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» Farr's top stocks » Miller still ahead » Market dangers » Correction » Next week

Farr's top stocks

KAREN GIBBS: It's that time of year -- New Year's resolutions that will be broken by February, predictions that will be forgotten by spring, and those promises to get to the gym, well, never mind. But it's also time to reassess your portfolio, and that's just what contributor and money manager Michael Farr has been doing. He joins us with the stocks he's buying for the New Year. Michael, what is your outlook for 2005?

MICHAEL FARR: Karen, I'm upbeat for 2005. I expect the market to expand, and I think probably at a measured pace, some 8 to 10 percent would be my goal for 2005. Earnings growth I think will increase at a moderate pace. The economy is still expanding. I'm nervous about the dollar. I'm still nervous about oil. But by and large, I think we're in decent shape.

GIBBS: What's on your list for 2005?

» Farr: Stocks for 2005

FARR: I have 10 stocks for 2005, Karen, three in the financial area: American International Group, the insurer, AIG; First Data Corporation, and Citigroup. In health care, I have Pfizer and Medtronic. In food and retail, I have Wendy's, the restaurant chain; Pepsi-Cola; CVS, the drug store chain, and Colgate-Palmolive. Finally, in education, Education Management Corporation, EDMC. I think it's a fairly well-diversified list. Again, if I'm managing your portfolio, you're going to own more stocks than this, though over the past couple of years, these lists have done pretty well. There's been no real money invested in these lists and there's no real cash track record for them, but they look good to me.

GIBBS: Let's talk about some of the areas that you might see some buying, recommending things like in the financials, AIG. That kind of interests me because of all the problems that we saw with the insurance industry this year.

FARR: Right. The insurance industry had a tough year. I like a lot of the financial stocks, and I've come up with my list for 2005, which is a little more defensive. It's not a particularly aggressive list, but I think over time you really will make some money.

GIBBS: What do you mean by defensive?

FARR: It's a little more cautious. I'm not buying the high-flying tech stocks that don't have earnings. There's no Google on this list. I'm going with some of the more established sort of companies. So I'm playing defense with my money when I say defensive. AIG got in trouble of course this year on a couple, this past year, on a couple of different issues that did result with some inquiries and some litigation, even a legal settlement. That brought the price down. This is a huge, well-diversified, well-run company, and I think that the valuations are very strong. And I think that at these levels you're going to make money as these earnings grow because people continue to need to buy it and they have a huge presence in China.

GIBBS: What do you think about the payment processing company First Data Corporation?

FARR: First Data is one of my favorites. I think it's sort of a chicken's way to play both finance and tech. They do credit card processing. Every time you run one of those Visa cards, it has to go through, most of them go through a First Data computer. But their real cash cow is Western Union, wiring money, and this is the way, this is really the way they make their money. Every one of those little Western Union signs that you see in a little supermarket or if you walk around Manhattan, every coffee shop has Western Union wiring. As the immigrant population has grown dramatically in the U.S., lots of money is getting wired overseas in $100 and $200 increments. These people make a lot of money at that business.

GIBBS: Cash starts with a C, and that brings to mind Citigroup.

FARR: Citigroup I think is a very well-diversified company. They have investment banking, they have international banking. They also got in trouble this year. Citigroup Private Banking got thrown out of Japan. I mean it was embarrassing for them, but this is an enormous company with international operations. I think that the investment banking, a lot of their underwriting are really going to do very well, their credit card operations. So I think at 10 or 11 times earnings, this is a very cheap stock and has a good dividend, the growth rate looks good, and I think it's stable. So I like it and I think long term, again, a lot of money made here.

GIBBS: Got a lot of things going on in health, both from the big pharmaceuticals and in health care providers. Pfizer is taking all kinds of hits on Celebrex news, why do you like the company?

FARR: . I think it's a well-managed company. They've got a good pipeline. So therefore I think you can make money here and I think the earnings will continue to grow.

GIBBS: Another company that kind of comes up on your radar actually is Medtronic.

