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Opening

GEOFF COLVIN: In the parallel universe that is Washington, D.C., the Senate last night passed a distinctly odd version of President Bush's proposed tax cut. Forget the details - they'll change in the conference committee - but to understand how weird it all was, listen to these reactions from legislators and economists:

• It "set a new standard for gimmicks"
• "No one thinks that's a good idea"
• "An incredibly bad idea"
• "One of the most incredibly absurd tax policies ever proposed"

Contents » Opening » Market summary » Roundtable: Tech investing » Fund Manager pay » Chris Lahiji interview » Brancaccio conversation

Of course there's nothing strange about criticizing a tax bill. What's so bizarre is that all those quotations came from the bill's supporters. Most senators were apparently glad to have passed any bill, but as one said afterward, in a quote you'll never see in a civics textbook, "I realize that in the Senate our standards of success are a bit lower than in other places."

Lower taxes mean higher deficits, at least near-term, and that's supposed to push interest rates up. Instead rates dropped this week to a historic 45-year low. Enjoy it while you can - the stock market did. Karen will be at the round table talking about a sector that's doing great, though you swore you'd never let yourself even think about it again.

We'll also look at some normally secret numbers - what mutual fund managers get paid. I'll talk with a 19-year-old stock picker who's been reading annual reports 14 hours a day for the past year - his stock picks are doing pretty well. And we'll have some fun chatting with David Brancaccio.

Karen, investors finally had a little fun this week - what happened?

Market summary

KAREN GIBBS: Geoff, don't look now but we may be in the midst of a stealth bull market.

In the face of some weak economic numbers, the stock market has managed to rally for the third week in a row, while interest rates have fallen to Eisenhower-era levels.

So what's going on? In a word, technology!

The Dow adding over 74 points this week, with IBM morphing from beaten-down to one of the best-performing blue chips this year.

The Nasdaq picking up nearly 20 points and outpacing the other market averages on the year as it appears that technology has exploded once again.

Just look at the S&P, Internet commerce boosting the index by 10 points this week alone.

All the Morningstar-style boxes made money this week, with mid-cap value beating mid-cap growth by a fraction.

So, does this mean that techonology has regined its special status? and more importantly, is it still a growth industry?

Tech investing roundtable

KAREN GIBBS: In the early 1990s, Jonathan Cohen was considered to be one of the best Internet analysts on Wall Street. Then at the height of irrational exuberance, Cohen was neither irrational enough nor exuberant enough for his employer Merrill Lynch. Exit Cohen, enter Henry Blodgett. And the rest, they say, is history. Blodgett now spends his days fending off prosecutors and regulators, while Cohen has quietly become a top money manager, picking through the rubble of busted Internet companies to lead his Royce Technology Fund to a terrific 28 percent increase. He joins us from Stamford, Connecticut.

In our studio, Bill Whyman, a technology strategist who was fed up with the conflicts he saw among Wall Street analysts, so he did something about it. When Eliot Spitzer was still wet behind the ears, Bill and his partners formed an independent research firm called the Precursor Group.

Also joining us, FORTUNE's man in Silicon Valley, Adam Lashinsky.

Gentlemen, welcome.

Jonathan, let me start with you. Just look at what's going on with technology right now. And in fact you see alternative telecoms, internet retailers, software, network equipment makers, they're all up like 40-50 percent. What does all this mean?

COHEN: I think it means that investors are refocusing on technology after taking a sort of multi-year break from the sector. At the same time, it does seem like we may have hit some sort of a bottom in terms of the fundamentals of the industry, broadly defined. So I think what we're seeing is sort of confluence of factors over the last several months.

GIBBS: Bill, have we been so focused on the dotcom bust that we've missed the boom?

WHYMAN: Yeah, I think that's actually true. The fundamentals in the technology sector are actually substantially improving. Corporations are spending more on technology, capacity utilization is going up, inventories are at historic low levels. So I think we're in a position to see tech return to growth after a three-year drought, actually a true depression in the technology sector.

GIBBS: Well, Bill, even looking at this e-biz boom, you see $2.6 trillion of e-business commerce, and the consumer's adding like $95 billion. What's behind all that?

WHYMAN: Well, there's always been a tremendous amount of underlying activity of volume, the way people use the Internet. The big question has been, has anyone been able to make money off of it? And there's a few good examples. But I've got to tell you, I'm still skeptical from an investment point of view in many areas. The big thing I'm looking for is subscriptions. When will someone be able to get millions of households across the United States to actually pay for a subscription, and there's very, very few examples.

