Tuesday, October 24, 2006

The Pigs Are Flying

When you look into the portfolios of almost any large mutual funds, you will likely see Johnson and Johnson, Coca-Cola, and Wal-Mart. They will be present, but in many cases, they will be significantly under-owned in relationship to their representation in the S&P 500. This is what I call benign neglect; the manager really does not like the stocks but owns them in some small measure -- just in case. Just in case, their fortunes change and their prices begin to rise, which, in the mind of the manager, will be about the same time that pigs fly. The question might be asked: why do the managers even bother with these exercises in benign neglect? The answer is simple, even though the aforementioned companies are often a drag on performance, they look good in the annual report; they denote a conservative philosophy, and a respect for companies that have stood the test of time -- in some instances, even a bold contrary view. There is always the thought in the manager's mind that he or she can quickly raise the weighting of an under-owned company, when, as, and if it gets its act together. The reality is different. Because the manager may have 300-500 stocks in his or her portfolio, the under-owned big cap stocks fall off the radar screen because the manager thinks he or she knows them. One day Mr. or Mrs. Portfolio Manager wakes up and realizes that they don't know the benignly neglected companies at all. That is what has happened for JNJ, KO, and WMT in recent days, and sure enough, the pigs took flight. There is another well-honed exercise on Wall Street. It is called flying pig catching. This happens when the neglected stocks come to life and Mr. or Mrs. Portfolio manager engages in a pitched battle to buy the stocks competing against the like-minded crowd that is trying to cover their shorts. It is a beautiful sight if you own the stocks when this happens. Johnson and Johnson, Coke, and Wal-Mart have all reported strong earnings, or earnings guidance in recent days. The market has rewarded all three with sharply higher prices. I have discussed in previous blogs that these companies were undervalued and that their businesses were improving. In addition, our models show that all three are still undervalued, even after their recent spikes. There is another thing about flying pigs that Mr. and Mrs. Portfolio Manager know all too well: They can fly higher and farther than a rational person would think possible. The link to Yahoo shows the last 12 months prices for all three stocks and the recent spikes higher. Yahoo Charts Clients and employees of Donaldson Capital may own one or all three of these stocks, depending on their investment styles. This site is for information purposes only. Do not use it to make investment decisions based on what you have read here. If you are not a client of DCM, please consult your own financial advisor.