Q: Michael, where did you learn the techniques you now use to manage money?
A: I guess certain people are destined to be in their profession based on their actions and interests as a child. At the age of nine I was already collecting money and by twelve I had a dozen bank tellers pulling out silver coins for me from their cashier's trays. I would ride by after school on my bicycle every day and collect my day's take. My parents were very supportive and would pick up bags of coins for me at every bank they would pass, then I'd take out the good ones and send the bags back for new ones. I liked money and, even more importantly, making it grow. Some of the techniques I use today as a money manager were developed over the years. I learned what I know about economics and supply and demand from studying and collecting rare coins. By studying old auction catalogues I tried to determine the real rarity of a coin by how many times it showed up for auction over the last fifty years. Often I would discover a coin that was actually more rare than people thought, yet commanded no premium versus more common coins. This helped me develop my research skills. Another technique that was transferable to managing money was an ability to look ahead and spot trends. The same analytical efforts that went into determining what would be in favor in the coin and bullion markets before the public caught on formed the basis for my research today. I learned that when everyone was overly bullish, it was usually time to step aside. I also learned what “smart money” was and how to invest like they do. I developed a skepticism for things that I read in the paper. I learned that if it is in the paper, it is probably too late to get in early. In fact, this was one of the sell signals that I used later on to get out of a popular area before John Q. Public realized that the trend had changed.
Q: Could you tell us a little about Cambridge and how you came to start your own money management firm?
A: I began my career as a stockbroker in the 1970's and from the very first day was a frustrated portfolio manager. I enjoyed researching stocks much more than selling them, though I did have a fair amount of success. I opened our brokerage firm, Cambridge Way, in 1987 and our money management firm, Cambridge Equity Advisors, in 1989. I really wanted the latitude to do things the way I felt they should be done. I started managing stock accounts on a discretionary basis in 1985 and building my track record in 1986. While I only opened Cambridge Equity Advisors five years ago, I have been managing money since the mid 1980's, but without charging a management fee. Over the years I had developed a pretty large following of investors and stockbrokers who followed my recommendations either as clients or because of articles and columns I wrote in local and regional publications. It was very frustrating hearing from clients and potential clients about other advisors that were mirroring my stock selections without me receiving any remuneration or recognition. I had made a lot of stockbrokers look pretty smart over the years and decided it was time to be paid. Opening my own money management firm was a natural next step for me after going out on my own in 1987. I had received portfolio management training from a large wire-house as part of a trial pilot program in 1986. They trained five top producers with no compliance problems and an aptitude for money management to be regional portfolio managers. What I learned fascinated me and I realized that I already used many of the portfolio techniques that I learned in my training. Unfortunately, they wanted me to use stocks from their approved list. When I came up with Amgen, Blockbuster Entertainment, Home Depot, and Compaq Computer back in 1986, they rejected these as too aggressive. These eventually became some of the premier growth stocks of the decade.
Q: What key elements do you look for in an investment that allows you to recognize its potential ahead of other investors?
A: One of the first things I look for is a strong market niche. A company with a product that can make an impact. I also look for top, motivated management and a strong industry position. I don't usually buy a “we're number two but we try harder” type of company. I want the best. Sometimes I will spot an industry that looks intriguing - like biotechnology in the late 1980's or computer networking stocks last year. Then I will work backwards to find the company that is or will be the leader in the industry. I want a stock that is early in its growth curve, but on the cusp of being discovered. I don't want to wait too long for the market to come to me. I'd rather wait until it is just beginning to be accumulated to make my investment. A product shortage or excess demand is something that attracts my interest. For example, we bought CML Group after I ordered a Nordic Track cross-country ski machine and was told I would have to wait a month for delivery. I called several more times and was advised by the sales clerks that they couldn't answer the phones fast enough and that they had to slow down their advertising to reduce sales until they could make the machines more quickly. We bought the stock the next week and are up 100%.
Q: You read a lot in order to find new investment opportunities. What are your main sources for information?
A: I read everything. We subscribe to over eighty different publications and I know I read probably twice that each month. I am always looking for trends, fads, or new products. You'd be surprised at some of the places I have uncovered stocks. My clients are also on the lookout for fast selling products or stores that have long lines. Sort of the Peter Lynch approach of keeping your eyes open. However, I don't look for companies that are so simple a twelve year old can understand them, like Mr. Lynch. I am willing to stretch it to technology an eighteen year old can understand. You miss too many new products and innovations if you keep it too simple. I also monitor what other managers buy. I scan their holdings. Sometimes I can find a particularly successful manager that specializes in some obscure niche that I don't follow or understand. If I see they have a certain stock as their largest position, I might look closer at the company to see why. There are a lot of smart people in our business. I'm not very good at technology so I try to see what people that are experts think about an industry.
