TIME: With stocks down so much from their highs, is the market cheap?
WEITZ: We had a 25-year bull market where stocks got systematically inflated, and we've had only a year and a half of squeezing that out. I don't think they're especially cheap. If you had to buy today and hold for five years, it might turn out O.K. But I don't think you automatically get 10%-a-year returns from here.
SCHOTTENFELD: This terrorism thing you can't quantify. But barring that, I think we're really in the economic sweet spot for stocks. You've got a lot of stimulus: government spending, tax cuts, a concerted effort globally to reduce interest rates. Bull markets never look good when they begin. I'm not saying this is going to be a blowout, but we have all the pieces in place to make a case for buying stocks now.
TIME: Price-earnings ratios are still in the 20s. Price to replacement value is way above 1. Doesn't the market look expensive by a lot of measures?
SCHOTTENFELD: Bull markets have started in the past at high P/E multiples because the earnings are depressed. And with bond yields so low, an S&P 500 at 23 times earnings isn't outrageous.
MILLER: This is self-serving, but I think it's going to be a great spot for active managers to beat the indexes over the next few years.
MILLER: Yes. The S&P remains overvalued relative to the rest of the market. I'd be especially wary of big tech. But there are pockets of value.
TIME: How far forward are you willing to estimate earnings?
MILLER: We'll go out three years. Beyond that, who the heck knows?
TIME: Sounds like a lot of guesswork when you look out even three years.
WEITZ: It is. But what you're really trying to do is think about probabilities, what a company will be worth over 10 or 20 years. In that context, it doesn't really matter whether the recession troughs in the second quarter or fourth quarter. What you're thinking is, When the economy gets back to where it was, will that company do about as well as it had been doing? If there haven't been any new hotels built and people are traveling again, the odds are pretty high that a high-end hotel will prosper. If it's in telecom, where wireless may have substituted for wire line, things will have changed.
TIME: Value-fund managers have outperformed growth-fund managers for the past year or so. Will that continue?
ROMAN: Value significantly underperformed growth as recently as 1999, which was the widest return differential in many decades. So last year was just the start of a needed adjustment. In an economic decline with declining gdp and falling interest rates, value stocks are going to continue to do better.
TIME: In a recovery, is it better to own stocks of small companies or larger ones?
SCHOTTENFELD: The case for mid-caps is that the companies are still smaller than large-cap companies, so they're quick. You can turn things around a lot faster. Yet a lot of them are more substantial than their small-cap peers. These are professional teams running real companies and real products that could be leaders in their industries.
TIME: Eric, is it true the small caps are run by Junior Achievement types?
MILLER: That's what makes it fun. Some are outstanding and some aren't, and that's where there's opportunity. One of the catalysts we look for is new management in a good business that had been mismanaged. This should be a great time for small caps. The statistics show that looking out one year post-recession, small caps have outperformed the S&P 500 by 10 to 13 percentage points.
ROMAN: There's no doubt history will tell you that the small-and mid-cap stocks initially will do better. We're a large-cap fund. I'm watching the mid-caps, and when they get to large-cap land, where we can buy, we're there. You want to make sure that you own companies that have low debt and can be nimble even though they're gigantic, because those are the ones that are going to buy the small- and mid-cap companies for growth.
TIME: How has Sept. 11 changed the way you think about investing?
WEITZ: I would hope none of us would say we have a new investment theory now. I was already getting to be much more conscious of credit quality and balance sheets and that sort of thing, feeling that maybe it was time to have a recession and that defensive business characteristics would be more important. I guess that goes double when you're in a period when anything's possible. I've been buying much more of the kinds of companies that are visibly hurt by the terrorist attacks, like hotels and entertainment companies. Some people might think that's very aggressive. To me, buying a hotel at a third of its replacement costs when the balance sheet is strong enough for the company to last is not aggressive at all.
TIME: How about airlines?
WEITZ: I can't go that far.
SCHOTTENFELD: I became more aggressive after Sept. 11. I've added to almost every existing position. I was able to buy names that I previously would never have bought--all in travel, like Starwood Hotels because it's selling for half or less of its replacement value. I was able to buy Carnival and Southwest Airlines, which is one of the only airlines that has a business model that makes money, and I bought it at a value price.
