Mutual Funds: Bad Time Bargains
April 1 -- A company with great prospects hits hard times,a top executive winds up in court and the stock starts to tank.That's when smart investors run, right?
Maybe, maybe not. If you're a mutual fund manager with an eyefor what Wall Street calls "deep value," you might spot a buyingopportunity where others only see negative headlines. It may seemcounterintuitive to the average investor, but sometimes badpublicity can be a good thing.
The key, money managers say, is to thoroughly evaluate acompany's balance sheet, decide whether the situation can beresolved in a year or two and keep a long-term perspective.
"It's fairly common for value investors to kind of embrace atroubled company," said Kunal Kapoor, director of mutual fundresearch at Morningstar Inc. "This is often when a stock can bebought for a song."
Stocking Up on Tyco
That's what Putnam New Value fund manager David L. King wasthinking when he continued to buy shares of Tyco Internationalafter its top officers were charged with looting more than $600million from the company.
Tyco, a massive conglomerate that makes everything from coathangers and trash bags to sophisticated medical devices, wastrading in the low $40s when King started buying it, and he keptbuying it as the share price sank — an investing strategy known as"averaging down." Using this tactic, King wound up paying anaverage of $16 a share over several years. Now that the stock istrading near $29 and he's collected 1.7 million shares, Kingreckons he's booked about $21 million in profits.
"When something you buy all the time goes on sale at the store,you buy a little extra and you put it in the closet," King said."Why would you do it differently when you're buying stock?"
King wasn't the only manager shopping for Tyco when it was beingshunned by the rest of the market. Bill Miller, manager of thehighly regarded Legg Mason Value Trust, liked it so much it hasbecome his third-largest holding. Other funds that take this sortof approach include Clipper, Longleaf Partners and Third AvenueValue.
Deep value investing can bring great rewards, but it can alsopose greater-than-average risks. For a more aggressive investorwith a growth-intensive portfolio, a fund with a deep value bentcan be a stabilizing influence. But a more conservative investorwouldn't want to make it a core holding.
"If you're going to buy one of these funds, understand thatthere is an opportunity for short-term volatility," Kapoor said."Don't assume just because it's a value fund it's risk free."
Be Patient
Potential buying opportunities come with varying degrees of riskas well, said John Buckingham, manager of the small-cap Al Frankfund.
An opportunity can be a major event in a company's history,such as Martha Stewart's conviction for lying to prosecutors abouta stock trade, or something less dramatic, like an earnings reportthat missed Wall Street's estimates or the unexpected resignationof a senior executive. The important thing from an investingstandpoint is the degree of damage, and whether it pushes the priceof a desirable stock to an appealing level.
In the case of Martha Stewart Omnimedia, the domestic goodsempire Stewart built from scratch, there's little to draw valuemanagers. Most say the stock is still too expensive at $10 pershare, and it's not clear whether the company can successfullydistance itself from its convicted founder. Buckingham said hewouldn't consider buying Omnimedia until it falls to the $6 range.
Waiting for a stock to get to a fair value, holding it throughdifficult times and then waiting for it to rise before pocketingthe gains, takes some patience, Buckingham said. "And that's athing most investors don't have."