FARR: Medtronic makes a lot of stuff. Medtronic makes pacemakers and valves and stents, the stents that go in the arteries and veins, that screen tube that's around a balloon and they inflate that balloon and prop open the stents. Drug-coated stents is a huge business in this country. Medtronic is the leading business in this country in medical devices. They've been a tremendous grower. They're not really cheap, but for as well-managed as they are and the consistency of earnings growth, I like it as a part of a portfolio.

GIBBS: You've got a group of food and retailers here. Let's talk about some of those.

FARR: They're a little more defensive, the food and retailers. I have four on my list for 2005: Wendy's, CVS drug stores, Pepsi-Cola, and Colgate-Palmolive. Now these are some old, stable names. Wendy's, there's a story within the story here. Tim Hortons is the story behind Wendy's. It's sort of Canada's version of Starbucks, and they're much bigger and more popular in Canada than Starbucks, and it's growing, it's hugely profitable. it's going to be good if we see Tim Hortons move this way.

Also Wendy's has expansion plans. 233 restaurants are going to go to 500 restaurants. They're going to increase that footprint here. They execute well. Wendy's, though, has the fast food restaurants here that are traditional fast food restaurants, and then they're sort of balanced. They've sort of got a counterbalance there in the Canadian operations of Tim Hortons. If one of the companies might be having a tougher year, as Wendy's did last year, and Tim Hortons sort of really pulled the mule train for the company in earnings, if both of those companies start moving along a little bit better, I think we'll have great returns. We're going to have good returns if they just keep executing the way they have been.

GIBBS: Let's talk about education. There seems to be a trend there.

FARR: A great trend in education. Now, we all think most of the time of what we call private education and not-for-profit education, most any major university that you think about. Six percent of the higher education market right now is for-profit companies. Strayer is one of the big names there, Apollo Group. These are very profitable companies. The one that I like in that space is called Educational Management Corp. EDMC is the ticker.

In general -- it's an exceptionally well-managed company -- in general that space, if you will, that industry is projected to double by the year 2007-2008. It's only two or three years. So 6 percent market share of higher education is going to go to around 11 or 12 percent. So they're gaining share, they're profitable, and they're in a section of that industry that's expanding dramatically. So lots of reasons to drive that business, and I think it's cool, too, big business.

GIBBS: There are a lot of questions being raised though and a lot of investigations into the industry itself.

FARR: No question about it. A lot of these for-public, for-profit companies receive student loan dollars, government student loan dollars, and there have been allegations of abuse of how they're applying for those student loan dollars from the government and accounting for their head count per student, and some of them may have not done it right. EDMC, Educational Management Corp, has not come under that scrutiny, they've not been questioned. They've not had any sorts of those problems, and they have a very solid management team. That's kind of why I gravitated that way.

GIBBS: Well, you're a nice guy and everything, but nice doesn't pay the bills and show me profit. Why should I listen to you?

FARR: Our 2003 list beat the S&P 500 handily. The 2004 list beat the S&P 500.

GIBBS: What did it have in it?

FARR: It didn't have any tech. Neither list had any tech. It had a lot of these consumer names. Pfizer's been on my list for the past two years, Kohl's, Bank America, Johnson & Johnson. Some have rotated off the list of my top 10 because of valuation, not because they're bad companies. I continue to hold most all of them in portfolios. Karen, we do our top 10 list for fun. We do it to have something to focus on and talk about a lot as we talk to clients at the beginning of the year.

Most of our portfolios have 30-35 different stocks. They're more diversified than this 10 list, but within this 10 list we have four major industry groups. As we mentioned, we have financial stocks, we have health care, food and retail, and education. There's not a tech weighting really anywhere in here, so I'm going to go back and use my buzz word again. This is sort of a defensive list. We're playing defense a little bit. We're not being aggressive with our money. This is the sort of portfolio I think you probably go to sleep at night with.

GIBBS: Michael Farr, thanks so much for joining us.

Miller still ahead

GIBBS: Well that slumber may include more than dreams of sugarplums. The hoped-for Santa Claus rally finally hit this week, with the Dow soaring to pre-9/11 levels.

