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5 Stock-Picking Secrets from Legendary Fund Manager Joel Tillinghast

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Legendary fund manager Joel ­Tillinghast says you don’t have to be a bold, daring investor to succeed. Great long-term portfolio performance isn’t about choosing the most exciting stocks, adds Tillinghast, who has managed the Fidelity Low-Priced Stock Fund since its inception 27 years ago. Whether you are the manager of a giant fund or an individual investor with a small portfolio, the best strategy is to avoid big mistakes and to find overlooked companies that have what Tillinghast calls, in his understated manner, “a high likelihood of a decent outcome.”

Tillinghast’s fund is proof of how effective the strategy can be. In real money terms, $10,000 invested in the fund in 1989 would be worth more than $350,000 today, compared with $128,000 for the Standard & Poor’s 500 stock index. His prudent, disciplined approach seems particularly useful in today’s aging bull market, in which many stocks are considered overvalued and a few flashy large companies seem to draw all the attention.

Bottom Line Personal interviewed Tillinghast to find out his secrets to picking good stocks without taking a lot of risk and how our readers can benefit from his approach…

My Secrets

When I was interviewed by renowned fund manager Peter Lynch for my first job at Fidelity back in the 1980s, I didn’t believe that I was ever going to match his uncanny ability to pick huge stock winners at the tremendously successful Magellan Fund. In fact, my first job at Fidelity was as an analyst researching the coal industry. But laboring in that unglamorous sector helped me clarify what to look for in stock investing.

What I’ve learned that can help anyone who chooses stocks…

Invest in businesses with long-term advantages over competitors. A company should dominate its market niche and have low levels of debt…a distinctive brand that consumers trust and seek out…and a business model that isn’t buffeted by the ups and downs of the economy. These guidelines make it easier to forecast a company’s profitability without being dangerously wrong.

Example: A decade and a half ago, I started investing in a California company now called Monster Beverage. I paid an average of eight cents per share (adjusted for splits) over the years. This company made energy drinks, sodas and juices using unusual ingredients such as guarana seed extract and ginseng that have powerful mood-boosting effects. It was a simple but outstanding concept. This year, the company will have revenue of more than $3 billion, and its stock recently traded at more than $50 a share.

Energy drinks are an example of a product that has a long runway of growth ahead. I avoid industries that I think are headed for obsolescence (such as the coal industry) or that have commodity-like products with so few differences from one another that price becomes the only basis for competition (such as airlines).

Make your initial purchase in a stock when it is trading at $35 a share or less. My fund typically keeps at least 80% of assets in low-priced stocks (which currently means stocks purchased initially at or below $35 per share). This is a somewhat crude way to point me in the direction of bargain-priced small- and mid-cap stocks, but the discipline it has imposed has served me well. Focusing on low-priced stocks often is a good way to find companies that are either too small for Wall Street analysts and big institutions to pay attention to or whose prices are temporarily depressed due to short-term problems. (Of course, a low price alone doesn’t mean that a stock is worth ­buying—there are plenty of stocks priced under $35 that I would never touch.)

Important: I don’t sell a stock just because it appreciates beyond $35 per share. I hold my winners as long as their long-term growth potential looks ­attractive.

Stay within your circle of competence. Back in 2000, I became very curious about a well-respected investor named Bernie Madoff. Even in sloppy markets, Madoff’s funds seemed to be perennially profitable. I wanted to learn from and incorporate his strategies into my own investing, so I met with a Boston money manager named Harry ­Markopolos who was trying to “reverse engineer” the returns of Madoff’s funds to figure out the formula. Markopolos, who later helped expose Madoff’s Ponzi scheme, couldn’t do it. I had no idea about the malfeasance and criminality involved in the Madoff fund at the time. But I was wise enough to know that if I didn’t understand it, I should just stay away.

You have to understand a company enough to be able to forecast with confidence how the business will make money in the next decade.

Example: One of my fund’s largest holdings is Ansys, which makes simulation software that allows engineers to save time and money by testing multiple concepts when designing products. An aerospace company, for instance, can simulate the effects of wind and stresses from vibration, temperature and velocity on new plane wings. Although Ansys software is highly technical, the business isn’t. The company has a ­proprietary product, a leading market share in a highly fragmented industry and a 95% renewal rate among customers.

Avoid “story” stocks. These companies are so exciting, you are tempted to suspend your normal investing criteria.

Example: Investors have piled into the electric-car company Tesla. Its CEO, Elon Musk, is a visionary who has ­created a very cool, marvelously designed product. At the same time, the company is losing money on every single car…is saddled with $18 billion in debt…and its stock has a price-to-earnings ratio of 3,600 based on expected earnings for the next 12 months (versus 19 for the S&P 500). Tesla could disappoint for many reasons, including its fading competitive advantage (every major car company is racing to produce electric vehicles) and its limited potential for long-term profitability.

Get serious about increasing your exposure to foreign stocks. The bull market in the US has left many investors overallocated to US stocks as their prices have zoomed up. About 40% of my fund now is invested in foreign stocks, which offer investors more chances to find undervalued buys. I’m finding good opportunities in Asian stocks. My fund owns shares in Hon Hai Precision Industry Co., a Taiwanese electronics manufacturer that makes mobile phones and is expanding into nanotechnology. The fund also holds some Canadian companies such as Metro Inc., one of the country’s largest grocery and drugstore operators.

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Source: Joel ­Tillinghast, CFA, manager of the $38 billion Fidelity Low-Priced Stock Fund, Boston. Over the past 15 years, the fund had annualized returns of 12% vs. 9% for the S&P 500. He is author of Big Money Thinks Small: Biases, Blind Spots, and Smarter Investing. Fidelity.com Date: November 15, 2017 Publication: Bottom Line Personal
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