GIBBS: Adam, you're in touch with a lot of savvy people out there in Silicon Valley. What are you hearing? What are they buying right now?

LASHINSKY: Well, obviously what they're buying are the e-commerce stocks. And the three biggies, if you will, Amazon, eBay and Yahoo, have exploded and are trading at valuations that are almost as silly as they were when Jonathan turned his skeptical eye on them before. What I'd add to the debate, Karen, is that you mentioned that technology has exploded. What it really is, is that it was almost like a dead man, almost a dead man lying in the street and left for dead, and it's gotten up and started walking again. That looks like a sprinter compared to lying with the blood coming out of its mouth, if you will.

GIBBS: So don't get too excited about all this movement.

LASHINSKY: Absolutely.

GIBBS: Jonathan, how about that? He mentioned Yahoo, Amazon, eBay, all making new 52-week highs. How can you tell whether they're overvalued or not?

COHEN: You can probably get a sense of whether they're overvalued or not by looking at their share prices and the share price movements relative to their fundamentals. And the bottom line is that those three companies have not seen dramatic improvements in their fundamental outlooks and their fundamental operating conditions that's in line with what their share prices have done. So I would suggest that those three largest names in that sector are probably fairly expensive. Certainly, Yahoo and Amazon, I think are getting quite expensive. eBay, you could argue has a somewhat unique business model and they have a very much higher margin business than either of the other two do.

But this is still, if you look at the Internet being very broadly defined, this is still an industry that's characterized by tremendous competition, by very low margins for most companies within this sector, and by a lot of companies not really benefitting meaningfully even as e-commerce is increasing. There are names within our portfolios that we hold that are really distinguished by the fact that they're either making money, a significant amount of money relative to their market capitalization, they've got great cash flow, or they've got a compelling proprietary technology. But you have to look fairly hard to find those sorts of names, especially at reasonable prices given the recent runup in the market.

GIBBS: Don't tease us like that. Give us some names then.

COHEN: Well, within e-commerce our largest holding is a small-cap stock called CyberSource, stock symbol CYBS. This is a company that has a proprietary technology for fraud detection and authentication for e-commerce merchants. They have a significant partnership arrangement with Visa. It's a stock that sells in the low $2.00 range. They've got well over a dollar a share in cash, a very strong management team, and I think the ability to generate meaningful cash flow in the not too distant future. And that's an example of a stock that the market doesn't really pay a lot of attention to, relative to an Amazon or an eBay or a Yahoo, but one which we've done a lot of work on and we've become pretty comfortable with. There are a handful of others in the Internet space as well. But again, the characteristic that distinguishes them tends to be proprietary technology, significant competitive advantage that we think is going to be sustainable over a long period of time.

We've been buying shares recently in a company called NetRatings, stock symbol NTRT. This is essentially the A.C. Nielsen of the Internet. It's a business that we think is going to be strong over a long period of time. It almost doesn't matter who's successful and who's unsuccessful across the Internet media sector. Advertisers are at the end of the day going to need to know how much to pay for their ad buys, and this is the dominant company in that sector. We think they're going to do quite well. And again, this is a company that's essentially trading at its cash value. We have the ability to buy the company for almost no enterprise value.

GIBBS: How interesting, Bill. He mentioned the same thing about the subscribers and ad sales, things like that.

WHYMAN: Yahoo is a traditional advertising company. They have been doing better because the overall advertising market has been improving. They've claimed that they have built enduring subscriptions with over 200 enduring relationships with over 200 million users. A good company, but I just don't buy that. They have not been able to build paying relationships with subscribers for more than a couple hundred thousand. There's 270 million people in the U.S.

RealNetworks claims that they're thrilled they now got to 1 million paying subscribers. That's not bad. But guess what? It took them three years, and that's less than one percent of all American households.

LASHINSKY: Well, Karen, I'll jump over to the other side. Being a journalist, we like to go both ways on the issues, right?

With RealNetworks, they've been trying to build their subscribers at a time when it was a tough proposition to sell people on buying music online because people were basically stealing music online. So there's an opportunity where the paradigm could be shifting for that company going forward. Because as Apple has demonstrated just over the past few weeks, people will pay for music online.

GIBBS: Well, Bill, let me talk to you about Warren Buffett. He said that he only pays for three things on the Internet: Wall Street Journal, online brokerage, and Amazon.com for books. In fact, he owns Amazon.com bonds, not stocks. Is that all there is to the Internet then?