Dow Jones Industrial Average

And while it hasn't received the attention of Peyton Manning's passing records, superstar fund manager Bill Miller appears close to keeping one of Wall Street's longest winning streaks in tact. The renowned manager of the Legg Mason Value Trust Fund has beaten the S&P 500 for a record 13 years in a row.

The streak appeared all but dead - until Miller's largest holding, Nextel, shot up on last week's news of a deal with Sprint. Miller then caught a hail Mary pass when his beleaguered Interactive Corp. Stock soared on this week's news that its travel business was being spun off. Now heading into the last week of trading, the Value Trust Fund in on track to beat the S&P for the 14th year in a row.

Market dangers

GEOFF COLVIN: Regardless of whether your performance is record-setting, you might think you have much to be grateful for as an investor this year. Top executives at many of the scandal companies have been indicted, and some are in prison. The Sarbanes-Oxley law imposes tough requirements for better financial reporting and corporate governance for jail time with managers who don't comply. New York Attorney General Eliot Spitzer has forced the mutual fund industry and Wall Street analysts to clean up their acts. It all sounds so encouraging, but in truth, you're not nearly as safe as you may think. What are the new ways you're being ripped off? Which slimy practices still haven't been exposed? And what can you do to protect yourself? Maggie Mahar is a long-time financial journalist and author of Bull: A History of the Boom, which Warren Buffett has recommended. She joins us from New York.

Edward Siedle is a former SEC enforcement attorney who now helps companies and investors spot fraud and abuse. Ted, after all we have been through these past three years, there are still mainstream players on Wall Street, I don't mean the marginal guys, the bucket-shops and so forth, I mean mainstream players on Wall Street who are not being absolutely fair with investors?

EDWARD SIEDLE: Absolutely. Very little has changed actually over the last couple of years. The brokerage industry is still being allowed to self-regulate, self-adjudicate, self-insure, and even control public access to the criminal and disciplinary information regarding its membership. That hasn't changed.

COLVIN: And so investors are still being abused, ripped off?

SIEDLE: The investors are still getting only a small portion of the disciplinary information available about the brokerage industry. So they're being misled into thinking that doing business with brokerages is far safer than, in fact, it really is.

COLVIN: Maggie, let's talk for a minute about mutual funds and that industry. A lot of people after Eliot Spitzer had a very showy bunch of accusations about the fund industry, and after a big settlement, a lot of people think well, it must be pretty well cleaned up by now. Do you think it is?

MAHAR: I'm afraid not. Conflicts of interests are still huge. One of the biggest problems is that mutual funds continue to pay brokerages to recommend specific funds. So when your broker recommends a fund, it may well be because his firm was paid to push that fund. And you're not told that. This talk about disclosing which funds are paying to have their funds recommended and how much, even if it's exposed, though, do you really want your broker recommending a fund because they've been essentially paid a bribe to do so? Probably not. You want him recommending a fund because he thinks it's a very good fund. He thinks the price is right, it's a good time to buy it. So this whole notion of revenue sharing, as they call it, or funds paying brokerages really undermines the whole fiduciary relationship between broker and client.

COLVIN: Ed, is this something that the SEC or somebody like that ought to do something about?

SIEDLE: The SEC claims it is doing something about it. They claim that they banned directed brokerage programs, but the fact is they aren't really doing anything about it. And the biggest indictment of the mutual fund industry to me is how many mutual fund companies have fired their advisors in the last two years? None that I'm aware of. So that must mean that they're all doing a terrific job. How many mutual fund companies have voluntarily cut their advisory fees? Only one that I know of, Fidelity has temporarily done so on one of their index funds. How many mutual funds have significantly reduced the brokerage commissions they pay to brokers which has always included a marketing component, the answer to that again is none. And have they changed the brokers they're directing the majority of their commissions to? Again, no. So I think the answer is nothing has changed.

COLVIN: Maggie, you were going to say something about whether this is something the SEC should do something about.

