PORTFOLIO TALK AN INTERVIEW WITH MICHAEL GOLDSTON President of CAMBRIDGE EQUITY ADVISORS
(FORTUNE Magazine) – The son of a U.S. Marine colonel, Michael Goldston spent three years of his youth near Cambridge, England. Fond memories of the place and a desire to evoke its Old World cachet led Goldston to christen his Brentwood, Tennessee, investment management firm Cambridge Equity Advisors when he opened his own shop in 1989. Cambridge now manages $240 million in assets for institutions and individuals. If investors came for the old-boy aura, they stayed for Goldston's skill at picking midsize growth stocks (see chart), those of companies with market capitalizations between $500 million and $2 billion. Goldston, 39, spoke recently with FORTUNE's Antony J. Michels.
Why is this a good time to be in growth stocks? In this slowly expanding economy, lean and mean companies with real earnings growth will do well. I look for companies whose profits will increase 25% annually for the next three to five years, and I'm not afraid to pay for that growth. I run a portfolio with a price/earnings ratio of about 25 times expected 1995 earnings. But I don't buy a stock unless I expect it to produce a 30% to 50% return over the next two years.
How do you find winners? I use the Peter Lynch approach -- keeping your eyes open, looking for the unique product made by a company that can dominate a fast-growing industry. I also search for companies that dominate old industries. And I read everything I can get my hands on.
What trends have you identified? About a year and a half ago we bought America Online, which accounts for 6.5% of our assets. It provides on-line computer services, an industry that is just exploding. AOL is the fastest-growing player in the business, and it's the only one that is a pure play. The number of AOL's subscribers jumped 165% over the last year and just reached one million. It's a $72 stock now, and I think it's definitely going to double in the next two years. We figure its earnings will grow about 48% a year on average over the next five years. The P/E on 1995 earnings is about 29. That's cheap by our measures.
Did the correction this year produce any opportunities for you? One fallen growth stock I own is Marvel Entertainment Group, the publisher of Marvel comic books like Spider-Man. We bought it in 1991 for $4 soon after it went public and sold it a little over a year ago at $17. It hit $36 last fall, which was slightly outrageous, and is now $21. The P/E on 1995 earnings is about 23. So we bought it again at $14 about four months ago. On the strength of annual profit growth of 25%, I think it will be a $30 stock again within 18 months. It had flat earnings in the first two quarters. But profits will jump in the second half, fueled partly by product-licensing revenues tied to a new Spider-Man TV show, which debuts in November.
Your portfolios got beaten up when technology shares fell this year. Why are 40% of your assets in tech stocks? Some of the fastest-growing companies are in technology. Now, because of the selloff, some of our best stocks are selling at 25 times earnings, which for a market-dominating company growing at 30% or 40% is a steal. MicroTouch Systems has a market cap of $144 million, but it's the world's largest manufacturer of touchscreen computer products, which allow you to touch the screen instead of using a keyboard. The stock hit $43 recently, up more than 200% since January. I think it could hit $60 within 18 months. Banks, fast-food restaurants, and computer manufacturers seem to be using more and more touchscreens every day.
Why are 20% of your assets invested in consumer or retail stocks? I'm just going with the companies that are doing best in their industries. Best Buy is one of the top two or three retailers in consumer electronics. And it's growing faster than its competitors. So far, it has 173 stores, mainly in the Midwest and West. People like the atmosphere in Best Buy. Because they are not paid on commission, the sales reps don't attack you. The stock is trading at 19 times estimated 1995 earnings, but its profits are growing at a 32% clip. The stock was selling for about $40 recently. I think it will hit $60 in the next year and a half.
How do you know when to get out of a growth stock? I tend to sell if I see the earnings growth rate slowing significantly or if a competitor develops a better product. But sometimes I'll have a very strong negative feeling and get lucky. In early 1992, I got the sense that investors were really overpaying for health care stocks, so I sold everything in that sector. A lot of doctors called, asking why we sold U.S. Surgical at $123 a share when we paid $40 for it. Everyone knew it was a $200 stock. And of course now it's a $26 stock.
CHART: NOT AVAILABLE CREDIT: FORTUNE CHART CAPTION: ONE OF HIS PICKS: MARVEL Entertainment Group