Q: What key fundamentals do you look for in your evaluation of companies?
A: I track many of the same things other managers do. Most important to me are earnings. What the company did the past five years, but, more importantly, anticipated earnings growth for the next three years. I love a stock that has been growing at 25% a year and expects to increase the earnings growth to 40% in the future. That's a winner. Accelerating earnings growth is one of the most significant signs I look for. I look at return on equity and profit margins. Mainly at the direction of these numbers. Debt is also important. We average a debt/equity ratio of 20% on our average portfolio so that there is significant self-financing for growth. I don't like leverage unless I'm positive which way it is going. I may have even looked at the price-earnings ratio once before. Usually just to see the number relative to other stocks in that industry since I don't care what the PE is. The whole time I have been buying some of my biggest winners they have had high PE's
Q: Once you identify a company you like, how do you go about timing the purchase and what technical indicators do you use?
A: I tend to buy and sell based more on technical indicators than anything else. Very few managers seem to consider the tape action of a stock before making a decision. It's all fundamental data for them. I like to buy a stock on strength. I love a stock breaking out to a new high on triple normal volume. I'll wait to purchase a stock until it is acting well. I've owned Wal-Mart for years but didn't buy it last year until September because it sat at the same price most of the year. There was no hurry. I hate bottom fishing. Every time I do that I don't do a very good job for the client. Even if I'm right, I'll lose patience before I'm rewarded. I would much rather buy a winning stock just beginning to move, and give up the first couple of points. Technical indicators I'll look at include relative strength, earnings per share rank, and, especially, volume. I was a very early follower of the Daily Graphs and William O'Neill's approach that is now so famous with the Investors Business Daily publication. I want to see that the stock is breaking out of a trend and ready to move. I can read a chart much better than I can read research reports. A chart gives you what is really happening to a stock. As I mentioned, volume is my biggest technical indicator. If a stock has already been screened and, fundamentally, meets all my parameters, it has to show technical strength for me to buy it. Increasing volume is usually how the stock signals you that a major change is taking place.
Q: How important is timing the sale of stock? What kind of analysis do you use to help you in making sell decisions?
A: Our best decisions, over the years, have been on the sell side. To me, it is the most important part of my job and where I earn my management fee. Sometimes the decision is not to sell. We've owned Home Depot and Wal-Mart for many years and the proper decision was to hold on tightly. Anyone can buy a stock. You rise to the top in this industry by knowing how to get out of a stock. I have been very fortunate over the years in exiting a stock and industry in a timely fashion. I make more than my share of mistakes, but the net results have been favorable. Our most successful and timely sale recently was in early January, 1992, when we sold almost all of our health care, drug, and biotechnology stocks after a 71% gain in 1991. You could see the writing on the wall by looking at the charts and how toppy everything looked. If you had used fundamental analysis only, you would only have recently sold these stocks at prices 50% lower. One of those stocks was U.S. Surgical, which we bought at $40 a year earlier. At $100 we quit adding the stock to new portfolios but held our position. A drop of $10 on over 1 million shares was my target for selling the stock. It peaked at $134, we sold at $120-$125 and it is now under $30. I also look at what insiders are doing, support levels on a stock, and who the new buyers are. Heaven help you if it is John Q. Public. I sold out of the health care industry last year after our phones began ringing from people wanting to buy the top performing stocks of 1991. They are always too late and buy at the top.
Q: In controlling portfolio risk, how do you go about determining the allocation between small, medium, and large companies in your portfolios?
A: I try to balance a portfolio between small, medium, and large companies. If I have too many small ones, my liquidity is limited and the volatility is too high. If there are too many large ones, performance will lag. A lot of the balancing decision is dictated by the market. Last year I had, on average, twenty-five stocks. Five were small caps, five large caps, and 15 medium size companies.
Q: Under what circumstances would you more heavily favor small-cap stocks versus larger-cap issues, or favor large issues over smaller ones?
A: Sometimes I will focus more heavily on one area depending on what the market is rewarding. The last half of 1992 was a great one for smaller, more obscure OTC stocks in the computer software industry and that's what we added. This year, it seems that large cap stocks will be better performers so we are beginning to lean that way more, although we still have a pretty even split. Tell us how you go about controlling risk through industry diversification. Diversification is a very difficult thing to balance in a portfolio. I know some managers that concentrate their holdings in a dozen stocks and some that spread it around. I like to have 20-25 stocks in 10-15 different industries. Sometimes there will be some overlap of similar industries. In 1991 we had over 1/3 of our assets in drugs, health care, medical supplies, or biotechnology, which was why we were up 71%. This year we are more interested in technology, computers, and retailing, but no one group is too large a percentage. This is the first time we have ever not owned any health care stocks, and I might be buying some in May before Hillary Clinton's report comes out.
