Download Newsletter for Investors Large blue chip growth stocks

October 2006
Newsletter for Investors
Large blue chip growth stocks soon the asset of choice?
As of this writing the Dow Jones Industrial
Average (DJIA) is climbing to new all-time highs.
Having gone full circle from technology stocks
to bonds to real estate to commodities, investors
are asking if it is finally time for large cap growth
stocks to shine. We think the answer is yes and the
reasons are plentiful and based on common sense.
First, the economy is clearly slowing. We have
written about the unsustainable boom in housing
Kornitzer’s Corner
The famous investor Benard Baruch once said,
“never follow the crowd, it is so simple, but so
difficult to do”.
My advice to clients is to make a copy of this
quote and always refer to it when you are about
to make an important investment decision. Far
too often individual investors get emotional about
their investments at exactly the wrong time. We
have seen and written about phenomenon such
as the internet bubble of 1999-2000 and more
recently the residential real estate bubble. In
each case, they turned into bubbles because too
many late-to-the-game investors simply followed
the crowd.
When any investment idea becomes the main
topic of discussion at cocktail parties, the
barbershop or with your plumber – it is not
likely the time to be following the crowd! This
is simple advice, but will serve you well in the
future.
John C. Kornitzer
President
in past newsletters. The Federal Reserve was
clearly intent on slowing activity and inflation in
housing and recent data suggests they have been
successful. New orders and prices for homes
have weakened materially across the country
(plunging in the hottest markets). Construction
activity and employment related to housing will
likely show a considerable decline in coming
months. The slowdown in housing (combined
with high energy prices) has had a negative effect
on overall consumer confidence, particularly
for big ticket items such as automobiles, boats
etc.. In turn, this has cooled investor’s love
affair with commodities and other deeply
cyclical stocks. This may be only a temporary
correction for some commodities that have been
fueled by global demand (such as oil), as the
outlook for global GDP growth still looks very
healthy. However, it appears reasonable that in
the medium term investors may begin to pay
higher valuations for companies with a bit more
certainty of growth. By more certainty, we mean
those companies that should still be able to grow
earnings in the face of a slowing economy and
whose fortunes are not tied to price inflation
for their underlying products. In general, this
should favor certain large cap growth companies.
Next, the recent decline in interest rates has
very positive implications for the relative
attractiveness of large cap growth stocks. They
appear attractive on a traditional valuation basis
such as price-to-earnings ratio (P/E) relative to
interest rates. Also, they look attractive from
an after-tax yield standpoint relative to CDs,
treasury bills and bonds. Below is a sample list
of traditional growth or growth at a reasonable
price (GARP) names that are part of the DJIA 30
stock index. They are incorporated into a table
Continued on page 2
that provides valuation (P/E), dividend yield and expected earnings growth for each company and for the
group as a whole.
Relative Performance by Style
Table 1
Company
3M
American Express
Altria
AIG
Citigroup
Coca Cola
Disney
General Electric
Hewlett Packard
Home Depot
Honeywell
Intel
IBM
Johnson & Johnson
J.P. Morgan
McDonalds
Merck
Microsoft
Pfizer
Procter & Gamble
United Technologies
Walmart
Average
*NTM P/E
15.9
18.0
14.0
11.3
11.6
18.3
18.9
16.0
15.6
12.1
15.8
20.1
13.6
17.1
12.7
16.8
20.0
19.4
14.2
21.1
16.8
16.1
16.2
* NTM- Next Twelve Months
We should note that we are not recommending the
purchase of these individual stocks or the group
as a whole, but that this group of names is simply
being used as an example. To support our case on
valuation we would point to former Fed Chairman
Alan Greenspan’s rule-of thumb for P/E ratios. His
formula was to calculate the inverse of the 10-year
treasury yield as a reasonable guide for the P/E of
the S&P 500 stock index. The basis for this formula
was that it equated the earnings yield on stocks with
the earnings yield on longer-term bonds. Today,
this formula (1/10yr treasury yield) would equate
to a suggested fair value P/E ratio of 21.9x. As seen
2
Dividend Yield
2.5%
1.1
4.5
1.0
3.9
2.8
0.9
2.8
0.9
1.6
2.2
1.5
1.5
2.3
2.8
2.5
3.6
1.5
3.4
2.0
1.6
1.4
2.2%
NTM Earnings Growth
8.3%
13.4
4.8
8.8
6.8
8.0
11.5
14.0
18.0
5.8
15.1
9.0
6.1
9.1
12.3
6.8
0
13.4
6.5
12.4
14.5
11.2
9.8%
Source:FACTSET
above in table 1, this sample of large cap growth
names are trading at a next 12 months (NTM) P/E
of 16.2x. Based on his model, this valuation looks
very reasonable relative to interest rates. Due to
the threat of terrorism and given the uncertainty
factor for earnings, the market P/E probably should
probably trade at a discount to Greenspan’s model.
