Beating the Street (15 page)

I was always careful to write down the name of everyone I met at the lunches and meetings. Many of these people became valuable sources I called upon repeatedly over the years. In industries with which I was only vaguely familiar, they taught me the basics of what to look for on the balance sheet and what questions to ask.

I didn't know a thing about insurance until I met with executives at Aetna, Travelers, and Connecticut General in Hartford. In a couple of days they gave me a crash course in the business. I never had the same sort of edge that an insurance professional has, but I learned to identify the factors that make the earnings rise and fall. Then I could ask the right questions.

(I've explained elsewhere that the insurance professional ought to take advantage of this edge, and not blow it by shunning the insurance stocks and buying railroads or waste management companies, the workings of which he or she is entirely ignorant. If ignorance is bliss, then bliss can be very expensive.)

Speaking of insurance, by March 1980 I'd put 25.4 percent of the fund in either property or casualty underwriters, and I owned so many of these out-of-favor issues that the industry asked me to give a speech at its annual conference as insurance's best friend. The underwriters might not have invited me had they suspected that a year later I would be out of insurance stocks entirely and into bank stocks.

Interest rates had risen to record levels in 1980, at the tail end of the Carter administration, when the Federal Reserve was putting
the brakes on the economy. In this atmosphere, the bank stocks were selling below book value despite the industry's superb growth prospects. I didn't discover this by sitting at my desk and imagining what would happen when interest rates declined. I discovered it at a regional investment conference in Atlanta organized by Robinson-Humphrey.

Actually, it was outside the conference that I started thinking about banks. During a lull in the proceedings, tired of presentations from companies with no track records and no earnings, I took a side trip to visit First Atlanta. This was a company with 12 years of continuously higher earnings. Its earnings were greater than the sales of many companies that were making flashy presentations downtown. Obviously, investors had overlooked First Atlanta, which was a 30-bagger by the time it merged with Wachovia of North Carolina five years later.

Wall Street was excited about all sorts of companies that might or might not survive, yet solid banks like this one were selling for half the p/e ratio of the market.

From the day I heard the First Atlanta story, I've been impressed with the quality of regional banks and perplexed by investors' lack of appreciation of them. They get little notice from the investment houses. Ask a fund manager to guess which companies produced the wonderful results shown in
Figures 4-2
,
4-3
, and
4-4
and he or she will probably mention Wal-Mart, Philip Morris, or Merck. These look like the tracks of fast-growth companies—who would suspect they're all banks? The company shown in
Figure 4-2
, the stock price of which increased 10-fold in ten years, is Wachovia;
Figure 4-3
is Norwest of Minneapolis; and
Figure 4-4
is NBD Bancorp of Detroit.

I'm still amazed by the fact that a bank like NBD, which for years has been growing at the same 15 percent rate as a Pep Boys or a Dunkin' Donuts or any other fast grower, is given a low p/e multiple in the stock market. The way banks are treated by investors, you'd think they were mature utilities, just plodding along.

This mispricing of regional banks creates a lot of buying opportunities, which is why Magellan consistently had four or five times the market weighting in bank stocks. One of my favorites, a $2-to-$80 shot, was Fifth Third—how could you resist a bank with a name like that? Then there was Meridian, whose headquarters no other investor had visited in years; and KeyCorp, which had the “frost belt” theory, acquiring small banks and thrifts in mountainous areas where the people tend to be frugal and conservative and less likely to default.

FIGURE 4-2

FIGURE 4-3

But my biggest winners in the bank group have been the regionals, such as the three shown on pages 96–98. I always look for banks that have a strong local deposit base, and are efficient and careful commercial lenders. Magellan's 50 most important bank stocks are listed on page 137.

FIGURE 4-4

One bank led to another, and by the end of 1980 I had 9 percent of the fund invested in 12 different banks.

In the annual report of March 1981, I was pleased to note that Magellan's shareholders had nearly doubled their money—the fund's net asset value had risen 94.7 percent from the previous March, as compared to 33.2 percent for the S&P 500.

While Magellan had beaten the market four years in a row, the number of shareholders continued to decline, and one third of the shares were redeemed in this period. I can't be sure why this happened, but my guess is that people who got into Magellan by default when we merged with Essex waited until they'd recovered most of their losses and then cashed out. It's possible to lose money even in a successful mutual fund, especially if your emotions are giving the buy and sell signals.

With the many redemptions counteracting the capital gains, Magellan's growth was retarded. What should have been an $80 million fund, thanks to a fourfold increase in the value of the portfolio over four years, was only a $50 million fund. In mid-1980, Magellan owned 130 stocks, an increase from the 50 to 60 I'd held at any one time during the first two years. A surge in redemptions forced me to scale back to 90 stocks.

