Rogers: Keeping Your Wits in a Tough Market

Michael Breen: Greetings. This is Mike Breen coming to you from the Morningstar Investment Conference. I'm fortunate enough to have John Rogers of Ariel Investments with me. How are you?

John Rogers: Glad to be here.

Breen: We just had a great panel with you and some other small-cap/mid-cap managers. And a common theme, sort of a tough year last year for a lot of folks. A lot of the same names that were down last year are back in the last three months. We've discussed this, you and I, but I've just been wondering how you stick to your discipline in a tough year like that when the fundamentals, in your opinion, look great, but the stock is diverging.

Rogers: Well, there are a couple of things. I think, first and foremost of course, you have to recheck the thesis and talk to everyone you can. You've got to go and talk to the management of the company over and over again, talk to the board of directors, you've got to talk to the sell-side analyst, you've got to talk to your competitors and peers who own the stock or don't own the stock for a reason. So you've got to check that thesis in as many places as you can when a favored stock is really out of favor. That helps to inform your judgment about whether to add more or not.

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And overall, to gain confidence in a down market, it's always good to talk to peers, too. During this period I had dinner with Bill Miller, and I had lunch with Staley Cates from Southeastern Management.

Breen: They were doing a little worse than you! [laughter]

Rogers: I know. I guess misery loves company! You've spent some time with Lou Simpson. He runs Geico investments. You go to people who you do respect and admire to help you keep your wits.

Breen: Have you ever seen a market that volatile? We'd spoken about one name, not just to pick one, but Royal Caribbean Cruise Lines. We had a firm that's sort of a strong player in its niche, financials look fine, but it had debt, and the market took it down. I think we were talking about it when it was at $20. It went as low as $3 and then sat there. You guys stuck with it and added to it, I believe. And then in the last three months it has gone up 175% and nothing has changed with the firm. I can't recall a time when that short of a period heeded that type of stock movement.

Rogers: I've never seen anything like it. As we have talked, the analyst community helped to light a fire there. You have a firm like William Blair where you have a thoughtful experienced analyst who maybe didn't believe completely the story that Royal would earn $1.40, but maybe was somewhere between $1 and $1.40 in their estimates. Then you had some other analysts who you thought maybe had been talking to short sellers and really didn't understand the story, who thought they would lose a dollar a share, and thought the company was worthless.

And it just didn't make any sense that you would have that kind of discrepancy in valuation and earnings projections from one analyst to another. And ultimately, the facts came out that the company will earn somewhere close to $1.40 a share and that's what has helped the company come back. Maybe they won't quite get there, but earnings will be reasonable.

And they also have been able to finance their new ship, which people were skeptical of. I think that what's happening, what we keep talking about in our research meetings, is the analysts get a bearish decision in their mind, and they are looking for facts to support their pre-determined position.

Breen: You had several examples of stock you had owned where the Wall Street analysts had taken down their projection for the results by, say, 10%, and then put a sell on it and took their target price down by 80%. So it is sort of a disconnect where it would be perfectly fine if they were aligned and went down equal, but the discrepancy is a little bit different as well.