A New Fund With Old Principles

This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.

The New York Sun

It worked beautifully in the 1930s and 1940s, and for one relatively new hedge fund, it’s proving to be a winning strategy again today.


That is, the principles of value investing as advocated by the granddaddies of this strategy, Benjamin Graham and David Dodd, who became household names in the 1900s as Wall Street’s premier value stock experts.


You don’t have to be a financial whiz to jump aboard their bandwagon. Simply, what is required is a focus on stocks that are basically cheap, based on such measurements as book values, dividend yields, price/earnings multiples, and cash flows.


A former Kidder Peabody analyst, David Rosen, took some pages out of a book written by our two value experts – “Security Analysis,” and one by Mr. Graham, “Value Investing” (which he calls his bible) – and is applying their principles to a hedge fund he started in January 2003. It’s called the Graham & Dodd Value Fund LLP. Mr. Rosen has a registered service mark for the use of the Graham and Dodd name in the securities industry.


So far, the 46-year-old manager, who zeroes in on such measurements as rising free cash flows, reasonably low book values, and companies selling below their asset values, is on the fast track. His record: an imposing 28% annual rate of return after fees since the fund’s inception. To date in 2005, the fund, which also sells short (a bet stock prices will fall), is up a market-beating 8%.


“We try to buy companies selling at two to five times cash flow and sell them at eight-plus cash flow,” Mr. Rosen said. This strategy has paid off for him on a number of companies, among them Toll Brothers, KB Homes, and McDonald’s.


His no. 1 sector right now: energy. Despite the big gains, Mr. Rosen notes that many energy stocks are still trading at only eight times earnings and generating heavy free cash flows. His top picks – and he’s added recently to these positions – are Sunoco, Amerada Hess, and Valero Energy.


Insurance, viewed as an undervalued sector, is another favorite. The industry, Mr. Rosen said, is throwing off good free cash flow. And, as the economy grows, so does its business. Likewise, he says, as interest rates go up, the industry is investing at better rates. He said his best bets are Chubb, Aetna, and Allstate.


Various stocks the fund likes that also fit Mr. Rosen’s free cash flow thesis are CIT financial, Deere & Company, Lockheed Martin, Costco, and KB Homes.


On the short side – the focus here is deteriorating cash flows – Mr. Rosen wouldn’t mention any specific names, but he is short some airline stocks whose price-to-book and cash flow multiples he views as extremely high. He also points to the lack of hedging against dramatic increases in the price of jet fuel and the squeeze on margins. Airlines, he added, should really be a utility.


Home-builders in general also worry Mr. Rosen. They represented about 14% of the portfolio through early last year until a month ago. Now they’re down to about 3% to 4%. Explaining the cutback, he notes the market fears higher interest rates. And when rates go up, as is now the case, it sells the homebuilders, he says, because they’re seen as an interest-rate proxy.


Mr. Rosen pays little attention to where the stock market is headed but rather looks strictly for value. At the moment, his portfolio is 60% long, 40% short. His overall market view: “It has decent upside.” He cites economic growth at a 3% rate, double-digit earnings increases, and deleveraged balance sheets (leading to decreased debt and increased stock buybacks). He is not looking for any surge in stock prices, noting that come December 31, the market should be somewhat higher than it is today.


***


THREE SEC TRADING PROBES: Investigations into possible illegal trading in mergers and acquisitions by the Securities and Exchange Commission are growing like crazy, a regulatory source intimately involved in this area tells me. One of the latest, I’ve learned, is an investigation into the recently announced $1.9 billion acquisition by TD Banknorth of Hudson United Bancorp, a Big Board-listed bank holding company in the tri-state area.


The deal, equivalent to about $42.78 a share in cash and stock, was officially disclosed July 12. The SEC investigation centers chiefly on trading in Hudson United’s shares that took place between June 21 and July 11.


The commission, I’m told, is also conducting trading investigations into two over-the-counter biopharmaceutical companies – ONYX Pharmaceuticals and Cell Therapeutics.


The SEC, as usual, declined to comment on the investigations, but a regulatory source confirmed all of them.


The New York Sun

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