The best of the buy side 2003

Stock gains have buoyed spirits but haven’t changed the harsh new realities of managing money. Analysts’ jobs only get tougher.

At long last a glimmer of light. The first prolonged stock market rally since March 2000 has given equity analysts at money management firms something to cheer -- even as their jobs just keep getting more and more demanding.

Barring a huge setback, major stock market indexes should post double-digit returns in 2003. Some sectors have risen spectacularly: Technology, telecommunications and biotechnology were up more than 50 percent through mid-October. Surging equity prices have helped to replenish money managers’ coffers, which were drained by poor markets and investor redemptions. Mutual fund assets had jumped 9 percent this year through August, to $6.9 trillion, just a shade below their February 2000 $7.1 trillion peak.

The rising market has given many buy-side researchers a chance to strut their stuff. Here we chronicle the work done by outstanding analysts -- those chosen for Institutional Investor’s 2003 Best of the Buy Side. To pick winners, we asked the Wall Street analysts who received votes in our 2003 All-America Research Team to identify their opposite numbers at money management firms who had done the most outstanding work in the past year. Nearly 440 sell-siders representing 78 firms responded.

An eye for changing market dynamics was important. Just a month into his first research job, P. Robert Bartolo of T. Rowe Price Associates recommended wireless telecom services stocks. That was in September 2002, and 13 months later the group had rocketed more than 100 percent. The 31-year-old’s top pick: Nextel Communications, which had tripled to 21 by this October.

State Street Research & Management Co.'s Denis Walsh, 43, a four-time member of the Best of the Buy Side, nailed a key turning point for coal demand: Over the following 12 months, his four picks rose an average of 97 percent.

To be sure, one year of stellar returns isn’t going to bring back the Roaring Nineties. “The fat and happy days are gone,” contends Ajay Mehra, State Street director of research. Three years of declining assets and horrid returns, along with layoffs and diminished research support from Wall Street, have seen to that. Today productivity and accountability are what count.

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“Sell-side staffs and coverage are shrinking, so we are required to do more,” says Mark Mandel, director of global industry research at Wellington Management Co. “Many of the things we depended on from the Street, including basic industry data and coverage of smaller and midcap companies, are no longer available. So we have to do it ourselves.”

Researchers who may already keep tabs on hundreds of companies have no choice but to expand their coverage lists. Pressure to select the right stocks is more intense than ever.

“It used to be enough to deliver elegant analysis; now research has to deliver ideas that work,” says Mehra. “There’s much more focus on performance and stock picking.”

Adds William Costello, who runs Boston Co.'s research: “We’re trying to breed more accountability. We track analyst picks now, but we need to expand that. Compensation now is based on criteria that are too nebulous. We need to create a tracking system where compensation is more closely tied to performance.” The analysts profiled here wouldn’t mind that one bit.

This feature was overseen by Assistant Managing Editor for Research Lewis Knox and Senior Editor Jane B. Kenney, with assistance from Associate Editors Emily Fleckner and Sivert Hagen and Researcher Michele Bickford. Contributing Editors Ben Mattlin and Michael Sisk and Contributors Pam Abramowitz and Karen Kroll wrote the profiles; Abramowitz also wrote the introduction.

Health Care

ANN GALLO

Wellington Management Co.

A year ago Wellington Management Co. unloaded hospital stocks like Tenet Healthcare Corp. and HCA because Ann Gallo had concluded that the shares had become overpriced, after having nearly tripled in three years. Eventually, the market agreed, slicing hospital stocks’ market cap by 37 percent in the ensuing 12 months. “The stocks had had a great three-year run, but it looked like the fundamentals had peaked,” says the health care specialist and five-year Wellington veteran who makes a repeat appearance among the Best of the Buy Side.

Selling the hospital shares was just another instance of the 38-year-old Massachusetts native getting her timing right. Even as Gallo was preparing to unload hospital stocks, she was boosting her health plan holdings. Her reasoning: With workers forced to pay more of their own health care costs, they were likely to shift to generic drugs and cancel marginal services, bolstering plans’ margins. Health plan profits did indeed surge, and the group had climbed some 15 percent in the year since she started buying. Gallo has a “great feel for what’s significant and news, as opposed to what’s just noise,” says a sell-side analyst.

The Boston College graduate’s coverage spans health plans, drug distributors, drugstores, hospitals and health care information technology. She keeps tabs on several hundred stocks, closely scrutinizing some 50 or 60. Gallo, who holds an MBA from Massachusetts Institute of Technology’s Sloan School of Management, views her all-encompassing coverage list as an advantage: “If I’m talking to a health plan, I can get information on benefit design changes that may help me anticipate hospital admission patterns, lab volume growth or drug utilization. If I’m talking to a pharmacy benefit manager, I can get information on the pharmaceutical supply chain that may help in my analysis of drug distributors or drugstore chains.”

