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Three Financials Experts Pick through the Wreckage

Fund managers spotlight winners and losers as the sector reshuffles.

Harry Milling, 09/30/2008

Did you own shares of insurance giant AIG AIG in the months leading up to last week's near-collapse? Three of our favorite financials stock-pickers did. But before you start throwing tomatoes at these fund managers (or us), consider this: The funds' three- and five-year annualized returns all remain above the majority of their peers--even with the recent free fall. And we're confident that all three managers will turn the recent market turmoil into opportunity.

These managers--Kenneth Fienberg of Davis Financial RPFGX, Charles Lahr of Mutual Financial Services TFSIX, and Jeff Arricale of T. Rowe Price Financial Services PRISX --are deep-value players who have achieved superior returns by sticking with stocks of companies during some of their darkest hours. For example, Feinberg of Davis Financial held on to Tyco International TYC through its accounting scandals and subsequently made a killing for his investors. Still, their stock-picking isn't always perfect: Feinberg held a chunk of AIG in the second quarter of this year, and Lahr held some, too. Meanwhile, Arricale freely admits that he made a mistake with his own second-quarter purchase of Lehman shares.

Even so, one reason we like these managers is that they are always trying to learn from their mistakes. They may make small tweaks to their strategies in light of recent events, but none is scrapping his strategy in a panic. Indeed, several of their picks paid off for the year to date and with stocks few would recognize, like Davis Financial's FPIC Insurance FPIC and T. Rowe Price's StanCorp Financial SFG, or in Mutual Financial's case, U.S. Bancorp USB.

All three have the ability to rise above the din of naysayers and to find stocks' long-term value. Here are some of their views on companies in the headlines.

New Risk Profiles for Morgan Stanley and Goldman Sachs
Manager: Jeff Arricale
Fund: T. Rowe Price Financial Services

Arricale acknowledges that the profitability for Goldman Sachs GS and Morgan Stanley MS looks significantly diminished, but so do the former investment banks' risk profiles. He says the companies are still good businesses and they should be able to earn an adequate spread over their cost of capital and increase book value (Warren Buffett just agreed to invest $5 billion in Goldman). With growing book value, midteens returns on equity, and dominant market share in a number of business lines, investors are likely to be willing to pay for the stocks at least 1.5 to 2.0 times a growing book value in the years to come. But, he underscored that steady 20% plus return on equity is likely a thing of the past for the these Wall Street firms given an expected reduction in leverage and proprietary trading.

Arricale thinks both stocks are reasonable bets here, but the situation is fluid and these stocks are higher risk than other industries within financials. One can own M&A advisory shops that don't take balance-sheet risk, such as Lazard LAZ, and probably do just as well with less risk, he says. Arricale's fund, a Morningstar Fund Analyst Pick, owns Goldman, Morgan Stanley, and Lazard.PAGEBREAK

JP Morgan Poised to Take Market Share
Manager: Kenneth Feinberg
Fund: Davis Financial

Feinberg sees more regulation and less leverage for banks going forward, but earnings growth--through market share gains--looks promising for the industry's strongest leaders. Some companies are going to benefit greatly from this dislocation, Feinberg says, include JP Morgan Chase JPM and Goldman because they should be able gain market share lost by weaker rivals. Feinberg also expects Bank of New York Mellon to buy some of the custodial businesses should global players sell theirs to raise capital.

(As of June 30, 2008, Davis Financial owned shares of JP Morgan Chase, Goldman Sachs and Bank of New York Mellon)

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