However, the current discount appears unduly
large, particularly for a group of companies that
should be able to grow earnings faster than the
S&P 500 in a slowing economy.
Continued on page 3
From an after-tax income standpoint these stocks
appear to be a good long-term value as well. As
seen in Table 1, the average dividend yield on this
sample of stocks is 2.2%. Given the current tax rate
on dividends of 15%, this represents an after-tax
yield of 1.87%. Assuming dividend growth of 7%
annually (slightly lower than earnings growth), the
effective after-tax yield would grow to 2.62% in 5
years. This would compare to an after-tax yield on
5-year treasuries or CDs of 2.7% (4.5% taxed at
federal and state combined average rate of 40%).
Thus, in 5 years you would have roughly the same
income yield from growth stocks as for bonds or
CDs. The advantage of owning the growth stocks
would be continued dividend and yield (and stock
price or principal) growth versus the uncertainty of
Table 2
Index
Style
Cum. Performance
12/00-9/06
Russell Top 200
Growth
Large Cap Growth
-16.32%
Russell Top 200
Value
Large Cap Value
+27.52
Russell Mid Cap
Growth
Mid Cap Growth
+9.69
Russell Mid Cap
Growth
Mid Cap Value
+93.82
Russell 2000
Growth
Small Cap Growth
+11.16
Russell 2000 Value
Small Cap Value
+112.82
Source: Russell & Co
Congratulations!
We are pleased to announce that Jeff Deardorff,
Paul Dlugosch, Nicole Kornitzer, and Frank Wei
have each passed all three levels of the Chartered
Financial Analyst (CFA) program. Final awards
of their CFA charters are pending CFA Institute
approval. Our entire staff of research analysts,
traders, and portfolio managers now have CFA
charters. To earn the CFA charter, candidates
must sequentially pass three six-hour exams that
are widely considered to be the most rigorous in
the investment profession. Since the first exam
was given in 1963, the average global pass rates
are 47 percent for Level 1, 52 percent for Level
II, and 68 percent for Level III.
the level of interest rates for reinvestment in treasury
bonds or CDs in 5 years.
Finally, large cap growth stocks have been out of
favor for a lengthy period, with value stocks well
out-pacing growth. Additionally, small and medium
sized companies have materially outpaced large
companies as well. Table 2 provides a picture
of the relative performance among the various
groups. Historically, out-performance and underperformance between growth and value, and large
and small have run in cycles. What we are pointing
out is the recent period of under-performance by
large cap growth has been long and deep. Over time
this will change and we think it will happen sooner
rather than later.
Kicking the Tires...
We have been traveling and meeting with the
management of many of the companies we’re
invested in this quarter. During times of shortterm uncertainty it always helps “to kick the
tires” one more time, to help separate Wall Street
chatter from reality. This level of due diligence
and in-depth research on our companies gives
us the level of conviction needed to buy when
others are panicking. We were asked recently why
company management teams are so willing to
meet with us. We believe company managements
are willing to spend time with us because of
our long term orientation. They view us more
as partners, not speculators or traders, and they
know that once we invest we keep our holdings
for a long time.
