Nicholas: different goals, one discipline


November 15, 1992|By WERNER RENBERG | WERNER RENBERG,1992 By Werner Renberg

"As I get older," says 61-year-old Albert O. Nicholas, "I realize more and more that you have to worry about companies and stock prices, not about elections, inflation, and the interest rate outlook. You can't ignore them, but you shouldn't be overwhelmed by them.

"You can't get away from the mission: picking stocks."

Milwaukee's Nicholas should know. He has managed the 23-year-old, $2.4 billion Nicholas Fund through six Presidential elections, six mid-term elections, four complete business cycles plus the latest recession and wide swings in inflation and interest rates. By sticking to his mission, Nicholas has achieved one of the top long-term performance records among growth funds.

And if that weren't challenging enough, in 1977 he took over management of a mixed income fund, restructured it into a "quality junk bond" fund, Nicholas Income Fund, and in the 1980s formed two small company growth funds, Nicholas II and Nicholas Limited Edition.

Their objectives may be different, but the four no-load funds have at least two things in common:

* Nicholas' name, which requires little explanation inasmuch as he owns 97 percent of their investment adviser, Nicholas Co.

* His disciplined approach to securities selection, which doesn't require much explanation either.

The approach has a few basic elements:

* Company size. He prefers small (less than $500 million in sales) and medium-size ($500 million to $1 billion) companies. But, because of Nicholas Fund's size, he has to buy larger companies (such as Philip Morris) for its portfolio, too.

* Valuation. He likes companies whose stocks have relatively low ratios of price to "trailing" -- not forecast -- earnings.

* Growth orientation. He favors securities of companies in growth industries over those of companies in cyclical industries.

* Financial strength. He wants firms with good balance sheets.

* Management ownership. Assuming that people work harder if they have a stake in their firms, he wants management to own shares.

* Patience. Investing for long-term results, he looks for issues that he can hold for five to 10 years. (Nicholas Fund, for example, has owned shares of Dean Foods and International Dairy Queen for more than 10 years.) "If you buy stocks cheaply enough, over time you can benefit from both earnings growth and an increase in the P/E ratio."

The low portfolio turnover rate resulting from a policy of holding securities for the long-term yields an additional benefit for shareholders. "We don't create a lot of [taxable] capital gains," he points out. "After-tax return to shareholders is important."

* Reasons to sell. "The only reason to sell a company is a very high P/E ratio or a disappointing turn in its earnings trend."

Nicholas tries to remain fully invested, which he defines as no more than 10 to 15 percent in cash equivalents. (At one time, he accumulated as much as 25 percent.) When comparing his funds' performance with the S&P 500 or other benchmarks, you have to remember that their returns were achieved with such cash positions.

So much for the past. What does he think of market prospects now?

Nicholas is cautious for the near term, he says, because "not many stocks are cheap" -- as indicated by the S&P 500's P/E ratio of around 24. He has held his portfolios to around 17 times earnings.

For each stock fund, his informal guidelines call for core holdings of around 10 percent in each of five sectors: consumer products, nTC retail trade, insurance, banks/financial services and industrial products and services. Beyond these, he has been increasing his positions in health care and slowly adding energy.

Nicholas Income Fund's asset distribution among sectors differs bit because its fundamental policy requires it to be 10 percent invested in electric utilities and because, unlike the stock funds, it has high income as its primary objective. Nicholas uses stock analysis to find "bonds that make sense" for the fund -- not surprising, since the prospects for both a company's junk bonds and its stock depend on its profit outlook.

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