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2/4/2013 11:35:00 PM
The market has played into John Hancock Large Cap Equity Fund's hands in the past 12 months and most other periods by bidding up high-quality stocks the fund bought at favorable prices.
The $1.6 billion fund aims to buy stocks when they are trading at 70 cents or less of what the fund's managers judge as intrinsic value.
That approach has been working well. The fund gained 20.78% in the 12 months ended Jan. 31. Its large-cap growth rivals tracked by Morningstar Inc. averaged 13.70%. The fund topped 96% of them. The S&P 500 gained 16.78%.
Co-manager Sandy Sanders, 40, discussed the approach he and colleague Walter McCormick take from his office in Boston.
IBD: You look for companies with sprained ankles, but no career-ending injuries, right?
Sanders: Correct. We focus on high-quality companies with sustainable competitive advantages, which are going through some temporary fundamental issues. What we look to avoid is something structural that is changing a business for the worse.
IBD: What's an example, please?
Sanders: We ownedStaples ( SPLS ) several years ago. But as we identified structural change in their industry, we noticed a decrease in paper usage for (potential customers') white collar employees. More people are doing stuff electronically. They are sending emails and so on, so they're using less paper. That's a structural change that can hurt Staples. So we sold the stock.
Whereas a company likeCBS ( CBS ) a few years ago was going through a cyclical period of weak advertising during the financial crisis of 2009. The stock sold below our bear-case scenario value. But it was only a cyclical setback. The business came back in 2009 and after that. We sold it when it got to our base-case value.
IBD: The fund aims for companies with above-average earnings growth. Yet it looks for temporarily fallen angels. Is this a growth or a value portfolio?
Sanders: If you look at our Morningstar box, we are in the large-cap core style box. We're tilted slightly toward growth. But we're still a core fund.
IBD: About 52% of your portfolio was growth stocks as of Nov. 30. Another 24% was value. The balance were blend stocks. When does that work best?
Sanders: In a recovering economy, the companies that will have faster revenue growth are the ones that we believe have strongest potential. But we approach stock picking bottom up, on a name by name basis.
IBD: You and Walter McCormick took the helm in December 2011. Has the fund had a growth tilt during your entire tenure?
Sanders: Yes, it's been tilted that way since then. It was already tilted toward growth, but it had higher positions in energy that we changed out.
IBD: The market did well in 2012. But it was volatile. Did that volatility push names into discount territory for you?
Sanders: Yes, in 2012 we had multiple opportunities to use volatility to buy high-quality companies at big discounts to our base-case values. In a few cases we were able to buy stocks at 50 to 55 cents on the dollar, the dollar being our base-case valuation -- our version of intrinsic value.
One example was when we stepped up our position inJPMorgan ( JPM ) near 34 after the London Whale news (about a JPMorgan trader based in England, nicknamed the London Whale, who incurred a multibillion-dollar loss with botched bets on an index of credit derivatives). That level was near the 55 cents on the dollar range.
IBD: Goldman Sachs' ( GS ) earnings per share grew in the two most recent quarters after nine stanzas of declines. What's finally driving this stock?
Sanders: Goldman is a dominant franchise within the capital markets space. It trades at just above tangible book value, so its competitive advantage is its people. They tend to be some of the most talented and competitive in the industry. The company also has global distribution for debt and equity issuance.
So they are in emerging markets, they are in the BRICs countries (Brazil, Russia, India and China). And as those countries develop and issue new debt and equities, they are there to collect a fee. They have a strong brand.
So their growth driver is the recovering capital markets, volumes and transactions.
With the stock selling around 70 cents on the dollar but with the global economy recovering, this is an investment we believe is very attractive.
IBD: You've got several financial names. T.Rowe Price ( TROW ) sold off sharply when it reported earnings per share growth of 21%, slowing from 32% in the prior quarter, though it's since recovered to a new all-time high. You've trimmed your stake in your Dec. 31 disclosure and the three quarterly reports before that. What's your take there?
Sanders: Like Goldman Sachs, one of their competitive advantages is their people. They have a performance driven culture and a strong brand name. That's meaningful, especially in the 401(k) and retirement space.
Their scale lets them offer competitive fees.
They haven't done as well asAmazon (AMZN) or Goldman, but the company is in a good position for continued growth as the capital markets recover.
IBD: JPMorgan Chase ( JPM ) also appears to be in rebound mode. EPS grew 37% and 54% after declining for three quarters. Is this another capital markets recovery story?
Sanders: Yes, this company is in a good position to benefit from the recovery in U.S. and global economies.
Like Goldman, they have global distribution and a strong brand. They're also a top player in mergers and acquisitions.
As I mentioned, they stubbed their toe last year with a trading loss that was widely publicized.
We bought shares at 34. The numbers were implying negative 2% annual revenue growth for each of the next six years, and only a modest 4% return on equity.
Our base-case scenario saw revenue growing at 4% a year and 10% ROE. That discounts the stock closer to 60 a share. And we recently revised our target price higher based on good performance.
IBD: When did you open your stake inMorgan Stanley (MS)?
Sanders: We bought it in mid-2012 when the stock was around 14. That price assumed negative revenue growth and no improvement in ROE. We believed the opposite would happen: midsingle-digit growth and low single-digit ROE.
It's selling at a worst-case scenario. But its business fundamentals are getting better, not worse.
IBD: You mentioned Amazon. It has eight quarters of declining earnings. Why do you still like it?
Sanders: They have a unique competitive position. They dominate e-commerce through three things: lowest prices, widest selection and best convenience.
E-commerce penetration is less than 8% globally. We believe this will double in the next decade. That will lead to an increase in their scale and efficiency, improving their profitability, margins and cash flow. And this stock is selling at an attractive valuation based on a base case.
IBD: Lennar (LEN) has roughly doubled in the past 12 months. It's a play on the housing recovery. So why did you trim your stake as of Dec. 31 and in two of the three disclosures before that?
Sanders: Lennar is highly diversified across the U.S. It is not heavily exposed to real problem areas. It has heavy insider ownership. And it has a better balance sheet than many of its competitors. But its valuation has come up, so we pulled back.
IBD: Qualcomm (QCOM) stock has been up and down. You've trimmed as of Dec. 31 and the three prior disclosures. Why?
Sanders: This company is exceptionally positioned to benefit from the trend toward mobile devices. They collect a royalty on every smartphone that uses their technology.
And they invest those royalties in developing the next generation of innovations.
It's selling at near 70 cents on the dollar, so it has an attractive valuation.
We believe smartphones have about 25% penetration of the world population. We believe that will triple in the coming decade.
So why have we trimmed? Our position size got quite large. It got close to 6%, so we moved that down. We were controlling risk. It's not a reflection on our confidence in the business or management team.
IBD: Google (GOOG) gapped up 6% after reporting 12% quarterly EPS growth. Investors hated the prior quarter's 7% decline.
Sanders: Google is taking share from offline advertising. And the other driver is the move to mobile. They have done an exceptional job with the Android operating system.
It's a strong competitor toApple (AAPL), but more open and adaptable to each manufacturer's needs. The stock is attractively valued and we continue to own it.