MAHAR: One problem to doing anything about this is the fact that the brokerage industry would point out since these were deregulated and since discount brokering came into being, it's hard for brokerages to make money just on the fees alone. Because the commissions we pay are much lower than we used to. So they say we have to make money somehow. And unfortunately the way they make money often involves a conflict of interest between their responsibility to the investor and their responsibility to themselves and their own shareholders.

COLVIN: And this is the ubiquitous problem, whether we're talking about mutual funds or stock research or pension funds or anything else, right? Conflicts.

SIEDLE: The biggest lesson to be learned in the last few years has been that anybody who purports to offer objective advice probably isn't. Most providers' objective advice have been corrupted because there's far more money to be made providing tainted advice.

COLVIN: Most people are going to think that this was fixed, right? That this was the crux of all the -- not all, but of many of the scandals of the past few years. They're going to presume this has now been fixed. Maggie you were going to comment on this.

MAHAR: I was just going to say, the only place you're likely to get objective advice if you're paying for research and probably paying quite a bit. There are research firms, boutique firms, that aren't in the brokerage business, that aren't in the business of selling you anything, that are just doing research. But as I said, that research is usually fairly expensive.

COLVIN: Ted, for a lot of people, their biggest investment actually is in the form of a pension fund that is through their employer or through their union or something like that. If that pension fund is getting ripped off, they themselves are getting ripped off. And I gather this is a problem?

SIEDLE: There's not a pension fund in this country that has in place the procedures to detect and prevent fraud. That's what I do for a living, and I've seen the largest funds to some of the smallest funds simply do not have procedures in place. So, pension funds are being ripped off, and there's a lot of self-dealing going on. For example, in products, it simply makes no sense, like variable annuities, including, you know, charging 4.5 percent in some cases to 403(b) and 457 plans. It's virtually impossible to accumulate wealth over time in a plan that's charging fees of 4 percent.

COLVIN: Well, it would be almost impossible. A fee that high is going to wipe out any differential above the market you could hope to get, almost ever. And you have found there are plans with expenses this high?

SIEDLE: Sure. Huge ones. The New York State United Teachers endorses an ING variable annuity product for their 403(b) and 457 plans.

COLVIN: That is analogous to a 401-k, but it's in an organization like that.

SIEDLE: Yeah. And the fees on that product are, I believe, 2.5 percent. The Ohio Association of School Business Officials, they have a product, same ING product that is endorsed by the association and that charges fees up to 3.5 percent, plus you have brokerage and other costs that bring it over 4. And these unions are getting paid by these insurance companies, or these variable annuity companies to promote the product. In the case of the New York State United Teachers they will be getting paid in excess of $3 million in 2005 to endorse the product and promote it among its membership.

COLVIN: Maggie, this was the kind of thing that happened, for one thing in the Enron case when people were shocked to find a lot of the Enron pension fund was invested in Enron stock. And that one instance, I know, enraged so many people that I've got to figure that most Americans believe that has been remedied in some way. It has not?

MAHAR: No, it has not. The only way to remedy it is for individual investors themselves to realize that it's, you know, not a good idea to have your savings in the same place where your job is. And talking about corporate fraud, at the very beginning of the program you mentioned Sarbanes-Oxley, which certainly sounds like a tough law, executives can go to jail for up to 20 years. How many executives have actually been sentenced to jail? Very, very few. People from Adelphia who are relatively small fish. Martha Stewart is in jail simply because she's a celebrity, had nothing to do with corporate fraud.

COLVIN: That wasn't under Sarbanes-Oxley anyway.

MAHAR: That's right. But what I mean is that CEOs who do commit fraud don't go to jail. The Rite Aid executives are an exception to that. By and large, the company pays a fine, the company subtracts that fine from their corporate income tax. It's part of the cost of doing business in the minds of many executives to gain the numbers. And so they continue to do so. Now, we've got some big trials coming up. We have the Enron trial with Ken Lay and Skilling. We've got Scrushy from Healthsouth. We've got Bernie Edwards from WorldCom. It will be very interesting to see what the outcome of those trials is.

