On September 21st, Steve Forbes sat down with investor Ron Muhlenkamp. Muhlenkamp is the founder, president and portfolio manager of Muhlenkamp & Company. Video and a transcript of their conversation follow.
Muhlenkamp’s track record from GuruFocus.com:
Performance of Muhlenkamp Fund
|Year||Return (%)||S&P500 (%)||Excess Gain (%)|
Steve Forbes: Well, Ron, good to have you back – the last time you were here was about three years ago. They say the market is a great humbler, and certainly in recent years everyone has seen things they never thought they would see, past patterns, everything else. First, describe what your approach is and then we’ll get into the environment today.
Ron Muhlenkamp: Okay. We think our task is to make money for our clientele within the stock and bond markets. And most of the time we prefer stocks to bonds because we’d rather own a piece of the company than lend it money. So we look at companies and philosophically we invest in companies. We’re not Warren Buffett, so as a practical matter we buy and sell stocks. But what we try to do is identify good companies. We start with return on shareholder equity because it’s much more reliable than growth.
Forbes: Low debt?
Muhlenkamp: Low debt, yes. In particular, when times are tough you start with the balance sheet. You want to be sure that the companies you own can survive whatever the heck happens. Today, for instance, we’re saying we want balance sheets better than the federal government.
Forbes: That’s a pretty low bar now.
Muhlenkamp: Well, that’s exactly right. But now, in expansionary times, once you get through a bottom then you look for growth. But when you expect rough times you look for balance sheets. So yes, we want good companies, sound balance sheets, nicely profitable. And then we want to be sure that they’re doing useful things with the money that they’re earning.
So today we’re looking at – frankly, the big companies are selling cheaper than the small companies. But companies with good balance sheets, lots of cash, lots of free cash flow; as you know, if you don’t owe them money they can’t put you out of business. So that’s the balance sheet. But also, if you’re generating cash it’s at your discretion what to do with it. A lot of growth companies absorb cash – for instance, if your growth is higher than your return on equity, chances are you’re absorbing cash.
Whereas if your return on equity is up there with your growth or higher, you’re generating cash. In today’s market we want to generate cash. But the bottom line is we want to identify good companies and then buy them when they’re cheap and then hold them as long as they fulfill our expectations.
Cash On Hand
Forbes: Now, in this kind of environment today, certainly since even 2008, you’ve seemed to have a lot of cash.
Muhlenkamp: We’ve got more than we had. We put out a quarterly newsletter, as you know. We said that if this were a normal recovery from recession we’d be fully invested. We don’t think it is. We believe what happened in 2008 was all these good companies we identified got cheap and then they got cheaper. We think there was a lot of forced selling going on out there, because hedge funds got word from their bankers that they had to cut their leverage in half. And both hedge funds and mutual funds got redemptions.
If you get redemptions, you’ve got to sell something. Or if your banker tells you to cut your credit in half, you’ve got to sell something. So what you saw in 2008 was everything got sold because people needed cash. And I added a line to my list of things you check and the line says, “Who might have to sell and how much?” We think today the people that may have to sell are called European banks and insurance companies. How much, we don’t know; it’s very hard to get assets on it.
But I, along with a lot of other folks, particularly those who did well coming out of the dotcom stuff, never played in the dotcom game. By owning good companies at cheap prices, that made us look pretty good. Well, owning good companies at cheap prices in 2008 didn’t help. And if we have another round of forced selling, this time we would expect it to come out of the European banks, not the U.S. banks. That risk is still out there, so yes, we own more cash than we normally would.
Forbes: Timing, though, is very difficult to do.
Muhlenkamp: Yes, it is.
What’s The Buy Signal?
Forbes: You’ve said yourself – you buy a good company and you figure eventually you’re going to be rewarded for it. How do you know when to get in? What’s the buy signal for you? Aren’t you taking a big risk instead of just buying stock like Cisco, which seems to be a bank these days?
Muhlenkamp: Well, I bought Cisco and then it got cheaper. But in answer to your question, for most of the time I’ve been in this business – which is now something over 40 years – you could take your cues from the Fed. Most of the bear markets we’ve had have been affiliated with recessions. Most of the recessions we’ve had since 1950 have been triggered by the Fed. Not necessarily caused by, but triggered by the Fed raising interest rates to slow the economy down on purpose to lick inflation, all that kind of stuff.