Q: Are you always 100% invested? Are there times you might go to cash when you think the market is over-valued or individual stocks seem over-priced?
A: I have never been 100% invested. We went to 98% a day before the Gulf War began and again last fall, but usually have some cash to save for a rainy day. This year we have had between 10-20% cash and I wish I had more. I rarely try to time the market. I'm much better at timing an individual stock than the market. However I do have brief moments of inspiration when I get more aggressively invested, like the day before the Gulf War. The most cash I ever had was around 25% and that was more a function of my inability to find stocks looking strong than any pessimism about the market.
Q: What's the turnover like in your portfolios? What kinds of markets would change the average level of portfolio turnover?
A: I am about middle of the road when it comes to turnover. I tend to hold my winners about two years, and I've been fortunate to have more of those than losers. I try to get the losers out quickly. I guess it's probably about 50% a year, with a good bit of that in January in past years. My turnover has probably picked up in the last couple of years. A growth strategy leads to some disappointments and my philosophy of big fairly active stocks leads to periodic adjustments.
Q: Who also works in your firm and what are their backgrounds?
A: I have a great group of employees that now number twelve. The head of marketing/client services and operations are Maggie Nuzum and Pam Redden. Both have been in the investment industry for ten years and with me for ten and four years respectively. Our other portfolio manager and research analyst is Gary Smith, who had been just our research analyst and an active private investor for years. He is a Vanderbilt University MBA graduate. To me, the most important attribute to have is the ability to make money, and he certainly brings this strength to our firm. There are a lot of very smart people that have no skills whatsoever at making real money in their stocks.
Q: What kinds of investors have been attracted to your management style?
Q: Are you also finding the average size of your portfolios increasing as you grow?
A: Our clients tend to be mainly physicians and business owners or executives. This probably represents 90% of our clients. Probably 70% of the funds are ERISA funds. We originally opened most of our accounts in the Southeast area, but in the past year we have been establishing a lot of new relationships all over the country. I guess part of this came when we hit $100 million under management and part of it from the national recognition we have received because of our track record. The average size of our portfolios has been increasing, particularly in the past year. We are now finding ourselves in manager searches that would not have considered us when we were under $100 million. Our current minimum is $150,000 so we seem to get a lot of clients who want to start with the lowest amount we'll take. Usually they like what they see and add to their accounts pretty quickly.
Q: As a potential client of Cambridge, if I liked your style but wanted a less volatile portfolio, could you accommodate me?
A: We have balanced portfolios that are tailored to the specific requirements of our clients. Our average balanced account would probably have 30% in intermediate term bonds and utility stocks, 30% in blue chip, more conservative growth stocks, and the remaining 40% in our typical growth stock selections. As a client's needs for conservatism increases, the portion in growth stocks would decrease. Our balanced accounts have a minimum size account of $250,000. We have had excellent returns on these accounts and an increasing amount of our new money has come from these accounts. We also manage portfolios of utility stocks and have a mutual fund advisory service comprised of five different strategies ranging from straight bonds to aggressive growth funds. We hold the mutual funds at Fidelity and have had an excellent relationship with them. The minimum on these portfolios is $50,000.
Q: As a money manager you have grown rapidly. How do you plan to continue to provide a high level of both investment performance and client service as your client base increases?
A: We have grown rapidly. One thing I have always done is to hire staff prior to really needing them. We now have more computers than employees and technology not found at some $1 billion firms. We stress client service whether it is the actual client or brokers and financial planners representing clients. Our staff is well-trained, courteous, knowledgeable, and motivated. As to performance, I have advised my clients that I will quit accepting individual accounts when I have too much money to do what I have always done. We intend to raise our minimum on a regular basis to curtail the inflow of smaller, more time intensive accounts. So far, we have been able to do a good job for clients with $150,000, so we'll keep it at this level a while longer. The homework I do on a stock has not changed, despite the increasing size of our positions. I do have to be careful on the smaller stock I buy and this has been a learning experience.
Q: Briefly summarize what differentiates Cambridge Equity Advisors from other managers?
A: We do several things at Cambridge that make us different from other managers. One is our ability to locate future winners at an early stage. It is not uncommon for our clients to have never heard of our stock when we buy the shares, and, six months later it is making headlines. Another thing that sets us apart is the usage of technical indicators to time the purchase and sale of a stock. We make more good decisions than bad ones and understand trends. I don't know how you can make good decisions without understanding how the technical picture of a stock influences the price.