Capital Goods/Industrials and Technology

BRUCE GLAZER

Wellington Management Co.

Wellington Management Co. analyst Bruce Glazer, who co-manages his firm’s technology sector fund, started buying shares of Accenture, the Bermuda-based technology services consultant, at a time when consulting looked like the worst segment of the whole faltering information technology sector. But Glazer reasoned that the former Andersen Consulting had a “strong customer base, a great management team and a well-positioned platform to continue gaining market share.” Moreover, he says now, the company had been hurt by “extreme negative sentiment about the outlook for IT spending.”

Glazer started closely tracking Accenture in fall 2002, buying on the dips opportunistically. The stock, having peaked in March 2001 at 29.9, dropped to 16 in November 2002 (and temporarily breached 14 in March of this year), but rebounded to 22 in mid-October as the outlook for tech spending brightened. “He was definitely there way before the crowd,” says a sell-side researcher who knows Glazer well.

The six-year Wellington veteran, who last appeared in the Best of the Buy Side in 2001, receives generous praise from Wall Street. One sell-sider calls him “the best mind out there"; another is impressed by how the Cornell University grad and Wharton School of the University of Pennsylvania MBA has the “raw ability to coalesce very quickly what is pertinent information and what’s just noise.” Glazer tracks a global list of 50 to 100 IT, computer and other business services companies, monitoring a subset of those especially closely.

A health care services analyst at Kidder, Peabody & Co. and Montgomery Securities during the early 1990s, Glazer appreciates the work of his brokerage industry counterparts. “I get a read on consensus expectations from them and how far my forecasts differ,” he says. A sell-sider calls the Wellington researcher unusually “open-minded.” Proof? Long Island native Glazer is a fan of both the Boston Red Sox and the New York Knicks.

Basic Materials

HARRIET (TEE) TAGGART

Wellington Management Co.

During a trip to China last December, Wellington Management Co.'s Harriet (Tee) Taggart paid the requisite visit to Beijing. But the chemicals analyst was much more eager to see Tianjin (formerly Tientsin), a small industrial town 85 miles southeast of the capital where China is feverishly building its first mainland deepwater port.

Her side trip allowed the four-time Best of the Buy Side stalwart to get a firsthand look at the port and nearby projects, including a Dow Chemical Co. plant. Taggart, 55, says that, long term, many of the 600 chemicals and environmental services companies she tracks will have to develop substantial Chinese manufacturing operations to survive global competition. This month she heads back to Tianjin to check on progress.

Trekking thousands of miles to get an up close view of what her companies are -- or, in some cases, are not -- up to is the sort of intrepid, forward-looking research for which Taggart is known. The analyst, who co-manages Wellington’s global materials sector fund, tracks so many companies (200 closely) that she’s broken them down into 30 key product clusters -- from flavors and fragrances to agrichemicals -- rather than into industries. “We try to understand which are the best producers of those products,” says the Smith College grad. “Much of our stock selection is a distillation from that.”

Taggart excels at finding long-term opportunities in short-term disruptions. In November 2002 she recommended Cleveland-based OM Group, a small-cap producer of metal-based specialty chemicals. A month earlier, OM had shocked investors by announcing a major restructuring; the shares dove from 31 to 9 in one day. When the stock proceeded to plunge to 4, Taggart pounced. The bargain price didn’t reflect OM’s strong franchise in metals like cobalt and nickel, she says. “We try to invest in things when the world hates them,” she notes. In mid-October the stock was at 17.

Taggart, who is celebrating her 21st year at Wellington, is so knowledgeable about her stocks that some Wall Street analysts find her intimidating. “It’s a challenge finding value-added information for her,” admits one sell-side researcher.

Media

HENRY ELLENBOGEN

T. Rowe Price Associates

Henry Ellenbogen is “remarkable in a number of spheres,” says a sell-side analyst of the T. Rowe Price Associates media researcher. “Quantitative, strategic, a Rolodex of contacts -- Ellenbogen has got the complete package.”

The 30-year-old, who holds undergraduate, business and law degrees from Harvard University, isn’t a bad stock picker either. Last year he scrounged among the rubble of interactive media and distribution companies for long-term prospects.

“The market was so focused on the short term that if the story was complex or the growth not obvious, there were opportunities,” explains Ellenbogen, a newcomer to the Best of the Buy Side.

The analyst, who describes himself as a “thematic” investor, covers approximately 50 companies and maintains positions in roughly 20 of them. In addition to advising the firm’s portfolio managers, T. Rowe Price researchers run the $71 million Capital Opportunity Fund.

