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Morningstar 2008: Growth by stress

Robert Hagstrom of Legg Mason.

Morningstar’s “Redefining Growth” panel included Robert Hagstrom of Legg Mason, Dennis Lynch of Morgan Stanley (and Van Kampen), and Alex Motola of Thornburg. But before the panel got under way, Robert Hagstrom met a few of us in the press room for a quick sitdown whose topic was electric, to say the least (free-form paraphrase, as usual)…

Hagstrom: Inflation in electric rates will accelerate for the US consumer, and people will be getting pretty upset. The demand for electric power and exceed supply. In fact, when asked what kept them up nights, Google named the supply of electricity as their #1 concern going forward. That’s because Google is the #1 consumer of electricity in the state of California.

After the panel assembled, the conversation focused on other topics.

Lynch: All sensible investing is value-based. The difference is that growth investors invest in higher than average P/E ratios and value investors invest in lower P/Es. Higher P/Es are not always expensive — earnings are often driven by accounting assumptions. We seek value beyond the obvious P/E.

Motola: We seek seek securities that are mispriced based on misperceptions. The marriage between value and growth approaches characterizes some of the best investment strategies.

Lynch: Momentum sounds dirty, but we don’t sell our winners right away because we want to capture some of it. Indexes don’t sell their winners. To quote Robert Hagstrom, who said several years ago: “When everyone hates ’em, we buy ’em. When everyone loves, we hold ’em.”

Hagstrom: Since March we started repurchasing financials because that’s where we believe the doubles, triples, 4-baggers and 5-baggers of tomorrow are. The problem is which, and when. Mispricing goes up with complexity (of the balance sheet).

Alex Motola of Thornburg in the Exhibit Hall at the Morningstar Investment Conference 2008.

Motola: Recently we’ve moved toward biotechnology with names such as Gilead, Alexian, Genentech, and Celgene, which we believe have a good growth profile.

Lynch: Inflation and demographics are pluses for healthcare, but government regulation and creative destruction are big ifs. Reimbursemnent changes, for example, can come quickly and catastrophically.

Hagstrom: The healthcare model is broken, and biotech is probably its best growth opportunity. Big pharma is no longer growth. Under a new administration we may be insuring 43 million people and we don’t know how that will affect earnings.

Hagstrom: [on turnover] Value managers buy crappy companies and hold on forever. We buy great companies and hold on forever. Growth guys should keep their turnover ratios lower, but value guys’ should go up.

Hagstrom: [on quality of management in financial service] Goldman did it right because they’re great at risk management. They watched out for the black swan.

During a gaggle after the panel discussion:

Hagstrom: You don’t make a lot of money unless it’s accompanied by a lot of stomach-churning stress. The probability of recession is going up, and that hurts GE. I think our next problem is deflation — of real estate, M&A prices of businesses, and wages. Everything but commodities is going down in price. That would have a big impact on financials. I would hope Bernanke would drop the rate to 1 percent. Europe is even more pessimistic than the US. They’re even closer to deflation because they’ve raised rates. Meanwhile, I’m still a bull on emerging markets.

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