Beat It, Losers : Bonnel’s Formula Is to Be Cold-Blooded About His Stocks

Among money managers, Art Bonnel is one of the sharpest shooters and quickest draws in the West.

From his home office in Reno, he has guided United Services Bonnel Growth, a 2-year-old stock fund, to one of the best records of any mutual fund over that stretch.

Previously, he beat the market as head of the now-defunct MIM Stock Appreciation Fund, which he managed from August 1987 to May 1994. Bonnel is a cold-blooded investor who seeks fast-growing companies, with little real regard for the businesses they’re in. He’ll buy any stock that meets his criteria--and quickly dump any holding that trips.

His $100-million fund, part of the United Services group in San Antonio, currently owns about 90 stocks from 50 industries. He is an outside subadvisor to the fund rather than an employee of United Services.

Russ Wiles, a mutual fund columnist for The Times, caught up with Bonnel while he was vacationing in Palm Springs.

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Times: It must be great to have your name on a mutual fund. Do you manage any money other than what’s in the fund?

Bonnel: No, just the fund. Running that much money, I don’t want to get too involved with other responsibilities. I’ve got my money in the fund, and I want to take care of it.

Times: What’s your formula for picking winning stocks?

Bonnel: The main secret is consistency. I have a set of parameters that I look at for every issue. As long as they’re working, I will hold on to the stock. If they break down, I will sell. The key to making money is finding a good system and sticking with it through good times and bad. For me, selling is easier than buying because if a company no longer can make it through one of the four steps, I get rid of it.

Times: Can you elaborate on those four factors?

Bonnel: First, the company has to be earning more this year than last. Quarter-by-quarter comparisons are the first steppingstone.

Second, I look at the current ratio, which divides current assets by current liabilities. I like to see assets exceed liabilities by at least a 2-1 ratio. I don’t want management worrying about being able to pay the current month’s light bills, salaries, insurance and so on.

Third, I like to find companies with very low debt. Very few of the stocks I own have debt that exceeds 30% of the company’s equity. About half of my companies have no long-term debt.

The fourth item is equity ownership by management. I’m a shareholder in my fund, and I realize how important this is. I want management to try to make money for themselves. If they do, I’m getting a free ride.

Times: How much management ownership is desirable?

Bonnel: I like to see top management own 5% to 15% of the total shares. But I don’t like the total to exceed 40% or 50%, because then the firm tends to be run like a family business, with little effort to enhance shareholder value.

Times: So four steps--that’s it?

Bonnel: Not quite.

A lot of companies meet these four parameters, so then I’ll look at additional factors like P/E [price-to-earnings] ratios and technical aspects. But if any one of those parameters no longer fits with one of my current holdings, then I will sell the stock, let the company work out its problems, then take another look at it later.

To me, stocks are basically just ticker symbols. I don’t love them or hate them. As long as they perform, I will hold them. In mid- to late January, many of the companies I own will report their earnings again, and I will reassess each situation.

Times: So which stocks do you like best at the moment?

Bonnel: Uniphase is one. I’m expecting very good things out of that company. They make laser subsystems and instruments for detecting defects on semiconductor chips. They use blue and green laser lights rather than red ones, which allows them to deliver more information faster. Don’t ask me specifically how their products work, but they’ve had a great track record.

Centennial Technology, my second-largest holding, makes computer peripheral equipment such as PC cards. I bought the stock at $8 a share in November 1995, and now it’s above $40. What has been driving this upward trend is triple-digit earnings growth for more than a year.

Times: So you don’t look too closely at what a company actually does?

Bonnel: That’s true. If you put a 32-bit processing chip and a 16-bit chip in front of me, I couldn’t tell the difference, unless maybe I put them under a microscope. But I do understand that one gives data quicker and provides for applications like videoconferencing better. I try to analyze whether there’s a long-range market for the product.

Times: Are you mostly buying small stocks?

Bonnel: Not exclusively. Another holding, Merck, is a big company with which everyone’s familiar. I also own Sears Roebuck. So any company is fair game for me. But in general, the majority of my companies have capitalizations between $250 million and $1 billion, which I define as the mid-cap range.

I don’t like to buy stocks that are too small, because then it can be hard to trade even 1,000 shares. I don’t want to move the market. And as I said, sometimes I find good values in larger companies such as Sears and Merck. But I’m not looking for extreme gains in these larger firms. Rather, it’s the smaller companies like Uniphase and Centennial Technology that can be a lot of fun.

Times: The average P/E ratio on the stocks in your fund recently was reported at 36.

Bonnel: That might be a little high. But when you’re looking for growth like I am, you have to be willing to pay for it.