WHYMAN: Well, I think there is more, but I think much of it is what we would call traditional technology. It's software companies. In particular, much of the Internet is software. Or there may be areas in network equipment.

But I think the number of pure-play Internet companies, like an Amazon or an eBay, you know, are far and few between. And by and large, the Internet is a set of technologies that are now being absorbed across virtually every business in America. And I think the business, the best investment opportunities created by the Internet are going to be not necessarily pure Internet stocks, but companies that leverage the Internet as a way of doing business.

GIBBS: Jonathan, what about the merger and acquisition activity? Do you think that's going to be re-ignited with consolidation?

COHEN: Oh, absolutely. I mean in technology overall, but certainly in the Internet sector and in the software sectors, as well. What we've seen over the last year or two are massive share shifts, companies that had been fairly successful, smaller and middle size software companies, are all of a sudden seeing, you know, either huge benefits or huge detriments to their business because of movements in share, and as companies get much more selective about what they're buying and who they're buying it from and much more demanding of their vendors. So I think that M&A activity is absolutely going to increase. I think it's going to increase sharply. And what we're looking for into that sort of a dynamic are opportunities to benefit from M&A activity in enterprises that are trading at very low enterprise value.

LASHINSKY: I would argue the problem is it's very hard for the individual investor to get a hold of that opportunity. Avanex, a fiber optics company, began to do a roll up recently, and JDS Uniphase's stock benefitted. But the individual investor has a very hard time getting their arms around whether or not that really means should I buy JDS Uniphase, for example, now.

COHEN: I agree, absolutely. I think that's a very difficult play for individual investors. It's maybe a little bit easier for institutional investors who just have a better flow of information.

GIBBS: Jonathan, Adam, and Bill, that's it. Thanks very much for joining us.

Fund manager pay

GEOFF COLVIN: Here's a rare look behind the veil of Wall Street pay. Did you ever wonder how much your mutual fund manager receives? Normally that information is secret, but every two years an industry survey reveals part of the answer. The latest figures show that this year the median stock fund manager expects to take home $325,000, and the median bond fund manager just over $260,000. Big numbers - but they're big comedowns from two years ago, when median pay was $436,500 for stock fund managers and $330,000 for bond fund managers. That means stock fund managers' pay is down 26 percent, while the average stock fund is down 19 percent.

Is that pay for performance? We asked Debra Brown, who's with Russell Reynolds Associates, which helped conduct the survey.

DEBRA BROWN: I think that to some degree the investor should take heart that the fund managers are feeling the same volatility in their compensation as the investor is feeling in their pocketbook.

COLVIN: But not all fund managers are feeling pain. In fact a few superstar managers get paid far more than those averages of three or four hundred thousand dollars. In public documents it's been reported that Mario Gabelli of Gabelli Asset Management was paid $47 million in 2001, and Bill Gross of Pimco receives $40 million a year under a five-year retention plan, not counting his salary - which is undisclosed.

Chris Lahiji interview

GEOFF COLVIN: If you've always suspected you could perform at least as well as a highly-paid money manager, here's evidence you're right.

It's the "What on Earth?" tale of Christopher Lahiji, age 19, a finance major at Santa Monica Community College who says that last year he virtually abandoned a teenager's social life to read the annual reports of every publicly-traded company in america -- 12,019 in all. He then picked 150 of them as investment recommendations, put them on his Web site last November, and that portfolio is up 81 percent. He joins us from Los Angeles.

Chris, when you look at all those annual reports, what are you looking for?

LAHIJI: I think the overall project was symbolic for how many companies lie out there that people can actually invest their money in. And more importantly, it's on the basis of the media itself and how they promulgate the same 30 companies. I mean I don't blame them, because they're well established, like Dow Chemical, Microsoft, Oracle, it really doesn't matter.

Personally, I wanted to show investors that there were more than a hundred companies out there that you can invest in, and that's exactly where my research lies.

COLVIN: I gather one thing that happens when you check in with 12,000 companies is they send you a lot of stuff. What did you get from these places?

LAHIJI: Oh, we got over 4,000 pens, 800 shirts, 700 hats, 600 mouse pads. I got some hot sauce from a regional bank. Someone actually sent me money. From Royal Pennsylvania they said, who says banks don't give out free samples? And they sent me a dollar.

COLVIN: I GATHER THEY SEND YOU A LOT OF STUFF. WHAT DID YOU GET FROM THE PLACES?

