature of things will probably be well managed for the future. Absolutely and we've always taken a long term view of the minimum period that we rate a fund for three years. So if you think about it we're cutting the fund managers a much longer much more slack than they give corporate America. I think the only way you can really evaluate a manager is over an extended period of time. You can't go in and say gee this fund didn't do so well this week the manager must not be doing a good job in the short term there's a

lot of noise in the market. What we want to do is encourage longer term thinking and to keep reminding investors to think about risk and think about cost. Well they're going to be some funds that have enjoyed a nice ride are going to lose a star now are going to be some that have been out of favor and may gain a star. Can you give us some examples of those. Well for the most part the funds that will be losing Starz right now are the ones that have been there have their asset classes most in favor. So for example small cap value which is had a great two to three year run now. Right now under the old system over half of the small value funds were getting 5 star ratings which is very analogous to back in 1999 when so many of the large cap growth tech heavy funds got top ratings so some of those will be losing stars. But as we've talked to the managers many of them say this is actually a very good thing. You know what we don't like losing stars. The nice thing is that now because we're in a category like small value that doesn't move a lot like the general market. Now instead of going from looking very out of favor. So getting a two star rating in 99 and then very much in favor a 5 star rating today. Now that much more of a steady performance a four five star and hopefully that'll keep more investors on board.

Can you give us some names of some funds that you think are up and coming. Well several firms that we like one would be a Dodge and Cox International. I really like the international area. You know investors have not been looking at international you've had such a strong dollar over the last seven or eight years. So many people are saying you know gee I haven't felt the need to have that my portfolio. But I think there's tremendous need to have international in the in the portfolio. Maybe it's because the first one I ever owned was the Templeton room which is a great international fund. What happens if the U.S. economy slips in those international economies fall as along with it. Well certainly that might happen but I think it's the reason for diversification. All of the opportunities are not going to be in the U.S. I think we've got a sort of myopic during the 90s because tech was so great in the U.S. dominated the tech scene. We're thinking all of the great companies were here. Well there's no reason that all the great companies are going to be living with this border. And the more you diversify the better your portfolio is likely to do other than Dodge and Cox commune other up and comer. Another fun that we like is that William Blair or small cap growth fund our analyst Emily hall is very impressed with the team there thinks they do a terrific job and they've got a bit of a contrarian streak. One of the problems you know a lot of growth funds they just tend to be very momentum oriented. You see

lots and lots of the same names in every growth portfolio. Well here's a group that really does a great independent research has a bit of a contrarian streak and we think it might have a good place an investor's portfolio today is not the time to forget about growth. Absolutely. Let's look at the other side done funds to avoid right now. Well you know couple of funds the you know I don't like IRA funds that you have a very volatile performance at high cost especially I think investors have to be attuned what risk is in the portfolio. So a couple of funds that I don't care for that much one would be the American Heritage Fund. The other would be Berkshire focus. I guess what I don't care about them is they've got names that are very soothing you know American heritage Berkshire focus you might think Warren Buffett had something to do with it. The reality is has nothing to do with the fund. These are funds that are very concentrated in some very volatile stocks. There are times when they'll pop up on the leaders list and they might look like hey these are great investments. But if you look at them they both have very high expense ratios and the name which may be so there really isn't. You know what you're likely to get in the portfolio.

What do you look for in a fund manager. What stands out and who do you see as fund managers that are on the horizon that we should keep an eye out on. Well when I look for a manager's passion you know it Warren Buffett used to talk about the one question job interview. Are you a fanatic. And that's what I look for in what our analysts look for in different funds and we view or hear them talking coming back from an interview. If they really like a manager it's because the manager just loves what he or she is doing and has a real passion and enthusiasm and that's what we look for because the best managers are going to be people you know that do this 24 hours a day you can't turn him off. It's like who. Well I mean I think it is a terrific example of you get people that absolutely love what they're what they're doing. You look at Fidelity you look at a number of the managers there and they've got a great shop and they've got people that love that you cannot stop and to be doing this on their own even if they didn't have the job getting paid to do it. You also mentioned growth funds do you see any growth fund managers that you may think might be worth looking at. Well one of our longstanding favorites in the growth would be Foster Friess at Brandywine. Again that passion for what he does in the way that he looks at portfolios and he's assembled a terrific team to do

that. Any other examples of fund managers and what they can do for the individual investor. Well you know that touches on a really important point. One of the things that concerns me is that mutual funds have a great opportunity to be the voice of the individual investor to corporate America. And I'm not convinced that that's happening as well as it might. Now when I talk to some CEOs they'll tell me that groups like Fidelity are so rigorous in voting their proxy statements and are really out there fighting for the investor. But a lot of that happens behind closed doors. And I think right today where you've got a bit of a crisis of confidence on Wall Street that's more important than ever that the fund industry be out there and be very vocal and show the world that they're really fighting for investor interest. I think they're doing it but it needs to move from behind closed doors out into the limelight. Don Phillips thanks so much for joining us here Karen. Well there's an awful lot going on next week. Alan Greenspan trying to show that the Fed will still matter if his semiannual assessment of the economy before Congress will analyze that and earnings

galore next week with a lot of attention focused on the beat down drugmakers five's a CEO Hank McKinnell will be here to explain how he's putting his company on the mend and give us his prescription for better corporate governance. He's the point man for the Business Roundtable on corporate governance and getting a lot of attention. And when does it make sense to invest in mutual funds that have lost more than 20 percent. Investors large and small are poor and more than a billion dollars into one such fund family. The money manager will tell us how he will not disappoint those investors. Have a great weekend Good night good night everybody. To learn more about this program visit PBS online at PBS dot org America Online keyword PBS for a transcript of this program. Send a $5 to transcript. Wall Street Week With fortune. Maryland Public Television. Owings Mills Maryland. 2 1 1 1 7. Wall Street Week With fortune was made possible in part by pointing to.

Markets may rise. Or they may fall. Who helps companies prepare for the unpredictable for business advisory services. The answer is that people have to wait until. And by contributions to your PBS station from viewers like you. Thank you. This is PBS.