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Lessons From the Large Caps

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Why portfolio manager Joe Milano loves tech and health care, but not financials.

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As he travels the country, chatting with C-suite executives from a range of diverse industries, Joe Milano, the 37-year-old manager of the T. Rowe Price New America Growth Fund (PRWAX), hears a common question: Where's the recovery?

"Companies are like investors: They're hoping a recovery is coming, but they haven't seen it," Milano says. "Things aren't worse and maybe, at the margin, they are a bit better, but not significantly so."

Milano himself, while cautiously optimistic about near-term economic prospects, is skeptical about the recovery the US will experience over the next two to three years. He's positioned his portfolio so it isn't reliant on a big economic tailwind.

"The fund doesn't need the economy to rip in order to benefit," Milano says. "I don't need a big number, just a positive one."

Milano took the reins of PRWAX in July 2002, and he's proven himself a capable captain. Through September 23, the large-growth fund's five-year annualized return of 4.22% leads the S&P 500 by 3.02 percentage points, and bests 85% of its Morningstar peers. In fact, Morningstar recently highlighted Milano as an early contender for domestic-stock manager of the year.

An added attraction of PRWAX: It costs a relatively cheap 0.91% per year.

Minyanville recently caught up with Milano at his office in Baltimore, Maryland. We spoke about his views on the economy, the market, and some of his favorite picks like Apple (AAPL), Medco Health Solutions (MHS), and Monsanto (MON).

Minyanville: What's your take on the economy?

Joe Milano: In the near term, things could look good. Consumers are getting more confident; unemployment is going up, but the pace is slowing a bit; comparisons are easy. So, for the next year, my view is that the economy is getting better. But I spend a lot of time thinking more long term and, there, I'm less positive.

Minyanville: How come?

Milano: My intermediate to longer-term view is that we will get some growth, but it won't be all that great. The consumer won't lead us out, taxes are going up, and the government isn't in good shape financially.

Minyanville: What's your outlook for investing in large companies?

Milano: I am bullish on a name-by-name basis. Right now, the sexier and junkier, the more it's up. The more boring and higher quality, the less it's up. But I think the market will get more selective as the rebound and rally age. Starting between now and 2010, we will be in a market where you will want to own larger over smaller, higher quality over lower quality, and stuff where expectations are low.

Minyanville: How do you see the earnings trend unfolding over the next couple quarters?

Milano: In the near term, they will be good. You have this little recovery on the demand side, and a rebuilding of inventories in the system. The comparisons will also be easy in the fourth quarter, first quarter, and second quarter. I actually think the earnings trajectory in the next few quarters will look positive because we will have a bounce in revenue growth and better-than-expected margins. Headlines will be more positive than negative.

Minyanville: Explain the fund's strategy.

Milano: I am trying to run a pure growth fund that blends out to be a large-cap growth offering. I also own mid-cap growth stocks because I want to infuse the portfolio with some names people haven't heard of. The power of growth investing is compounding. I would much rather own a company that can grow 15% per year for five straight years as opposed to a company that can grow at 20% for two years and then flames out. I am looking for sustainable, durable growth companies. Finally, I use the market's volatility to my advantage.

Minyanville: How so?

Milano: When people are bearish, I tend to be bullish. When people are bullish, I tend to be bearish. The herd moves so quickly. Back in March, you couldn't give a stock away. Now, six months later, the psychology has changed so much. I am not a contrarian, but I do like to lean against the wind a bit. I want to buy great companies, but I don't want to pay exorbitant prices for them.

Minyanville: Moving on, let's talk about technology, which has the largest weighting in the portfolio. What do you like about that sector?

Milano: For one, there is secular growth there. If companies want to grow, but they don't want to hire, then they have to get more productive. Productivity will be important over the next few years, and technology in general is an enabler for that. Also, people have gained religion on how important balance sheets are. The nice thing about technology companies is you don't have to worry about their balance sheets. Most are financially very strong. Third, the valuations of a lot of tech stocks I own were very reasonable.