LAHIJI: 4,000 pens, 800 shirts, 700 hats, hot sauce from a regional bank. Someone actually sent me money. We have a documentary on my web site, lahiji.com:

From Lahiji's home video narration:

• A good example would be golf balls. Cases of them.
• Mousepads.
• Perhaps you want to calculate something.

• » Lahiji profile » Lahiji.com

  Frisbee. Over 200 of these.
• Beanie. Over 50.
• Comforter for your wrists. Only six.
• Sports bottles. 300 of these.
• Note pad, paperweights, t-shirts
• Only 20 calendars.
• Six ties.
• Did I mention a Ducati?

Out of all the companies I've read my personal favorites are the ones that sent me their products.

Interperfumes were kind enough to send their entire kit of mascara, hairspray, perfume.

Nuskin was kind enough to send me their entire dermatology kit. It even smells good in plastic.

When it comes to tech companies, I love it when they send me stuff like this. This comes from Transmeta which makes a CPU -- their best selling product.

My personal favorite was a company called Wellco, which makes boots specifically for the U.S. Army. Well, they sent me a boot, too.

COLVIN: Now obviously, more science goes into your stock selections than who sends you the best goodies. So which stocks do you like now?

LAHIJI: Well, you know, I picked 150, and since November 1st they're up 81 percent year to date, so I've done quite well. But my favorite companies as of right now continue to be Arotech Corporation and Identix.

Arotech is a hybridized homeland security bill company that has locations both in Israel and America. And I think because of the war in Iraq and the protraction, it's going to get a lot more business going forward.

And also Identix is also another security, indirect way of playing security, and that basically is the Microsoft of biometrics. They control about 86 percent of the biometric industry, which is the ability to access information using one of your body parts, like your thumb print, your hands, your eyes. I think that's going to be a very big segment moving forward.

COLVIN: Those are both very small companies right now, and I gather virtually all the companies you've picked are very small, micro-caps, as they're called.

LAHIJI: Correct, correct. 95 percent of them are worth less than $50 million market cap at the time I recommended them.

COLVIN: We should point out it's an imaginary fund. These are stock picks you have put on your web site, but you haven't bought the stocks.

LAHIJI: Correct. I currently own positions in several of the companies, and this is copyrighted work, so it's not apocryphal. But, you know, a lot of people still do not want to give me the credibility I deserve because they say, hey, you're not putting your money where your mouth is. And quite frankly I do own shares in a lot of the corporations that I preach to investors.

COLVIN: A lot of the gain seems to have come in the past few weeks. You've had a lot of publicity. And part of it may come from people going to the web site, seeing the stocks that are there, buying them. They're very thinly traded. The price goes up.

LAHIJI: Correct. And that's what I'm trying to control right now. Nowadays I have to be very careful with the credibility I've created for myself, so I really don't recommend individual companies anymore. And, you know, that's always been a problem of mine. And I tell people regardless of what I say, I still want them to go out and do their research.

COLVIN: Now, these micro-cap stocks have a lot of attraction because, as you say, they're not followed. You can find bargains there. The downside is that they are prone to manipulation. Isn't that a big danger?

LAHIJI: Yes, it is. For every thousand that I analyze, I only recommend one or two, and I invest in those one or two companies. So, quite frankly, I do love small corporations, but I don't select everything.

COLVIN: Now you talk about the research you do. What do you look for in a company? What makes you choose one?

LAHIJI: Oh, well, obviously market capitalization is the first thing I look at. I will not buy a company if it's worth more than $100 million.

The second thing I look at is how much, what's the debt-to-equity ratio. Because a lot of people, they have a big problem with micro-caps because of the money and the fear that they might not be generating enough financing to actually survive. So the corporation actually has to have enough cash to last throughout at least two years, okay? Not a lot of debt, and a well-established insider base.

COLVIN: You're a finance major in school. Does a normal investor need financial training of any kind to do what you do?

LAHIJI: Absolutely not. I mean I was self-taught myself. I went to the library every single day when I was younger. I read every single book in the entire aisle. It's something that's very autonomic.

Basically my advice is to go on the Internet. There's plenty of information for everything that I do. And, quite frankly, it's just a lot of hard work. There's nothing mysterious about selecting good companies to invest in. It just takes 12 to 14 hours of research every day.

COLVIN: Which is what you've been doing for how many months?

LAHIJI: About a year now.

COLVIN: It's amazing. Now one thing I have to ask you, especially in this environment, what's in this for you?

LAHIJI: I really want to prove to investors, not just investors, but individuals out there, that there can be someone that is this young that can pick companies as well as I do.