One of his biggest bets to date: Yahoo!. When Ellenbogen started buying the Internet portal’s shares in October 2002, they had shriveled from nearly 240 in January 2000 to less than 10. But he points out that Yahoo!'s chief, Terry Semel, has persuaded well-established companies to advertise on the service, even as he has reduced the company’s dependence on online advertising by building subscription and sponsorship businesses. Semel has also imposed discipline on sales. In mid-October, Yahoo! shares, bolstered by a surge in revenue at the company, hit 41.

Another Ellenbogen winner is satellite television company EchoStar Communications Corp., whose failed bid to buy the Hughes Electronics Corp. subsidiary of General Motors Corp. in October 2001 (Institutional Investor, March 2002) raised doubts about whether EchoStar could increase cash flow.

Convinced that the company’s satellite distribution system could compete against cable and that investors did not appreciate EchoStar’s substantial cost advantage, Ellenbogen started buying the shares in October 2002 at 17. One year later EchoStar had more than doubled to 40.

The Miami Beach native brings something of an insider’s perspective to regulation-dependent businesses like satellite TV. Before joining T. Rowe Price three years ago, Ellenbogen served as chief of staff for Representative Peter Deutsch, a Florida Democrat who serves on a House subcommittee on telecommunications and the Internet.

Telecommunications

P. ROBERT BARTOLO

T. Rowe Price Associates

Barely a month after he joined T. Rowe Price Associates in August 2002, P. Robert Bartolo brashly decided to buck the bearish consensus and buy wireless telecommunications service companies. The 31-year-old Las Vegas native made two companies that investors had given up for dead -- Nextel Communications and Western Wireless Corp. -- his primary picks to play the upturn that he (though few others) foresaw. By mid-October 2003 Nextel had soared 200 percent and Western nearly 600 percent. Wireless stocks generally were up more than 100 percent.

“Bartolo just nailed it,” says a sell-side researcher. “There’s not a lot of people who had the guts to go long on wireless, but he was not just right in terms of exposure, he was also right in how to have that exposure. He was fundamental and counterconsensus at the same time.”

Bartolo, a University of Southern California grad who holds an MBA from the Wharton School of the University of Pennsylvania, points out that wireless service providers were “gradually growing revenues, minutes of use and customers, while the opposite was happening at wireline companies.” Moreover, as far as the analyst was concerned, investors’ aversion to Nextel in particular was an argument in the company’s favor.

“People love to hate Nextel,” he muses. “They say it’s got an oddball technology with no upgrade path, but that’s what I liked about it.” The company has developed a walkie-talkie, or push-to-talk, feature that rivals are just starting to emulate as well as a solid base of business users, says the first-time selection to the Best of the Buy Side. Still, Nextel’s heavily indebted international unit had gone into bankruptcy the previous May (see CEO Interview), spooking many investors. Bartolo, however, knew that the debtors of the separately capitalized subsidiary had no claim on Nextel, so he started buying the shares at 7 in September 2002. This October, with the international group out of bankruptcy, the stock hit 22.

Western Wireless, which serves rural areas in 19 western states under the CellularOne and Western Wireless brands, was an even bolder choice. Speculation was rife that the debt-choked telecom would have to declare bankruptcy, and its shares were trading at less than 3 last September, down from a high above 72 in January 2000. Bartolo, though, saw promise in Western’s international operations: Although still unprofitable, they were rapidly adding subscribers everywhere from Bolivia to Côte d’Ivoire to Haiti to Ireland to Slovenia. Better overseas performance in fact helped push Western shares to a gratifying 20 this October.

Energy

DENIS WALSH

State Street Research & Management Co.

State Street Research & Management Co.'s Denis Walsh has spent 17 years traveling to oil rigs, coal mines and natural gas facilities around the world. Perhaps that explains why the 43-year-old analyst has what one brokerage firm researcher calls a “360-degree grasp of what’s going on in his industry.” Walsh, adds this sell-side analyst, has “an incredible understanding of the interactions of different fuels and is well plugged in to all the forces that influence energy stocks.”

Unlike many of his Wall Street counterparts, who track energy sectors, Walsh follows the entire energy group. (He also manages the energy portion of State Street’s $41 million Large-Cap Analyst Fund.) He has supplemented his coverage of 35 to 40 companies by adding electrical utilities. “I take an integrated approach,” he explains.

