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Following bad news
Managers finding value amidst devastation

I have to admit that last year, when stock market indexes were suffering as a result of the then one-year-old "tech wreck", I wasn't all that enthusiastic about the prospects for a market rebound. While some were attempting to call for a turnaround, I (along with many others much brighter than me) pointed to the persistence of very high stock valuations and a sluggish economy. Today I'm whistling a slightly different tune. No, I'm not wearing my bull horns, but I'm hearing more and more from managers who are starting to put their cash to work in attractively valued stocks.

Telecommunications

Just six investment funds focusing on telecommunications companies have been in existence for a full three years to the end of June. The best performer of that group has generated an average annual compound loss of 11 per cent annually. That's not a typo. As the time period shrinks, the losses grow. For the first six months of this year, the median telecom fund shed fully 38 per cent of its value.

It's been an ugly sector to be sure. How about putting some money into it - interested?

Value managers putting cash to work

Maybe you should be, because many of the industry's best money managers are doing a bit of bottom fishing - some of it in the telecom sector.

And not just any managers, but those that employ the style that I've repeatedly espoused in this space: value managers.

George Morgan, lead manager of the Templeton Growth Fund Ltd., said this week at the fund's annual meeting that he's been actively buying stocks. Morgan quipped that "[stock] bargains are plentiful" and that he's finding far more value now than he has in years. SBC Communications and Nortel Networks are two of the telecom stocks that have grabbed Morgan's attention lately.

He's not alone.

Chris Richey, lead manager of the new Brandes Global Equity fund, confirmed in a recent interview that he also bought some of Nortel's recent debt and stock offering for his firm's clients. In fact, the fund he was managing until a few weeks ago - AGF International Value - had about 19 per cent of its assets in the telecom sector.

Tim McElvaine - lead manager of Cundill Value fund - has been building positions in many beaten up telecom stocks. While McElvaine's definition of "telecom" is broader than most (i.e. radio, TV, other media and communications), his 30 per cent weighting in these industries remains a striking figure. McElvaine has entered the telecom sector in a more opportunistic fashion. He owns bonds of distressed companies such as Liberty Media and IDT; but he also owns stock in companies like VSNL - a major Indian telecom firm with substantial institutional and government ownership.

Telecom and the Oracle

Perhaps most surprising is the fact that Warren Buffett's holding company, Berkshire Hathaway, recently bought a block of convertible bonds issued by Level 3 Communications . It's surprising because Buffett has said in the past that he won't invest in an idea he can't illustrate with a crayon. In other words, a business' basic raison d'jtre should be easy to understand. This led many to believe (including me) that technology was taboo for Buffett - an investing legend known as the Oracle of Omaha. It's also interesting to note that Level 3 CEO, Walter Scott is a friend of Mr. Buffett's and occupies a seat on the board of Berkshire Hathaway.

Fortune magazine ran a great article on Buffett's investment in Level 3.

Value managers and bad news

It's important to note that none of these managers is saying that the telecommunications sector is about to embark on another bull ride. Value managers typically look for investment ideas on a stock-by-stock basis; not because they think a particular industry is attractive.

The examples noted above simply illustrate that managers are finding many individual stocks that they see as good opportunities. Sure, the sector will eventually see better times, but these managers are not counting on a return to a 1999-like telecom boom.

Since the goal of the value manager is to pick up stocks at bargain basement prices, it sometimes means that bad news must be followed. Hence, it's important to understand that following bad news usually means getting into a stock before it has bottomed.

Particularly for two of the managers noted above, Chris Richey and Tim McElvaine, following bad news is one of their favourite ways of finding good investment ideas. In the telecom context, both would likely admit that many stocks are seeing their prices taking a beating for good reason. But the hunt for the relatively few stocks that are being unduly punished is too tempting for these bargain hunters to resist.

This article shouldn't be taken as an endorsement of any of the stocks mentioned or of the theory that telecom will come booming back. Rather, my point was to illustrate that value managers are finally starting to find good value among many different sectors - even those whose futures seem the dimmest.

Frankly, that's something I haven't heard them say in some time.

With all of the bad news that peppers the daily headlines, today seems like a good time to put some money to work - particularly with one of the fine money managers profiled above.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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