If you talk to John Elwood directly you'll get an earful about what's behind stock-price moves. And if you get his voice mail, you won't miss out: Elwood greets callers with his thoughts on the market that day.
Elwood, a Dain Rauscher broker in Chicago and a 31-year veteran, has offered his own brand of contrarian value investing since surviving the bear market of 1973-'74. Specifically, he finds companies with good fundamentals whose stock price has slid from a peak seven years ago.
Elwood calls his stock picking philosophy "The Seven-Year Circuit." It was born back in 1974 when a client bought Boeing at 7 dollars. About three years later, the stock had nearly tripled. "I asked myself how I could find more Boeings," Elwood remembers. "A colleague pointed out that in 1974 Boeing was seven years down from its previous peak. I wondered what could be significant about that?"
In 1977, Elwood began poring over hundreds of stock charts going back to the 1920s. He found that it typically took seven years for a mid-sized company's stock price to travel from a peak to a valley, before climbing in value again.
"Companies get sick because of too many good times," Elwood says. "They then go through a process of denying a problem, realizing a problem, then beginning to focus on solving the problem, which is getting back to basics."
There's nothing magical about seven years-it's just an average. Some large companies complete the cycle in four years, Elwood says, while very large, old companies are so ingrained that they remain in denial longer than seven years.
Each year, Elwood uncovers 50 to 75 stocks in their seventh year down from a peak. He analyzes annual reports and talks to management, looking for "the recognition factor," he says. That's what puts pressure on the leadership. "The stock price doesn't drive management's decision to deal with a problem," Elwood says. "Only the lapse of time and how it wears on management's mind causes change."
Elwood then screens the stocks using Graham analytics, focusing on 10-year price-to-sales, price-to-book-value and price-to-cash-flow ratios. That results in five to seven companies a year with strong balance sheets and a moderate discount from historical valuations.
This year Elwood likes stocks such as Angelica Corp., Battle Mountain Gold, Wellman Inc., British Petroleum Royalty Trust, P.H. Glatfelter Co., Overseas Shipholding Group, Providence Energy Corp. and Ranger Oil Ltd.
About 30 percent of Elwood's nearly 100 million dollars under management is in Seven-Year Circuit portfolios. That represents about 80 percent of his retail clients. (Elwood also does institutional fixed-income business.) Clients are satisfied with returns slightly above 10 percent, annualized over three years, in return for fewer bumps along the way. "I look for regression to the historical mean," he says. "I tell clients that's the bird in the hand."
Each portfolio is customized with about five to 10 stocks. Elwood works with as little as 25,000 dollars, never uses discretion and always lets clients decide if they want to pay commissions or fees. Most choose commissions because of the portfolios' low turnover.
Elwood enjoys the "astounding" ways some companies recover. "An ordinary firm like Maytag has gone from 15 dollars to 70 dollars in three years," he says. And several years ago, he zeroed in on Times-Mirror because both the newspaper industry and California were in a recession. He bought it at 23 dollars, the company spun off Cox Communications, and his holdings of both within three years totaled 70 dollars.
But Elwood sometimes feels like the Rodney Dangerfield of the brokerage business. Contrarian value investing doesn't get any respect, he says. The toughest time yet has been since early 1998. "When the market's focus went to big names with high multiples, big money managers bought growth. From July 1998 through February 1999, my portfolios were down 15 percent on average."
Early this year, Elwood called executives at several companies in his portfolios to offer his explanation of the firms' stock declines. "I told them people were looking at their 401(k) statements in January and were switching to large-cap growth companies. I told them maybe they could talk to their employees about avoiding that."
Elwood isn't about to change his 20-year-old strategy. It continues to pay off since his portfolio returns have recovered since February. "When you live through the bear markets from 1969 to 1974, you're scarred for life. You evolve into value investing and won't touch growth investing."