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Jewish World Review June 6, 2002 / 25 Sivan, 5762

James K. Glassman

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Consumer Reports

Frank investing advice

http://www.NewsAndOpinion.com |
Al Frank, who died of cancer April 25 at age 72 in Carmel, Calif., was one of the very best stock pickers in America. He never sought the spotlight and few investors recognize his name, but he deserves a place in the investing pantheon with gods like Warren Buffett, Peter Lynch and John Templeton.

The Prudent Speculator, the newsletter he founded in 1977 and edited until his death, ranked No. 1 in the nation, according to the meticulous scorekeepers at the Hulbert Financial Digest. Frank's record was both public and spectacular. Year in and year out, he beat the market averages by wide margins and left his competitors in the dust. Over 25 years, his TPS portfolio -- an actual stock account that he maintained and publicized in his newsletter -- returned an annual average of 23 percent.

Frank's style was eclectic, like his own background. He had a hard time breaking free of the groves of academe, earning two master's degrees but finally giving up work on his doctoral thesis, "The Concept of Consciousness in Higher Education," to devote all his time to investing. He eventually built a stake of $8,000 well into the millions.

According to one of the few articles ever written about him, a piece in Worth magazine in 1993, Frank also did time as a Linotype operator, print-shop owner and literary-magazine publisher and as "a professional shill at the Flamingo Hotel in Las Vegas and a down-and-out would-be writer living the vagabond life in a hut on an island in Spain."

Frank lives on. In the May issue of The Prudent Speculator (www.alfrank.com; 888-878-3944), Frank's successor, John Buckingham, picked Ford Motor Co. -- down from more than $60 a share in 1999 to just $17.65 on Friday -- as Stock of the Month in his late partner's memory. Frank loved Ford and kept it on his recommended list for 19 years (he bought it first at $2.51 a share, adjusted for splits).

But Ford was not a typical TPS stock. Frank leaned toward tiny companies that were beaten up, unwanted and cheap -- but had good balance sheets. Of the 74 stocks the newsletter currently recommends, 33 have market capitalizations under $100 million (that is, they're micro-caps, smaller than small), 51 are selling for less than $10 a share, and 29 have no debt.

Maybe this affinity for the underdog -- indeed, for the whipped dog -- was, like his eclecticism, a product of Frank's own history. Also in his partner's memory, Buckingham composed a 10-stock portfolio that includes such down-and-outers as Solectron Corp., the high-tech contractor, whose price has dropped by four-fifths in a year and a half; fiber-optics manufacturer Corning Inc., down from over $100 in the fall of 2000 to under $5 last week; and chipmaker LSI Logic Corp., which last year lost $1 billion on sales of $1.8 billion.

In addition, Buckingham added a bunch of drug stocks -- now in the doghouse -- to the recommended list this month: Schering-Plough Corp., Bristol-Myers Squibb Co. and Merck & Co. Said Buckingham, "Al Frank always had a soft spot for undervalued and out-of-favor household names." Me, too. Buying drug stocks when investors treat them as if they had rabies is frequently a smart strategy. In fact, Buckingham delights in markets like this one.

"This is the time to build a diversified portfolio for the long term," he told me last week. "We are able to recommend stocks that we couldn't in the past because they were too expensive." Drug companies are a good example. "We only put the big pharmaceuticals on our list once before," he says. "That was in 1993, when Hillary Clinton put a scare into the sector." Between 1993 and 2000, Merck rose from $15 to over $90, not including substantial dividends.

A more typical Frank stock, however, is minuscule Smith-Midland Corp., which makes innovative pre-cast concrete products, including temporary highway-safety barriers. Last year, sales were $27 million and earnings were $2 million. Yet the stock's market cap is only $7 million, for a price-to-earnings (P/E) ratio of less than 4, compared with P/Es in the mid-20s for the stocks of the Dow Jones industrial average. Another is Vicon Industries Inc., a maker of closed-circuit surveillance cameras whose earnings took a tumble when sales to the U.S. Postal Service fell off. Still, Vicon has a solid balance sheet (cash exceeds debt by $4 million for a company whose market cap is $19 million) and a book value (that is, net worth per share) that's about one-half its stock price. Even with a fourth-quarter loss, Vicon earned 62 cents per share last year -- for a P/E of 7.

Other micro-caps on the TPS list include LCA Vision Inc., which owns a chain of laser eye-surgery centers; One Price Clothing Stores Inc., a South Carolina-based discounter; Consolidated Freightways Corp., trucking; and ScreamingMedia Inc., which helps its customers distribute digital content over the Internet. What these four firms have in common is red ink -- they've all lost money in the past year -- and, in Frank's view anyway, good fundamentals at a low price.