In 1981, Magellan was merged with the Salem Fund, bringing the Puritans on board with the Portuguese explorers. Salem was another of Fidelity's small operations that had gone nowhere. It used to be called the Dow Theory Fund, and its losses had produced another big tax-loss carryforward. Warren Casey had done a superb job of managing Salem in the two years after the merger was first announced in 1979, but still the fund was too small to be economical.

Only at this point, after the merger with Salem, was Magellan finally offered for sale to the public. That it took this long is an indication of how unpopular investing in stocks had become. Rather than return to the outside brokers who had sold the fund door-to-door a decade earlier, Ned Johnson, Fidelity's chief executive, decided to give the job to Fidelity's in-house sales force.

Our first offer was that you could buy Magellan with a 2 percent sales charge, or load. This worked so well that we decided to raise the load to 3 percent to slow down the rush. Then we tried to accelerate the rush by offering a 1 percent discount on the 3 percent load to anyone who bought the fund within 60 days.

This clever marketing ploy almost came to ruin when we published
the wrong phone number in the notice to shareholders. Interested parties who thought they were calling Fidelity's sales department were connected to the switchboard at the Massachusetts Eye and Ear Infirmary. For several weeks, the hospital had to deny it was a mutual fund, which is probably the worst thing ever said about it.

Between the existing assets, the merger with Salem, and the new offer, Magellan crossed the $100 million mark for the first time in 1981. Here we'd gotten the first flurry of interest from the public, and what happened? The stock market fell apart. As is so often the case, just when people began to feel it was safe to return to stocks, stocks suffered a correction. But Magellan managed to post a 16.5 percent gain for the year in spite of it.

No wonder Magellan had a good beginning. My top 10 stocks in 1978 had p/e ratios of between 4 and 6, and in 1979, of between 3 and 5. When stocks in good companies are selling at 3–6 times earnings, the stockpicker can hardly lose.

Many of my favorite picks in those years were the so-called secondary stocks, small or mid-sized companies including the retailers, banks, etc., that I've already described. At the end of the 1970s, fund managers and other experts were advising me that secondary stocks had had their day, and that it was time to invest in the big blue chips. I'm glad I didn't take their advice. The big blue chips did not have exciting stories to tell, and they were twice as expensive as the secondaries. Small is not only beautiful, it also can be lucrative.

The Middle Years

My working day began at 6:05
A.M
., when I would meet the Saab driven by Jeff Moore, a friend from Marblehead who gave me a ride into town. Next to him in the front seat was his wife, Bobbie. Both were radiologists.

It was still dark. While Jeff drove, Bobbie held X rays up to a small light on the passenger side. I was in the back with another small light, perusing annual reports and my chart books, which fortunately for Bobbie's patients never got mixed up with the medical records in the front seat. There wasn't much conversation.

By 6:45, I was in my office, but not alone. Fidelity was a no-nonsense New England institution, where even on weekends you could have gotten up a basketball game with analysts and fund managers who arrived before dawn. I doubt our competitors could have gotten up a double solitaire game.

But we didn't play basketball, we worked. Ned Johnson loved the idea of people working extra hard. His customary business hours were 9:30
A.M
. to 9:30
P.M.

From the mess on my desk, I retrieved the sophisticated tools of my trade, the S&P stock guide available free from any brokerage house, the antique Rolodex, the empty yellow legal pads, the 2½ pencils, and the clunky Sharp Compet calculator with the oversize
buttons that I've used for 15 years. Copies of outdated S&P guides would pile up on my desk. Behind the desk on a separate stand was the Quotron.

The earliest version of the Quotron required that you type in a stock symbol and push the enter button before the current price would appear. Otherwise, the screen was blank. Later versions, which you've probably seen, display an entire portfolio and the prices for all the stocks, which are updated automatically as the day's trading progresses. The blank screen was a better system because you couldn't stare at it all day and watch your stocks go up and down, as many contemporary fund managers do. When I got a newfangled Quotron, I had to turn it off because it was too exciting.

In the precious hours before the market opened and before the phones began to ring, I reviewed the summary of the buys and sells from the day before, prepared by Fidelity clerks. These so-called night sheets indicated what Fidelity fund managers were doing. I read the in-house summary of what our analysts had learned from their talks with various companies. I read
The Wall Street Journal.

By 8:00
A.M
. or so, I had written out a new buy and sell list, largely made up of companies that I'd bought the day before and the day before that, in an attempt to slowly build up a sizable stake at reasonable prices. I called my head trader, Barry Lyden, who worked in the trading room on a lower floor, to give him the orders.