Comments & Outlook

It’s hard to tell how the markets will evolve. One of the things we try to do is play the hand the market deals us and be opportunistic–agility is key. Over the last year or so we’ve added to our technology holdings, a sector that’s not usually a big part of our portfolio.

We’re in a very severe period of economic and profit contraction, and technology firms aren’t necessarily immune to these weaknesses. At the same time, you can’t judge a company by its current-year earnings because expectations are being reset across the board to reflect new realities. But there’s opportunity to grow off that reset base, and a broad swath of technology firms still has the opportunity to generate above-average growth. Valuations have contracted a bit, particularly on a free cash flow basis, but yields are really attractive in the sector and balance sheets are generally in very good shape.

Recommended Strategy

We recommend that investors stay focused and buy what’s on sale. We look at what’s going on in a particular sector or industry and then evaluate the company’s business strategy within that context. Finding attractive valuations and identifying potential growth catalysts is a key part of this process.

Timeframe is also important. The danger is taking too long a view and reassuring yourself that everything works out eventually. I’ve found that a 12 to 18 month time period is long enough to get beyond the emotions of the moment but not so far out that you end up with a big forecast error.

What to Buy Now

Qualcomm (NSDQ: QCOM) is fairly large and has no debt on its balance sheet. The firm’s royalty stream constitutes its biggest source of income. Not only does the company own and license its technology, but it’s also going to participate in the 3G smart phone roll out and the buildup in China’s telecommunications infrastructure.

Symantec (NSDQ: SYMC) will benefit as people become increasingly worried about data security. The stock really got punished last fall and looks really inexpensive now. Symantec changed management, and the balance sheet isn’t quite as strong as in the past, but the firm is in very good shape, generates lots of free cash and has a great business model.

Craig Hodges   Co-manager, Hodges Funds

Comments & Outlook

I guess I’m in the minority in that I think we’ve seen the bottom. I would say that 90 percent of the people to whom I speak think we’re in a bear market rally. Also, in my 22 years in the business, I’ve never seen people get out of the market as quickly as over the last six weeks. That suggests that the market’s probably washed out. I’m not saying that the news is going to improve dramatically overnight, but anytime you have this much pessimism and such low expectations in the short term, that tells me that most of the selling has been done. And you can build a nice base from that.

One thing that we’re hanging our hat on is a survey we did of the twelve bear markets since WWII. Once the market finally bottoms, the first twelve months’ rate of return is roughly 40 percent. By the second year it’s up to around 53 percent in the first 24 months. And that’s just the average. That gives us a pretty high degree of confidence that our purchases should be well rewarded over the next 24 months.

Recommended Strategy

Don’t play defense anymore; the time for that was 2008. The time to be more aggressive is now, because, in our mind, the damage has been done. There’s money to be made in this market. You’ve got maybe a 10 percent to 15 percent downside risk in a lot of these stocks, but the upside potential outweighs that.

What to Buy Now

We believe that deepwater drillers are the most undervalued part of the energy business. Most of the stocks in the group are at trading three-, four or five-times earnings. Transocean (NYSE: RIG) will probably earn $13 a share this year and the stock trades around $60, down from $165. Yet they’ve had no slowdown in their business; there’s still a shortage of rigs–if you found oil today, you wouldn’t be able to get a rig to drill until 2011 or 2012 at the earliest. The day rates that these deepwater drillers are able to charge have held up remarkably well even though the price of oil has come down dramatically. And that’s because the big oil companies and the contractors of these rigs aren’t looking at the spot price of oil; they’re looking at where the price will be in the next three to five years. I think those stocks have come down partly because that’s where a lot of the fast money was made over the last couple of years.