Ralph Wanger

President of the Chicago-based Acorn Fund, run by investment firm Harris Associates.

Investment style

Theme-driven investment in smaller growth companies for the medium to long term.

Profile

After a brief period in insurance, Wanger joined Harris Associates in 1960 as an analyst. Later he became a portfolio manager. In 1970, he was put in charge of the Acorn Fund. He has since turned this into one of the top-performing growth funds of the last 30 years.

In the six months after its launch, the Acorn Fund lost over a third of its value in the most severe market downturn since the Thirties. Thankfully, the market recovered in the second half of the year and the fund survived. But the experience taught Wanger the value of a light-hearted approach to the vagaries of the market.

He subsequently became famous for his amusing quarterly reports:
"Some people have written to tell me they became shareholders just so they can receive the reports, which makes the quarterlies the world's most expensive literary magazine."

He recently summarized his time at the fund in his book A Zebra in Lion Country (1999).

Long-term returns

The Acorn Fund returned 17.2% annually between 1970 and 1998, against a return from the S&P500 index of 14.4%.

Biggest success

Wanger has made big money from many unglamorous small companies. One is International Game Technology, the world's leading maker of slot machines. He paid $1 a share for it in 1988, when new management had just taken over and were planning a new range of electronic slot machines. In 1993, the stock hit a high of $40.

Method and guidelines

Concentrate on spotting trends that will last for at least 4-5 years.

Your life is driven by strong economic, social and technological trends. These also drive corporate sales and profits. When thinking of investing, start by looking around you and picking out those trends you think will be the most important and longest-lasting. Wanger's own favourites include:

the information revolution, and particularly its impact on costs
the expansion of world telephone and data networks
the business of leisure, boosted by affluent older baby-boomers
outsourcing, as companies strip down to their core functions
money management, essential for the future wealth of an aging world.

Think small.

Smaller companies as a group have made far more profitable investments than larger ones. Although you cannot buy large numbers of them, try to focus your research on the best prospects in this group. Consider avoiding micro companies - they can be too risky. (In the UK, this means sticking to companies with a capitalization of about £30m-£250m.)

The best small companies are those that dominate their chosen niche. Their characteristics include:

growing markets for their products
good design
efficient, low-cost manufacturing
outstanding, entrepreneurial management
skilled marketing
high profit margins.
Look downstream for the best profits.

T Rowe Price focused on the leaders in growth industries. But the best money is often to be made by the downstream beneficiaries of a growth business. To use the old cliché, it wasn't the prospectors that made the money in the Yukon gold rush, it was those who sold them the picks and shovels.

Example

Rather than investing in semiconductor companies like Intel that manufactured microchips, Wanger went for cellular telephone companies that built their products into handsets.

Insist on financial strength.

Growth can only be sustained by companies with strong finances. It will be undermined by those that have to guzzle cash to feed their growth. So

Check the balance sheet to see if there is too much debt, or rising debt
Check that other liabilities, such as pension payments, are reasonable
Look for real cash generation, not simply accounting profits
As a rule, avoid turnarounds, start-ups and new issues, which tend to be weakly financed, especially if they are blue-sky tech companies.
Insist on fundamental value.

A good company is not necessarily a good stock unless it is attractively priced. Look for companies that are cheap in relation to their earnings-growth potential.

A crude measure of potential is the PEG
A better measure is to estimate the likely earnings per share 2 years ahead and multiply that by the likely P/E to arrive at a probable value. P/E ratios will be higher if interest rates are lower, and vice versa.
(Professionals calculate this using a 'dividend discount model'.)
Sell only reluctantly.

If you have done your homework, you should be able to hold stocks for at least 4-5 years as a trend plays out. Wanger himself only turns over about one-quarter of his portfolio each year.

Sometimes, though, the P/E will rise to dangerous levels. Then you should consider selling some or all of your stock to reduce risk. Wanger sold International Game Technology when its P/E reached 40 and its estimated growth rate was 25%.

"In real-life portfolio management, sell decisions are often tough. You can't really apply hard-and-fast rules. Instead, you have to continually re-evaluate each situation."
Source: A Zebra in Lion Country

Key sayings

"First I determine themes that will be played out over the next several years. Then I identify groups of stocks that reflect those themes."

"What I don't want are me-too companies that rank fifth or sixth in their industry, because their profit margins will rarely be as good as those of the industry leaders."

"Going downstream - investing in the businesses that will benefit from new technology rather than in the technology companies themselves - is often the smarter strategy."

"Assume that one of your eccentric friends who runs a large bank has just offered to lend you a great deal of money at about 10 percent interest, with which you may tender for all the stock of the company you are studying at the current market price. If you study the company and say 'Boy, this is terrific! Give me the loan and I'll do it. I'll quit my job and go run that company. It's a tremendous bargain,' then you probably have a good stock."

Further information

John Train profiled Wanger in The New Money Masters(1989). One of the appendices contains some fine extracts from the quarterly reports. Wanger himself brings the story up to date in A Zebra in Lion Country (1999).

INTEGRATE

Born: Chicago in 1933.

Affiliations:

•Harris Associates
•Acorn Fund
•Wanger Asset Management

Most Famous For: Wanger was widely known for his witty and far ranging quarterly letters to shareholders as lead manager for the Acorn Fund, which, between 1970 and 1988 was one of the top-performing small-cap growth funds in the U.S.

Personal Profile

Wanger received his bachelor's and master's. degrees from the Massachusetts Institute of Technology, graduating in 1955. He started out in the insurance business and then began his investing career with Harris Associates in Chicago in 1960. He worked as a securities analyst and portfolio manager until the formation of the Acorn Fund in 1977, at which time he became its portfolio manager and president, a position he held until his retirement in 2003. While the S&P 500 Index climbed 12.1% per year during this period, Acorn racked up an annualized 16.3% return.

Investment Style

Wanger's investing style at Acorn was simple: be a long-term holder of smaller companies with financial strength, entrepreneurial managers and understandable businesses that will benefit from a macroeconomic trend. He's quoted as saying, "If you're looking for a home run [Wanger preferred these to singles] – a great investment for five years or ten years or more – then the only way to beat this enormous fog that covers the future is to identify a long-term trend that will give a particular business some sort of edge."

Wanger employed the idea of investing according to "themes." For example, if he had been around during the California gold rush, he would not have been investing in gold claims, but he would have loved the businesses that sold miners their picks and shovels. The mines played out in a matter of months, but gold diggers kept at it for several years.

It is reported that Wanger was a voracious consumer of investment information. In valuing a company to invest in he looked for the following parameters:

•A growing market for the company's product or service
•Evidence of a company's dominant market share
•Outstanding management
•An understandable business
•Evidence of a company's marketing skills
•A high level of customer service
•Opportunity for a large stake in the company
•A strong balance sheet
•The price must be attractive

Lastly, Wanger said he constantly had to remind himself that you can have a good company but a bad stock.

Publications

•"Zebra In Lion Country" by Ralf Wanger and Everett Mattlin (1999)

Quotes

"An attractive investment area must have favorable characteristics that should last five years or longer."

"Chances are, things have changed enough so that whatever made you a success thirty years ago doesn't work anymore. I think that by concentrating on smaller companies, you improve your chances of catching the next wave."

"If you believe you or anyone else has a system that can predict the future of the stock market, the joke is on you."

"Since the Industrial Revolution began, going downstream – investing in businesses that will benefit from new technology rather than investing in the technology companies themselves – has often been the smarter strategy."