Beating the Street (18 page)

As jittery as I must have looked, the appearance on Rukeyser's show did wonders for Magellan. The Fidelity sales department got very busy answering phones and taking orders. What had been a $100 million fund after the merger with Salem in 1981 became a $450 million fund by the end of 1982. New money was pouring in at a rate that would have been inconceivable four years earlier: $40 million in October, $71 million in November, $55 million in December. A roaring stock market had a lot to do with this.

Instead of having to sell one stock to buy another, as I'd done in the past, I now had the luxury of maintaining old positions while initiating fresh ones. I wasn't allowed to spend all the money on Chrysler, so I invested some of it in the other autos, in chemical companies, and in retailers. In three months, I bought shares in 166 different companies.

Some of these were large companies, but the majority were not.
One of the many ironies of my career is that when Magellan was a small fund I concentrated on the bigger stocks, and when it became a bigger fund I found myself concentrating on the smaller stocks. This was not a deliberate strategy, but that's the way it worked out.

Magellan's popularity continued to grow into 1983. In February, another $76 million had to be invested, and in March, $100 million. It would have been easier to find stocks to buy in a terrible market, but by early 1983 the Dow had advanced 300 points from the 1982 lows. Many of the technology issues had risen to giddy heights that wouldn't be seen again for six or seven years. These high prices were the cause of great jubilation on Wall Street, but I found them depressing. I was happier with a good 300-point drop that created some bargains.

Bargains are the holy grail of the true stockpicker. The fact that 1030 percent of our net worth is lost in a market sell-off is of little consequence. We see the latest correction not as a disaster but as an opportunity to acquire more shares at low prices. This is how great fortunes are made over time.

Chrysler was still my biggest holding (5 percent of the fund), and remained so for most of the year. It had doubled in value in eight months. Horn & Hardart, Stop & Shop, and IBM continued to show up in the top five. I dutifully maintained a 3 percent position in IBM (less, it turns out, than IBM's overall weighting in the market of 4 percent of the total value of the S&P 500). Perhaps I was responding to a subliminal message: you aren't really a fund manager unless you have Big Blue in the portfolio.

In April, Magellan hit $1 billion, a milestone which elicited a great ho-hum at the office. Soon afterward, a newsletter writer suggested that Magellan had gotten too big to succeed. This argument would soon gain in popularity.

The Later Years

How much time you spend on researching stocks is directly proportional to how many stocks you own. It takes a few hours a year to keep up with each one. This includes reading the annuals and the quarterlies, and calling the companies for periodic updates. An individual with five stocks can do this work as a hobby. A fund manager of a small- to medium-sized fund can do it as a nine-to-five job. In a larger fund, you're looking at a 60- to 80-hour week.

By mid-1983 there were 450 stocks in the Magellan portfolio, and by fall, the number had doubled to 900. This meant I had to be prepared to tell 900 different stories to my colleagues in 90 seconds or less. To do that, I had to know what the stories were. My able assistants helped me investigate the facts.

John Neff at Vanguard Windsor still had the largest mutual fund in existence, but by the end of 1983 Magellan was running a close second, with $1.6 billion in assets. This latest growth spurt prompted a new group of critics to say that Magellan, like the Roman Empire, had gotten too big to succeed. The theory was that a fund with 900 stocks in it didn't have a chance to beat the market average because it
was
the market average. I was accused of managing the largest closet index fund on the planet.

This theory that a large fund can only be a mediocre fund is still in vogue today, and it's just as misguided as it was a decade ago.
An imaginative fund manager can pick 1,000 stocks, or even 2,000 stocks, in unusual companies, the majority of which will never appear in the standard Wall Street portfolio. This is known as “flying off the radar scope.” He or she can own 300 S&Ls and 250 retailers and no oil companies and zero manufacturers, and his results will zig when the rest of the market zags. Conversely, an unimaginative fund manager can limit his portfolio to 50 stocks that are widely held by institutions, and create a miniature S&P 500. This leads to Peter's Principle #9:

Not all common stocks are equally common.