Kornitzer Capital Management and Buffalo
Funds Recognition
We have been very fortunate to receive a
number of press mentions lately. In the third
quarter alone, The Buffalo Funds were written
up in the Wall Street Journal, Forbes, Kiplingers
and USA Today, and shortly after quarter end
we were the topic of a nice article in Investor’s
Business Daily.
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Kornitzer Private Client Services
The Kornitzer Private Client Services (KPCS) group is dedicated to providing personalized
investment solutions for its clients. The group adheres to a strict discipline of prudently investing
each client’s assets in a customized, diversified portfolio of securities offering attractive risk/reward
profiles.
*Professionals working together on your distinct portfolio.
•Determining your goals and objectives
•Designing your strategy
•Working as a team with trust companies, custodians, administrators, estate planners and
banks to ensure a smooth process
*Strategy implementation
•Dedicated Value and Growth teams
•Proprietary in-house research
•Team based investment management
•Continuously monitor investments
*Results
•Solid long-term performance track record
•Tax efficient
•Competitive fees
Contact Information
Kornitzer Capital Management
P.O. Box 877
Shawnee Mission, KS 66201-0877
(913) 677-7778
John C. Kornitzer, President, Portfolio Mgr.
Kent W. Gasaway, Portfolio Mgr.
Robert J. Male, Portfolio Mgr.
Grant Sarris, Portfolio Mgr.
Bill Kornitzer, Portfolio Mgr.
Clay Brethour, Portfolio Mgr., Research Analyst
Dave Carlsen, Portfolio Mgr., Research Analyst
Jeff Sitzmann, Research Analyst
Elizabeth Jones, Portfolio Mgr., Research Analyst
Jeff John, Research Analyst
Patrick D. Cubbage, Equity Trader
Jeff Deardorff, Fixed Income Trader
Dwight Twillman, Relationship Manager
Jeff Ream, Relationship Manager
Chris Nelson, Relationship Manager
Nicole Kornitzer, Research Analyst
Alex Hancock, Research Analyst
Paul Dlugosch, Research Analyst
John Bichelmeyer, Portfolio Mgr.
913/384-4339
913/384-1513
913/384-5733
913/754-1512
913/754-1537
913/754-1510
913/754-1509
913/754-1532
913/754-1508
913/754-1507
913/754-1527
913/754-1526
913/754-1506
913/754-1505
913/754-1543
913/754-1528
913/754-1531
913/754-1529
913/754-1544
Brad Miller, Portfolio Mgr.
John Shepley, Portfolio Mgr.
Vern Cushenbery, Research Analyst
Scott Moore, Research Analyst
David Levenhagen, Research Analyst
Feng (Frank) Wei, Research Analyst
913/754-1535
913/754-1540
913/647-2307
913/647-2303
913/754-1542
913/647-2314
Susan E. McElwain, Director of Operations
Denise Minet, Staff Accountant
Stephanie Snyder, Staff Accountant
Kristi Misejka, Staff Accountant
Lisa Adair, Staff Accountant
Monica May, Staff Accountant
Kathi Brink, Staff Accountant
Jackie Albertson, Administrative Asst.
Sarah Hodges, Administrative Asst.
Kelli Manson, Administrative Asst.
Shauna Rice, Administrative Asst.
James T. Dore, Systems Administrator
Barry Koster, Chief Financial/Compliance Officer
Sharon Weaver, Marketing Coordinator
Heidi Welch, Advisor Liaison
913/384-6254
913/384-6956
913/384-4315
913/754-1519
913/754-1523
913/754-1521
913/754-1522
913/677-7778
913/754-1524
913/754-1534
913/677-7778
913/754-1511
913/754-1533
913/754-1501
913/754-1525
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