BI > MARCH 2004

Monday Morning Quarterbacking

Fourth Consecutive Victory for 'Patience and Discipline'

Every year since 1956, Better Investing has compared the performance of its Stocks to Study (the tortoise) from about five years ago with that of the Dow Jones industrial average (the hare) for the corresponding period. The tortoise wins for the fourth year in a row in 2003, increasing the lead in this 48-year-old contest. The all-time score stands at Tortoise 30, Hare 18.

Groceries are scattered all over the parking lot just in time for Brett Favre and his wife Deanna to stroll by. The Green Bay Packer quarterback hops over a rolling can of peas and shares that "I'd have double-bagged them." This MasterCard commercial -- part of the "Priceless" series -- is a humorous stab at the art of Monday morning quarterbacking. Second-guessing is one of those All-American pastimes, as the sports talk show hosts use their 20/20 hindsight to quiz the likes of Favre and his coaches. Can we play Monday morning quarterback with some of those selections made five years ago in an effort to learn something? In the spirit of the top-rated television show "CSI," we'll take a stab at some forensic hindsight.

When Bubbles Meet Recessions

You already know how this usually works. What stocks do you talk about at the hair salon? Be honest. They're usually the stocks that have performed the best -- the ones that prove our gargantuan genius.

We often have a hard time with the decisions that don't work out so well. We avoid dwelling on them during our time in the barber chair. One of my investment clubs sold Dell Computer back in 1995 after it had gained some 30 percent. We kept Dell on our watch list until it had increased another 14,495 percent and we simply couldn't stand the sight of it anymore. Many investors banish their poorer-performing selections to some sort of purgatory to suppress the memories.

BI's Editorial Advisory and Securities Review Committee -- the team that selects the Stock to Study and Undervalued companies -- is not immune to this. Our most recent monthly meeting started out with some vivid and fond memories of "Who nominated Copart?" Memories were a little more selective and the table got a whole lot quieter when we tried to remember who nominated ADC Telecommunications and Dana.

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Dana Corp. -- Cycles of Profitability? At the time of selection in 1999, Dana had acquired Eaton's axle and brake business and was working to integrate the aftermarket business of Echlin. The Value Line 3-5 year forecast (Jan. 8, 1999) for pre-tax profit margin was 9.5 percent. As the graph shows, rather than expanding, profit margins were lower in the years that followed.

How to read this table: The market price of HON INDUSTRIES increased from $23.38 to $43.32 since the company was featured as a Stock to Study in March 1999. The stock price appreciation, adjusted for stock splits during the five-year period, represents an increase of 13.6 percent per year. HON INDUSTRIES paid an average annual dividend yield of 1.8 percent for the period. Combining the price appreciation and income gives us an annual total return over the period of 15.4 percent. The best performing stock was Copart with an annualized total return of 27.5 percent. The worst performing stock was ADC Telecommunications. The goal Better Investing's Securities Review Committee strives for in selecting cover stocks is an annualized total return of 15 percent over five years, a result that two of the 12 stocks achieved as of year-end 2003. Eight of the 12 selections outperformed the Dow Jones industrial average (DJIA.) The DJIA ended the last five years at 2.1 percent -- the second-lowest result since 1974. BI's Stocks to Study lead the traditional "Tortoise and Hare Race" -- 30 wins for BI vs. 18 wins for the DJIA.

The best-performing selection from 1999 was Copart (see chart, above) the Stock to Study from December 1999. The 2003 tortoise was a few points behind at the end of 2002. Strong finishes by Copart, HON INDUSTRIES, AptarGroup and Synovus Financial during the second half of 2003 made up some lost ground, enabling this year's tortoise to humble the hare again.

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ADC Telecommunications -- When Bubbles Burst Into Recessions. This Stock Selection Guide provides a look at the forecasts (red dotted line) from 1999 with actual results displayed. Expected sales growth was approximately 18-20 percent at the time of selection, and it would have been reasonable to expect $0.75 in split-adjusted earnings five years later. Note that actual sales accelerated to a peak in early 2001 and have steadily declined. The average expected annual total return according to the Value Line analyst (October 9, 1998) was 30.5 percent.

The weakest-performing pick over the five-year contest period has been ADC Telecommunications. The accompanying chart (right) shows what ADCT stock selection expectations looked like for some investors around five years ago. Think back to those days as the 1990s drew to a close. Remember Y2K? The growth environment for companies like ADCT had been boosted by international growth expectations and a wave of capital spending by telecommunication companies.

With perfect hindsight now, we could probably imagine how some sales were displaced from 2001 and 2002 into 1998 and 1999. Making matters worse, this bubble was closely followed by an industry recession that still seems to be in progress. Cross your turtle fingers for Tellabs in the 2000 selections.

It could have been worse for ADCT. The company has very little long-term debt and could generate positive earnings one day again. (Analysts forecast this for 2004.)

Part of the lesson here is that it would not have been easy, perhaps even somewhat impossible, to have seen this one coming. When you look at the Stock Selection Guide for ADCT, some clues are visible. While sales exceeded expectations during 1999-2001, earnings did not. Investors who use NAIC portfolio management tools may have detected an early warning signal. An updated SSG in mid-2001 may have signaled a substantially overvalued condition, with the stock price at $49.

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HON INDUSTRIES -- Only Slightly "Off Course." This office furniture manufacturer is subject to the pressures of the same economic cycles that affect any growth-cyclical company. This HON SSG provides a review of sales and earnings results versus forecasts (April 16, 1999) made near the time of selection. Expected sales growth was approximately 10-12 percent. The average expected annual total return according to the Value Line analyst was 20.5 percent. Investors who stayed the course were rewarded with a stock price increase during late 2003 in response to stronger earnings.

The circumstances surrounding ADCT provide a reminder that we buy to hold but not to forget. A securities review committee member noted that regular updates of SSGs and using the Challenge Tree process may have delivered a large realized gain on ADCT from the price at time of selection.

Expectations and Results

ADCT was among the group of four selections with the highest expected returns at the time of selection. American Power Conv., Carlisle Companies and Copart were the other three companies with the most promising expectations. The average annualized return for this group of four was 9.8 percent.

Some cyclical-growth companies fared better. Take a look at the results delivered by HON Industries (right). Economic cycles test management and profit margins.

It's Official -- A Four-Peat!

The tortoise has now surged to four consecutive victories. Since inception, the Stocks to Study have averaged an annual rate of return of 13.9 percent over the last 48 years, while the hare has delivered 10.4 percent. (See links below for annual results.)

Stock to Study 1983 - 1989

Stock to Study 1990 - 1999

Stock to Study 2000 - 2003

Brett Favre may be a three-time most valuable player in the National Football League, and his Monday morning quarterbacking skills are solid. But wouldn't it be more helpful if Brett would see fit to share that double-bagging recommendation before the cans of peas are rolling in the parking lot? For 48 years our patient, disciplined tortoise has been leading the way.

Now that's priceless.

*Note: Periods in which the tortoise beat the hare. Results are expressed in terms of compound annual increases. A doubling in value is equivalent to an annualized rate of 14.9 percent.

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Mark Robertson is director of online resources and senior contributing editor for BetterInvesting. He serves as a member of BetterInvesting Magazine's Editorial Advisory & Securities Review Committee. Mark can be reached at Robertson_Mark@comcast.net.