Great to Great

Great to Great

By Francis X. Gilpin

AssociateEditor

Seven years ago, Jim Huguet wrote a book about investing after trying to figure out where to put the proceeds from the sale of a corporate consulting firm. The book was called, "Great Companies, Great Returns."

Huguet believes companies that keep increasing their intrinsic value - a measure of future free cash flows - are stocks that can be held forever.

At the height of the tech bubble, when both mathematics and profits were treated as afterthoughts, Huguet's longer view seemed a bit quaint. Huguet went ahead anyway. He founded a mutual fund company called Great Companies LLC.

After a couple of rocky years, his company's first fund returned about 24% in 2003. Great Companies - America, which includes names such as Hewlett Packard Co. and Johnson & Johnson Co., enjoyed smaller gains in 2004 and 2005, when the overall market was soft. Huguet's stodgy approach was somewhat vindicated.

But the 61-year-old Huguet has been reassessing, especially during the past year. As he wrote of his 14 choicest blue chip stocks in "Great Companies, Great Returns:" "These are great companies, not perfect companies."

Sitting in a Clearwater office cluttered with books, spreadsheets and stock reports, Huguet declares: "You're in a different investing environment now."

Huguet is more open to technology and other growth stocks. Great Companies has launched two additional funds, Great Companies - Technology and Great Companies of the Future, which invest in companies that haven't necessarily been around for at least half a century. "We're not as hung up on the 50 years in business, which was one of the screens we originally had," says Huguet, who now considers market capitalization a better guide than longevity for his funds that manage about $1 billion.

One example is 25-year-old IGT, a Reno gambling technology vendor that brought the first video poker machine into the world.

Out with an oldie

"We had a very defensive portfolio," Huguet says of his original Great Companies - America lineup. "We had a lot of old, established names."

Since the book, Huguet has chucked one of those established names, Coca-Cola Co. Coke's much-criticized corporate directors tapped a retiree who'd been passed over twice for the company's top job.

"On the day that they announced that Neville Isdell would become the CEO and they weren't going outside," Huguet says, "we sold the stock."

Outstanding management is a key component of what Huguet believes makes a "great company."

A second "great company" of his, Gillette Co., was recently absorbed into a third, Proctor & Gamble Co. But the biggest change has been dictated by the growing influence of hedge funds in the equity markets.

Huguet blames hedge funds, which are largely unregulated pools of money generally invested on behalf of pension funds and the wealthy, for the unusually high volume of buying and selling in the Great Companies portfolio during 2005. "It's forcing us to trade more," he says.

Hedge fund managers like to start shorting stocks that they've held long once the shares reach a certain high, in order to protect themselves against a downturn. A short sell is a way to profit from a stock's decline. As a result of massive hedging by hedge funds, Huguet says the prices of some stocks in his mutual funds become trapped in a trading range. "So it limits what your upside is," he says.

Huguet suspects two of his Great Companies buys, data-storage supplier EMC Corp. and the advertising agency holding company Omnicom Group Inc., have been victimized by hedge funds selling them short.

"If you're an investor of ours and let's say I put you in Omnicom, when it's selling for $77," Huguet says. "It goes up to $87. You say, 'man, that was really great.' Then, all of a sudden, it goes back down to $78. Then, you're looking at me and saying, 'man, that was really dumb.' I'm no better than when I got into this thing."

To avoid that situation, Huguet says he has been forced to trim back on a few of his best performers earlier than he would have preferred, because he was alarmed by a spike in short activity.

Such is life up against hedge fund operators. "They like to see stuff really bouncing around," says Huguet. "Whether it's going up or whether it's going down, they don't seem to really care. They just look for volatility."

Tech is back

Despite all the volatility, Huguet is leaning toward the drug and tech sectors in 2006.

Not just any drug stocks, however. Big Pharma was represented well among the 14 "great companies" in his book: Bristol-Myers Squibb Co., Merck & Co. Inc., Pfizer Inc. and Schering-Plough Corp., plus health care conglomerates with some drug exposure.

"That business has changed pretty dramatically," says Huguet. "It takes much longer to get drugs approved. The legal risks, I think, are much greater. Keeping the drug on patent is much more difficult."

Huguet jokes that pharmaceutical companies used to be able to keep a generic medicine off the market for another 10 years by telling the U.S. Food and Drug Administration that they had changed the color of a brand-name pill from blue to green.

"We're much more enthused about the biotech sector," says Huguet. He does stick with quality names in the young industry, such as Amgen Inc. and Genzyme Corp.

Great Companies is also jumping into tech stocks. Like many investment professionals, Huguet sees more stability and profit growth in 2006 than in 1999. "Technology stocks are really mainstream," he says. "It's taken four or five years to get there."

On Sept. 30 of last year, Motorola Inc. was the biggest holding in Great Companies – America at 4.2%. Microsoft was the biggest single stock in the tech fund, at 7.5%.

"Technology is being driven by the consumer," says Huguet, who recently attended an industry conference in San Francisco and is heading back out west for another soon.

The Dow Jones Industrial Average floated above 11,000 this month for the first time since 2001, suggesting that bad memories are slowly fading.

"A lot of people got burned by the technology bubble blowing up," says Huguet. "They never thought they could lose that kind of money in the stock market."

Those investors have been gun-shy for five years. That's why corporate earnings are up 90% since 2001, Huguet notes, but stock prices have yet to reflect fully that showing. "The time to buy stocks is when people don't want to buy stocks," he says.

GREAT ADDITIONS

Here are three of Jim Huguet's most recent additions to Great Companies LLC's stock portfolio:

Akamai Technologies Inc.

Headquarters: Cambridge, Mass.

Ticker: AKAM

Exchange: Nasdaq National Market

Jan. 9, 4 p.m. close: $22.13

Why he likes it: Akamai untangles data transmission jams on the Web. As bigger audio and video files clog cyberspace, Akamai's services will be in high demand. "It gives horsepower to the Internet," says Huguet.

Logitech International SA

Headquarters: Apples, Switzerland (U.S. headquarters in Fremont, Calif.)

Ticker: LOGI

Exchange: American Depositary Receipts trade on Nasdaq National Market

Jan. 9, 4 p.m. close: $50.45

Why he likes it: A pioneer in the development of the desktop mouse, Logitech continues to innovate with a broad array of new computer interface devices.

National Oilwell Varco Inc.

Headquarters: Houston

Ticker: NOV

Exchange: New York Stock Exchange

Jan. 9, 4 p.m. close: $69.87

Why he likes it: National Oilwell is a drilling equipment supplier that should continue to generate profits wherever energy companies are extracting crude.

RATES OF RETURNS FOR GREAT COMPANIES' MUTUAL FUNDS

As of Dec. 30, 2005 Opened Last year Last 3 years Last 5 years

Great Companies - America 2000 4.78% 10.49% -1.06%

Great Companies - Technology 2000 2.81% 19.04% -8.14%

Great Companies of the Future 2003 8.01% 18.79% n/a

Source: Great Companies LLC