COLVIN: How can investors protect themselves, Maggie? What can you do? Because it's clear that the laws, the reforms aren't doing the job. What can you do for yourself?

MAHAR: That's right. Well, first let's look at mutual funds. What you can do for yourself is look for a fund, and this may mean going to Morning Star, Lipper, look for a fund with a long track record, ideally more than 10 years. We know the studies show the track records of three, five, six years aren't very meaningful in terms of telling you about the talent of the manager.

You want to look for a fund that has a longer track record with the same person managing it. And then you want to look at not just how he's done on average, but you want to look at his performance year by year. In other words, if this guy has made 11 percent on average over 12 years, that's nice. But does that mean that he had two or three very lucky years when he made 29 percent? Or does that mean that was steadily making money over time and losing very little money. And that's the kind of steady long-term performance you're looking for. In other words, you want a manager that takes a long-term view of things.

COLVIN: Ted, let me ask you something because some people in business are contending that enforcement of these big rules have become too vigorous and some of the lobbying groups are campaigning quietly for Bill Donaldson, the chairman of the SEC, to be moved out of that job because they say he's pushing too hard. Do they have a point?

SIEDLE: Well, they have a point. The point is that the regulatory environment -- or pendulum -- has been swinging against them. But we haven't even begun to enforce these new rules that have just been put on the books. And by the way, I would disagree with Maggie in a few respects. I would caution people, especially about Morningstar.

Morningstar is not, in my opinion, an independent rating organization. They earn fees from mutual fund companies and they are very much involved in promoting the sales of mutual funds. And as you may recall, very soon after some of the mutual fund scandals at MFS and elsewhere, within months, Morningstar said the scandals had been -- 25 years of scandalous behavior had been cleared up, it was now safe to get back in. Morningstar has had a poor track record at predicting mutual fund scandals and therefore, I think, should be very much discounted when they say that mutual fund companies are clean.

MAHAR: I just want to say one thing about Morningstar. I differentiate between Morningstar's columns and Morningstar's stars, and the information you can get if you go deep enough. When I wrote On Morningstar, I interviewed Don Phillips and he said, "Anyone who just goes on Morningstar and looks at the first level of information is making a mistake." You need to go down and check some of the things I was talking about earlier. Has the same person managed over a period of time? How has he done year by year? How has he done in hard times as well as good times? That information, that raw data that you can get on Morningstar, is very useful. But I would agree that these star systems have all turned into marketing tools. And so you have to be very wary of the stars, of what you see in mutual fund ads and the way in which these ratings are used. I entirely agree about that.

SIEDLE: Again, it's the point: anybody who purports to be offering objective advice should be viewed with great suspicion.

COLVIN: Let me ask you this then -- can you trust anybody?

SIEDLE: Well, I would say that given human nature when individuals are entrusted with substantial assets that don't belong to them, there is a propensity over time to convert those assets to the advisor's personal use. So I think whenever it comes to handing your -- whenever you hand your money to someone else, you should continue to be suspicious of what's going on. Constantly monitor.

COLVIN: Can I ask you, who manages your money?

SIEDLE: I actually have my money entirely in Berkshire Hathaway.

COLVIN: So you know who's managing your money.

SIEDLE: I know who's managing my money and it's my personal preference, but that happens to be where I am.

COLVIN: Look, this has really been interesting. The bottom line advice is pretty clear, which is watch out for yourself, at least as much today as you ever did before. Ted Siedle, Maggie Mahar, thanks so much.

MAHAR: Thank you.

Correction

COLVIN: One investment money manager Buffett doesn't have a stake in is the Longaberger company. Last week, in a discussion of direct marketers and their success, I suggested that he owns the company. So to clear up any confusion, Longaberger is a successful direct marketer of baskets and other home products, but they are operating quite happily as a privately-owned firm out of America's most distinctive corporate headquarters in Newark, Ohio.

Next week

GIBBS: And this most distinctively is the end of our penultimate program in 2004, but the year won't end without a bang. Next week, a look at some of the worst predictions ever, and a market seer's view of 2005. Goodbye.

COLVIN: So long, we'll see you next week.