But these companies are not for the squeamish. Some of them may go broke. Others may soar. Look at such TPS selections as D.R. Horton Inc., a home builder that has more than tripled in a little over two years; Maxwell Shoe Co., a small-cap that's risen 150 percent since the start of 2000; or Golden West Financial Corp., up 9,491 percent since being recommended in 1978. With Frank's strategy, patience is a requirement. His two huge winners last year were InVision Technologies Inc., maker of explosives-detection devices for airport security, first recommended back in 1999 at $3.50 a share and a dog until last September (it's now $22.40), and Jo-Ann Stores Inc., which, after languishing since 1998, has quadrupled in the past year and a half.

Ford fits the underdog pattern. A little more than a year ago, it was trading at $30 a share. Since then, rival General Motors has risen 20 percent but Ford has fallen 40 percent. As Buckingham wrote, "About everything that could go wrong did go wrong in 2001 as Ford endured difficult economic conditions, tough competition, the Firestone/Ford Explorer tire mess and a management shake-up that saw founding-family member William Clay Ford Jr. return to the helm."

Ford spilled copious red ink in 2001 and is expected to lose money again this year, but between 1994 and 2000, earnings averaged about $4.50 a share -- an indication that Ford's "normalized" P/E is currently less than 4. Ford is cheap, all right, but it may be cheap for good reason. The "shares continue to run on an empty tank," wrote Value Line's analyst, Anthony P. Pandolfi, recently. Posthumously, however, Al Frank is recommending Ford, and Al Frank's record can be viewed only with awe.

Mark Hulbert's impartial Digest ranks The Prudent Speculator first among all newsletters tracked over the past 20 years and first as well over the past 10 years, with an incredible average annual return of 26.9 percent. The closest competitor, No-Load Fund X, returned 18.8 percent and the Wilshire 5000 Total Return index (a measure of all listed U.S. stocks) returned only 11.8 percent. Frank is also far ahead of the market averages since the start of 2002 and over the past five years as well.

There are two drawbacks to Frank's investing style. First, the TPS recommended list, with more than six dozen stocks, is too big for the average investor to handle. (Another, even more comprehensive list, includes 425 stocks.) To his great credit, Frank always believed in diversification. With his deep-value style, he knew he would always have losers, and he needed winners to balance them. Buckingham writes that Frank wanted at least 17 industry sectors represented in his accounts. That's fine, but small investors can't manage that many stocks. Indeed, Frank's attitude, says Buckingham, was to "give readers a fishing pole instead of a fish." In other words, you should use the list as a starting point for your own research -- a good idea, though it makes investing tougher.

The second problem is that Frank tolerated a lot more risk than most people can stand. He often used leverage (buying shares on margin), and his stocks were highly volatile -- more than twice as risky, according to Hulbert, as the average portfolio.

A solution to both these problems is to buy the Al Frank Fund (symbol: VALUX) and hold it for a long time. With Buckingham as co-manager, Frank launched the mutual fund in 1998, and it quickly massacred the Standard & Poor's 500-stock index, beating the benchmark by 39 percentage points in 1999, by 16 in 2000 and by 42 in 2001. So far this year, it's up 3 percent, and for the three years ended May 29, average annual returns are 27 percent, compared with a 5 percent loss for the S&P. The fund is hugely diversified, in the Frankian tradition, with 352 stocks, none of them representing more than 1 percent of total assets. Turnover is just 18 percent a year (less than one-fourth that of the typical fund), and the average stock has a price-to-book value of 1.8 (about one-third the S&P average). Top holdings include PacifiCare Health Systems Inc., which operates HMOs; teen-oriented retailer Gadzooks Inc.; and, of course, Ford.

Despite its success, the fund is tiny -- just $78 million in assets. It's also expensive. The front load (or commission) is 5.5 percent and annual expenses are 2.25 percent. By contrast, the typical index fund has no load and charges just one-fifth of a percentage point. On the other hand, Frank was a genius whose selections beat the Vanguard Total Stock Market Index fund by an average of more than 15 percentage points annually over the past decade. That's enough to cover a whole lot of expenses.

The question remains whether Buckingham, who worked with Frank for 15 years, starting at age 21, can perform this well on his own. My guess is that he can, but he admits that investing is as much artful intuition gained from experience as it is fundamental analysis. Frank mastered both.

I never met Al Frank, but I followed his newsletter for a long time. I liked his style -- the way he combined a lust for value with a demand for growth. He wouldn't buy a stock just because it was cheap; it had to have the potential to increase its profits much faster than the market as a whole. He had an effective method for finding underdogs that might succeed, and he stuck to it, despite what the establishment was saying.

"Buying the dogs of the world," Buckingham reminded me, "is not what Wall Street tells you to do." Frank was a value guy -- and a raging optimist -- to the end. "Until he discovered the stock market," Buckingham wrote in a final appreciation, "Al never had much money, so bargain-hunting was always a way of life. That mentality seemed to permeate everything that he did -- even though he was worth several million dollars, he would go out of his way to buy cheap gasoline or place an unfinished cigar in the crook of a tree before entering a restaurant so that he could smoke the rest later." With Frank's death, I like to think the cigar is still there -- a fitting memento mori.

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JWR contributor James K. Glassman is the host of Tech Central Station. Comment by clicking here.

Up

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© 2002, Tech Central Station