Minyanville: You like Apple. What's the thesis?

Milano: I think we are in the early stages of growth in the smart phone market. There may be lots of people trying to make a play in that market but, for now, there are two serious competitors: Apple and Research in Motion (RIMM), and I own both. The growth in the iPhone, along with the fact that the Mac line will be a market-share gainer within the PC segment, tells me there is a lot of growth left in this company. At the margin, I have trimmed some of the stock as it lifted, but it is still a top position for the fund.

Minyanville: How about health care? That sector accounts for 18.5% of the portfolio.

Milano: The market doesn't like health care for two reasons: political uncertainty and the fact that, if the economy is recovering, then you want to own more cyclical stuff. So health care has underperformed this year.

Minyanville: So what do you see?

Milano: I look at health care as to what it could look like over the next couple years. The economy is not going to rip. From a big picture standpoint, health care will look relatively attractive to people.

Minyanville: What about the ambiguity of health-care reform?

Milano: The market doesn't like the uncertainty. But the market can absorb anything that comes out of Washington, actually. And I think it is pretty clear that whatever does come out of Washington will not be the worst-case scenario. So, I think that once we get some certainty as to what the plan looks like, it almost doesn't matter what the plan is. Third, when I look name by name, there are just more companies in health care that are intriguing to me.

Minyanville: You're a fan of St. Jude Medical (STJ).

Milano: Yes, it's a high-quality company that should grow mid-teens. It's not an expensive stock. I am upping my position. There are lots of situations like St. Jude where I can buy them when people hate them and make good money over time.

Minyanville: How about Medco?

Milano: Medco is a potential beneficiary of health-care reform. The whole idea of reform is to cut costs in the system. We pay too much for it. Generic drugs are a clear way to do that. Medco's mission is to convert people from branded drugs to generic drugs when the generic is available. It's a pretty clear and simple thesis. The trend line for generic drug use is up and to the right. Medco is a leader in that space.

Minyanville: What about health care IT stocks?

Milano: I do like companies like Cerner (CERN) and Allscripts-Misys Healthcare Solutions (MDRX). There is big stimulus money behind trying to digitize doctors' offices and hospitals and that is a theme that will stay with us for at least a couple years. So, again, people might get nervous and question what I'm doing in the middle of this health-care reform, but I think companies like Medco and Cerner could be beneficiaries to reform rather than vulnerable to it.

Minyanville: Financials aren't big area of emphasis for the portfolio.

Milano: I have avoided big bets in financials. I'm not convinced that we're totally out of the woods in terms of the bad news coming out of the financial sector. We still haven't seen the worst of what will happen in commercial real estate, for example.

Minyanville: How are you playing consumer discretionary right now?

Milano: I own Electronic Arts (ERTS), Priceline.com (PCLN), Carnival (CCL), Advance Auto Parts (AAP), Whole Foods (WFMI), and I recently started buying a position in Harman International Industries (HAR). But I think we are in the later innings of that sector being a good sector, not the early innings.

Minyanville: Finally, let's talk about agriculture. Why should I like Monsanto?

Milano: The long-term theme around agriculture is very positive. When developing countries build a middle class, people shift to protein-based diets which require more corn and soybeans. It's pretty clear to me that the demand side for the types of seeds Monsanto sells will be strong. Also, what the company is really selling farmers is technology to help their acreage be more productive. That's important because there just isn't that much farmland left in the world to tap.

Minyanville: How did you deal with the stress of running a portfolio during the market meltdown?

Milano: After seven years at this job, I have confidence in my process, and the process said to buy the highest-quality companies I could that would grow over a multi-year basis. It was a scary time, but I focused on the opportunity, and the potential to make a lot of money in these stocks. That's what I told myself every day and it has paid off. I learned that if you keep a level head, while other people are freaking out, you can pick some things off pretty nicely.

Minyanville: Thanks for your time, Joe.
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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