The size of a fund and the number of stocks it contains tell you nothing about whether or not it can excel. The publicity I received for having bought 900 stocks, or, later, 1,400 stocks, may have caused some investors to shy away from Magellan. This is unfortunate. Of the 900 stocks in the portfolio in 1983, 700 accounted for less than 10 percent of the fund's total assets.

These tiny positions I took for one of two reasons: (1) the companies themselves were quite small, so even if I owned the maximum 10 percent of the shares the dollar value didn't amount to much; or (2) I wasn't convinced they deserved a substantial commitment. Most of the stocks in Magellan fell into this “tune in later” category. It was easier to follow the story when you owned some shares and were put on the mailing list.

An illustration of how an insignificant holding could lead to a great opportunity is Jan Bell Marketing. The executives of this jewelry supplier, a $200 million company and far from the
Fortune
500, came to Fidelity to meet with our fund managers. I owned the stock, so I hustled over to the conference room to hear the presentation. No other fund managers showed up.

Jan Bell was too small to add much to Magellan's bottom line, but I'm glad I went to the meeting. In describing the business, the executives mentioned that their best customers were the discount clubs (Pace, Warehouse, Wholesale, Costco, etc.) that were ordering a tremendous amount of jewelry—so much, in fact, that Jan Bell had to struggle to keep up with the demand.

That's where I got the idea to invest in the discount clubs. It occurred to me that if they were selling as much jewelry as Jan Bell said they were, then their general sales had to be excellent as well.
I asked Will Danoff, the retail analyst who later took over the Fidelity Contrafund, to do the research.

These stocks were very popular after the initial public offerings, but the euphoria was short-lived. Expectations were so lofty that the results couldn't possibly live up to them, and the stocks sold off. True to form, Wall Street lost interest. Danoff called the big investment houses and found out that not a single analyst was assigned to follow these companies.

The two of us contacted the companies directly. They confirmed what Jan Bell had said—business was terrific. They also told us they'd strengthened their balance sheets by paying off debt. Earnings were on the upswing, the stock prices were still on the downswing—it was a perfect situation. I bought hundreds of thousands of shares of Costco, Wholesale Club, and Pace. All three made money—Costco was a triple.

Employees and shoppers in these stores could have seen the evidence of prosperity with their own eyes, and learned the same details that Danoff and I did. The alert shopper has a chance to get the message about retailers earlier than Wall Street does, and to make back all the money he or she ever spends on merchandise—by buying undervalued stocks.

During the mid-80s, I also scooped up nearly every S&L that came public. Most of them were quite small, so for them to have made a difference to a $1 billion portfolio, I had to buy a passel. Besides, after several financial institutions told me their profits were improving thanks to lower interest rates, I could see that many others would benefit from the same trend. Of the 83 new acquisitions I made in April 1983, 39 were banks or S&Ls. By the end of that year, I'd bought 100 S&Ls, enough to make that group 3 percent of the fund.

The financial press noted my “emphasis” on the S&Ls in enough articles that the casual reader might have gotten the impression that Magellan's fortunes rose and fell with them. It's a good thing it didn't, because when the weakest of the S&Ls collapsed, the prices of the strong ones declined in sympathy. If I'd put 20 percent of Magellan into the S&Ls I might have been forced to retire much earlier.

Banks and S&Ls notwithstanding, it was the autos that get the most credit for Magellan's success during this period. Ford had led me to Chrysler, and Chrysler to Subaru and Volvo. The favorable economic tide that lifted one was lifting them all.

The price of Chrysler stock shot up so fast that for a short period my Chrysler holding exceeded the limit of 5 percent of the fund. Once it got to 5 percent, I wasn't allowed to buy more, though I was allowed to exceed the limit if an increase in a stock's price pushed the value of Magellan's position over the 5 percent limit. At the same time, I was building up Ford and Volvo, until the three together accounted for 8 percent of Magellan's assets, and autos as a group, 10.3 percent.