And quite frankly, I want to indirectly help the economy become prosperous once again, because growth happens from the bottom up. If we don't help these small corporations, no one will. And I want this to permeate to every single corporation going forward.

COLVIN: Are you in the position of a good basketball player who has to decide whether he's going to finish school or go pro?

LAHIJI: Exactly.

COLVIN: Well, what are you going to do?

LAHIJI: I don't know, but my heart says yes, but my parents say no.

COLVIN: Well, good luck on making your decision.

LAHIJI: Thank you, sir.

COLVIN: Good luck in everything else you do. Thanks for being with us.

LAHIJI: Thank you.

Brancaccio conversation

KAREN GIBBS: Well Geoff, fortunately for Chris, his parents won't be the first to try to align their teenager's head with his heart.

But hey, we have our own problems to worry about: benign inflation leads to worrisome deflation; the dollar's down, the euro's up; Alan Greenspan and Warren Buffett are sparring over the dangers of derivatives; and if you happened to catch one network's recent typographical error, you may still be wondering if the Fed chairman was hospitalized with an enlarged prostitute or an enlarged prostate.

Joining us to talk about all of that is David Brancaccio, host of "Marketplace" from Minnesota Public Radio. David, the word of the week is deflation.

DAVID BRANCACCIO: No, the word of the week is prostrate. It's where the prices are these days. No, deflation right?

GEOFF COLVIN: Yeah, that's right. It's the new thing we're all supposed to be worried about. Are you worried about it?

BRANCACCIO: No. I'll tell you why I'm not worried about it. A couple of weeks ago, gas on my corner was $2.69 a gallon. That was what I was worried about. Now it's down to $1.79. Prices fell. I'm not worried. But you've seen the headlines. We've been doing it on "Marketplace." You've been doing it as well here. There is concern. And even the Federal Reserve in one of its recent statements talked about its keeping a weather eye out for the possibility of declining prices. And what they're worried about is Japan, a downward spiral of prices. That could be debilitating. The idea there would be that if you knew that prices were going to keep going down, that they would always get cheaper, what you'd do is you wouldn't buy. You'd wait. You'd say, hey, you know, it's just going to get cheaper. If too many of us wait, that can hurt the economy, but that's not going to happen here. As a matter of fact, we learned to day, as you mentioned, that retail prices, the CPI Consumer Price Index down 3 percent for April. I'll tell you what. If you actually look at prices, they're still rising, over the last 12 months leading to April up 2.1 percent. That's not even disinflation, which is a minor version of deflation. That's still inflation. It's the darndest thing. We business reporters are always looking for a nasty headline. I think deflation is the latest one.

GIBBS: David, keeping up with this alliterance of mood, let's talk about derivatives. Alan Greenspan said that they're crucial to the global risk management, while the sage of Omaha, Warren Buffett, says it's the financial equivalent of weapons of mass destruction. Is there common ground here?

BRANCACCIO: Well, I'll tell you what. The group of seven richer countries are meeting this next weekend to talk about just this issue. And they, I assume, will figure it out if they're very, very dangerous. The thing is that derivatives in the wrong hands can be extremely dangerous and they can be complex; they can also be benign, a great way to hedge if you're running a business or even hedge if you're just trying to do that for your personal finances. But if they blow up and you lose a lot of money, you hate derivatives. And let's guess what had happened to Warren Buffett, the sage of Omaha. He bought an insurance company where the derivatives didn't work out, and he hates them. I think this is another one of these things that we should not spend the entire weekend worrying about.

COLVIN: How about the dollar? All right, we're not going to worry about deflation, we're not going to worry about derivatives. We're supposed to be worrying about the dollar, too, if you don't mind. Are you worried about that?

BRANCACCIO: Yes, the dollar, it's getting lower. That's supposed to be a reflection on my manhood. I'm not that much of a cool guy because my country's currency is falling. Let me get this straight. I was just reading that the only hope or one of the few hopes for American manufacturing, for American factories is that the dollar continues to be weak, so that U.S. goods are cheaper to buy overseas and we sell more of them. Foreign operations of U.S. companies, when they send their profits back to America also benefit from the lower dollar. Now of course, you know, if you're going over to France this summer, you're going to get killed on that euro. But I think in the bigger picture, dollar not so bad.

COLVIN: All right, David. Thanks so much. I feel so much better. I'm worried about nothing.

BRANCACCIO: Have a great weekend.

COLVIN: You too.