MILLER: We added into positions after Sept. 11. But there is a little more emphasis on a safety net. Were we looking at a typical economic cycle, right now as a value investor, you might look for low-quality value--companies with a little more debt. Those are the ones that really can grow earnings dramatically, but because of this terrorist aspect, we're just not doing the low quality.
ROMAN: You need to ask different questions. Where are the facilities? Are they all in the same place? There will be a big cost to companies having to spread out.
TIME: Would you avoid companies that face such expenditures?
ROMAN: We want to avoid companies that haven't thought about it yet.
TIME: What are you buying now?
ROMAN: Consumer cyclicals and, in the very short run, financials. I want to highlight Fleet Boston. They have a very strong management team. They did a very interesting thing at the beginning of this year. They knew they had some loans on their books that could be problematic as we went into an economic downturn, and they consolidated them and basically got them off their books very early.
We also like Sherwin Williams, one of the largest paint producers in the U.S. This is a classic value idea. There's a Rhode Island suit against them, saying they made lead paint that was put into buildings in Rhode Island and potentially caused illness. When this first hit the news, the stock sold off because people were thinking it was like asbestos. The lead-paint issue is very different. We don't think the plaintiffs will be able to make the case.
MILLER: We like a company called Exponent, which used to be called the Failure Group. Fortunately, they changed their name. They're a consulting firm with expertise in accidents, like the Hyatt hotel in Kansas City when the walkway collapsed. They did structural analysis there. The catalyst for us was when they developed a relationship with the U.S. Army, outfitting soldiers with the best technology. It has a $10.30 book value, and the stock trades at $9.50.
A name that's not a classic value story but that we have a big position in is Orthologic, a $4 stock. Because of that low price, you get a lot of people who won't touch it. That's an advantage for us long term because it depresses what we think is the fair value until you get a higher price and other people start looking at it. Orthologic was a leader in a slow-growth rehabilitation business. They finally sold it, and now they're focusing on the electromagnetic hard-to-heal-fracture market.
TIME: Oh, yes, that one.
MILLER: No matter what the economy is like, people are going to break bones, and if you have a fracture where a doctor has set it and it's still not healing, he probably will prescribe a little machine that you wear around the break for an hour a day, and it will help the healing process. That's Orthologic's expertise. The sexy part of the story is they've just come out with a spine product that could grow revenue 30% a year.
SCHOTTENFELD: I mentioned Starwood before, and I love it. The price is totally right. The stock was at $41 back in May. I've been buying at $23. The stock is worth between $40 and $50, based on the replacement value of the rooms that they own, which is 58,000 rooms. The hotels are Westin, St. Regis, Sheraton. This year earnings are going to be down for obvious reasons. What I like is on the macro side. Construction in new hotels is going down dramatically, so when we come out the other end of this downturn, they're going to have huge pricing power.
A turnaround I love is J.C. Penney, which has 2,600 Eckerd drugstores. That's really the jewel in the whole piece, and they own a catalog business that is quite good too. Alan Questrom came in in May of 2000 and turned it around. You can make a case that this stock will hit between $40 and $50, and the stock is now at $23. They're doing a lot of things: new operating systems, changing the merchandising, lowering price points. The story is definitely working. Eckerd's is a great business because they're in the greatest places. They're in Texas, Florida. Aging populations make for a good drugstore business.
WEITZ: I'll piggyback on the hotel business with Host Marriott. The stock is about $7.50. They own Ritz Carltons and Marriotts and high-end hotels. Going into this year, I expected them to earn about $2 per share, pay out $1.04 as a dividend, spend about 50[cents] on required maintenance and have about 50 cents left to reinvest in new properties. On that basis, the properties could be sold with one phone call for about $15 a share. So if it takes five years to get to $15, you make 15% a year. And I can't imagine it taking that long.
Liberty Media is an oddball idea. It's John Malone's collection of both public and private media-content businesses. It's at $11.50, and there's probably $10 worth of publicly traded stock in his collection of assets, including AOL Time Warner, Sprint, Motorola and News Corp. He also has about $10 a share worth of private companies like Discovery Channel and QVC. The list is as long as your arm.
TIME: We'll get the rest of the list next time. Thanks to you all.