An individual can pick the most promising auto company and put all his money there, but to get the full benefit from a rebound in autos, the manager of a large fund is forced to make what is known as an “industry bet.” There are different ways to make such bets. One way is to tell yourself, “This year, I want to have eight percent in autos,” because you have a hunch that autos are going to do well. You can close your eyes and throw darts at a list of auto stocks, and buy a few. Another way is to analyze each company on a case-by-case basis.

In the first instance, the 8 percent weighting in autos is deliberate and the choice of the companies is incidental; in the second, the choice of the companies is deliberate and the weighting is incidental. As you might have guessed, I prefer the latter. Doing the homework takes more effort than throwing darts, but in 1983 the dart throwers were likely to have ended up investing in General Motors.

I never owned much General Motors, even in this favorable period for autos, because I thought that saying it was a miserable company was about the nicest compliment you could give it. Even GM tripled in value from 1982 to 1987, but the fund manager who made the number-one U.S. automaker his number-one investment didn't get the full advantage of the 17-fold profit from Ford, and the nearly 50-bagger from Chrysler.

I have to admit that in my bottoms-up analysis I was right about the rebound in autos, but wrong about the big picture. I was convinced that the Japanese would continue to concentrate on the small-car market, and I never imagined that they would get into the midsize and luxury markets the way they've done. In spite of this miscalculation, I was able to get the maximum benefit out of Ford, Chrysler, and Volvo.

During the entire six-year stretch from 1982 to 1988, at least two of these three auto manufacturers could be found among the top five holdings in Magellan, and sometimes all three appeared at once. Ford and Chrysler stock rose dramatically, and subsequently I made
well over $100 million in profits from each, plus $79 million from Volvo. It was huge gains in a few huge positions that led to Magellan's superior results.

Although Magellan was continually described as a growth fund, it was the flexibility to buy any sort of stock that enabled me to take advantage of opportunities such as I found in the autos. Chrysler and Ford would not have appeared in the growth-fund portfolios, yet because these stocks had been beaten so far down, on the rebound they outperformed almost all of the growth stocks.

Another way that a lot of fund managers hemmed themselves in was by worrying about “liquidity.” They avoided all the wonderful small companies—a good collection of these could do wonders even for a big portfolio—because the stocks were “thinly traded.” They'd get so absorbed in this problem of finding stocks they could get in and out of in five days or less that they'd lose sight of whether these things were worth owning in the first place.

In stocks as in romance, ease of divorce is not a sound basis for commitment. If you've chosen wisely to begin with, you won't want a divorce. And if you haven't, you're in a mess no matter what. All the liquidity in the world isn't going to save you from pain, suffering, and probably a loss of money.

Take Polaroid, which lost 90 percent of its value in a single year, 1973. A lot of fund managers wish they hadn't. Polaroid was a big company and very actively traded, so it was a cinch to sell large blocks of shares at a moment's notice. The stock was in a slow descent for three years, so everybody had a chance to get out, but I know several professionals who didn't. You have to want out to get out, and they didn't notice that the company was falling apart.

They had the chance to get out of Xerox, too, and for some reason they didn't do that, either. So the expert who decided not to invest in something because “it only trades ten thousand shares a day” is looking at things cockeyed. For one thing, 99 percent of all stocks trade fewer than 10,000 shares a day, so fund managers who worry about liquidity are confined to 1 percent of all publicly traded companies. For another thing, if a company is a loser, the fund manager is going to lose money on the stock no matter how many shares it trades, and if it's a winner, he or she will be delighted to unwind a position in the stock leisurely, at a profit.

When Magellan grew into a medium-sized fund, it got harder for me to make a meaningful investment overnight. Once in a while I
got the chance to gobble up a huge block of shares from an institutional buyer, which is how I acquired 2 million shares of Owens-Corning in one day. Another time, I bought 2 million shares of BankAmerica in the same fashion. But these were the exceptions to the rule of constant nibbling.

Every time the fund got bigger, which happened almost every day, I had to add to each position to maintain its relative weight versus the other stocks in the fund. With the smaller stocks especially, it sometimes took months to acquire a decent amount. If I bought shares too rapidly, my own buying could cause the price to increase beyond the level at which I would have wanted to start selling.