Times: You said you track management’s ownership in a company, but how much scrutiny do you give management itself? For example, how often do you meet with management?

Bonnel: I never meet with management. I just look at the ownership numbers that top managers are required to file when they buy or sell stock. If I see a lot of insider selling, it might mean something is wrong. That’s a real flag of caution for me. Of course, everything is relative. I once noticed that a manager had sold $19 million in shares. But that represented less than 1% of the person’s holdings at the time. It happened to be Bill Gates [of Microsoft].

Times: How about a favorite company that exemplifies your low-debt focus?

Bonnel: One would be ADC Telecommunications, a company that works with fiber-optic cable to transmit data quicker, cheaper and more efficiently. They reported 22 cents a share in quarterly earnings versus 15 cents a year ago. They have $400 million in cash and $100 million in current liabilities. Their debt equals 1% of capital.

Another example is a stock I recently bought, American Power Conversion. It makes surge protectors for computers. It has no long-term debt and just $60 million in current liabilities, compared with $300 million in cash. That’s a 5-1 current ratio. Officers and directors own 21% of the stock. That’s a little high but still within my range. The company had a couple of years of touch-and-go earnings but now appears to have gotten its act together. At the end of October, it reported quarterly earnings of 30 cents a share, versus 18 cents a share a year earlier.

Times: The amount of cash in your fund recently was reported at just 0.5%, with everything else in stocks. How can you keep cash so low with shareholder redemptions and all?

Bonnel: The report I got today showed we had just $828 in cash on a $100-million portfolio. That’s what’s called being fully invested. You got that 0.5% number on a day I had a little extra cash!

I stay fully invested as a general rule. If earnings are coming out and I don’t like some of the numbers, I might sell some holdings and wind up at 3% or 4% cash. If the market was heading down and redemptions were rising, I’d have to build up a little more cushion, but I’d never go to 20% or 30% cash. If people buy my fund, they’ll get a fund that stays nearly fully invested. I don’t try to time the market.

Times: It seems as if you’re bullish about stocks in general.

Bonnel: I’m extremely optimistic about the market. The true genius of investing comes from recognizing the direction of the big trend, not trying to pick short-term tops or bottoms.

The long-term direction is up. It’s being fed by baby boomers focusing on retirement planning. The money funnels every day into IRAs, 401(k)s, 403(b)s and SEP-IRAs. If the market goes down, enough people are going to buy in at the cheaper prices to help it recover. They’re looking long-term.

There are 76 million baby boomers. Every 7.5 seconds, somebody is turning 50. According to federal government statistics, people in the 45-to-54 age range are in their highest-income years. I turned 50 not long ago. I associate with people in this age group. I understand what they’re saying.

The market has a very good chance of hitting 20,000 on the Dow in 2007. We’re at around 6,500 now. Reaching 20,000 would represent a yearly return of only 10.7%. If I’m wrong and the market rises only 7.9% a year by then, that’s still 15,000 on the Dow.

Times: Do you ever buy foreign stocks?

Bonnel: I tend to avoid them because they don’t meet the strict accounting standards that are imposed on U.S. companies. The U.S. has something like 9,000 stocks. I have plenty to pick from here.

Times: Your fund’s turnover rate of 145% seems a bit on the high side, and its expense ratio of 2.48% seems quite high. Any comments?

Bonnel: Turnover is a bit high, but this really reflects a tendency to sell losing stocks quickly while hanging on to the winners.

For example, [in 1996] we’re paying out only 16.5 cents a share in [capital gains] dividends--less than 1% of the fund’s per-share price. Considering we returned around 25% over the 12 months ending Oct. 31, that makes us a very tax-efficient mutual fund.

I’m a shareholder too, after all. If I can postpone taxes or move them into the long-term capital gains category, I will do it.

As for the fund’s expense ratio, that just dropped to around 1.83% this year. I hate to see that 2.48% number. It reflects our first year of operation, when we had only about $20 million in assets. As the portfolio has grown, we have been better able to spread out our fixed charges--for accounting, legal and other services--over a wider asset base.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

United Services Bonnel Growth Fund

Strategy: The fund seeks long-term appreciation by holding domestic growth stocks, mainly small- to mid-size issues.

VITAL STATISTICS

Total return: 1995: +45.2% 1996: +27.9%

2-year average annual return: +36.6%

2-year average annual return for

general U.S. stock funds: +25.0%

Five biggest holdings as of Nov. 29:

1. Uniphase. 2. Centennial Technology. 3. BMC Software. 4. PeopleSoft. 5. Northern Telecom.

Max. sales charge: None Assets: $100 million

Min. investment: $5,000 Phone: (800) 426-6635

Sources: Lipper Analytical Services, Morningstar Inc.