The four-time member of the Best of the Buy Side has been pursuing a macro theme: Walsh believes that existing coal, nuclear and hydroelectric plants won’t be able to keep pace with U.S. electrical demand. Thus, he has been recommending the beneficiaries of this energy shortfall. His coal-company picks -- Arch Coal, Consol Energy, Massey Energy Co. and Peabody Energy Corp. -- have risen an average of 97 percent in the past 12 months, nearly four times the Standard & Poor’s 500 index’s 24 percent gain.

The University of Massachusetts grad, who holds a master’s in finance from Boston College, is a nimble value investor. Newfield Exploration Co. has acquired properties in Oklahoma and Texas that will double its reserve life, yet it was trading at a discount to its peers on an enterprise-value-to-cash-flow basis when Walsh bought it at 32 in January. The stock hit 40 in October, and he expects it to reach 50 in six to nine months.

Consumer

ERIK MACE

Credit Suisse Asset Management

He considered law school, but Erik Mace worried that a legal career would bore him. So in 1994 the University of Virginia graduate took a research job at PaineWebber in New York. “I was intrigued by the dynamics of this industry,” says Mace, now a retailing analyst at Credit Suisse Asset Management. “You learn every day, and your job changes daily.”

Mace has risen to the top of buy-side researchers (this is his first year on the team) by fashioning an exacting analytical approach to 30 mid- and large-cap retailers. “He’s very methodical, focuses on the numbers and does his own models,” says one brokerage firm analyst.

A six-year veteran of the retail sector, Mace, 34, earned an MBA at Columbia Business School in 1996 after his two-year stint at PaineWebber and then joined Warburg Pincus Asset Management (which was acquired by CSAM in 1999). In his analyses he pays particular heed to return on investment and cash flows, reflecting the capital-intensive nature of retailing. And if the numbers offer a compelling enough case, Mace will challenge conventional wisdom. “He doesn’t get caught up in the market’s prejudices,” says one brokerage analyst.

Mace knew that investors were skittish about uneven sales at Abercrombie & Fitch Co. The retailer, which once outfitted Ernest Hemingway in safari clothes but now sells oversize sweatshirts to Generation Y’ers, was set back by unseasonably warm weather, among other things. But Mace believed that investors were overlooking the contributions of the retailer’s 112-store Hollister Co. chain, which caters to 14- to 18-year-olds. “He concluded that Hollister was an emerging growth division,” says a sell-side researcher. Last December, Mace urged CSAM portfolio managers to buy A&F: By mid-October the stock, buoyed by strong sales at Hollister, had jumped 42 percent.

Financial Institutions

BRIAN ROHMAN

Weiss, Peck & Greer

“The past is more prologue than you think,” contends Brian Rohman, a financial services specialist at Weiss, Peck & Greer. The 43-year-old researcher believes that companies that over time have created value -- and higher share prices -- are the most likely candidates to succeed in the future. Thanks to his faith in the relevance of historical performance, Rohman, says one brokerage firm analyst, “doesn’t get caught up in short-term trends.” Nor does he hesitate to buck the consensus.

Rohman demonstrated the strength of his convictions in February when he recommended Countrywide Financial Corp., a Calabasas, Californiabased mortgage giant, at 55. Many investors thought Countrywide’s earnings and share price would crumble as record-low interest rates rose, slowing frenetic mortgage refinancing. However, the second-time Best of the Buy Sider trusted history -- and the quietly spectacular rise in the mortgage company’s share price from 2 in 1990.

Unlike many investors, Rohman fully appreciated that fees from Countrywide’s $606 billion mortgage-servicing portfolio -- which tend to rise as originations decline -- would act as a hedge if refinancing volume dropped, buttressing earnings per share. What’s more, Countrywide CEO Angelo Mozilo had wrested market share from rivals. Despite a drop in mortgage production, Countrywide was trading in mid-October at 95. Rohman’s hedging thesis, however, awaits a stress test, as refinancing activity recovered.

Although he prefers proven performers, Rohman, who contributes ideas to two WPG financial services funds, also works relentlessly to uncover cheap stocks -- many of them little known. His talisman: a rising return on equity or, for banks and thrifts, on assets. A Wall Street researcher admires Rohman’s diligence in “combing the country looking for small, underappreciated banks.” The buy-side analyst estimates that he chats with the managers of more than 200 companies a year. “I never met a company I didn’t want to meet,” he jokes.

A meeting last year prompted him to recommend Meadowbrook Insurance Group, a Southfield, Michiganbased workers’ compensation specialist that had been hurt by a high claims rate and a couple of bad reinsurance decisions. Meadowbrook shares had tumbled from a 1998 high of 32 to 3 in mid-2002. A cheap price, new management and a replenished capital base persuaded Rohman to back the stock (and he bought more when it dipped that November). In mid-October 2003, Meadowbrook was trading at above 4.

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