Buffett, 3 funds set to soar

By Tim Middleton

Wall Street celebrated two investment milestones last week, and you can make money by taking the path they follow.

The Dow Jones Industrial Average ($INDU) broke through its record of 11,722.98, set in early 2000, demonstrating that companies that make things have become investors' best friends. This is an Old Economy market; the New Economy benchmark, the Nasdaq Composite ($COMPX), is still 40% below its peak in 2000.

Also, Class A shares of Berkshire Hathaway (BRK.A, news, msgs) traded above $100,000 -- a price surge of 5% in just two weeks. Berkshire's boss is Warren Buffett, the ranking high priest of value investing, which celebrates manufacturing and shuns technology.

As embodied by the Dow and implemented by Buffett, value investing is winning in the market today because of two essential qualities completely alien to the Internet bubble.

The first is the notion of intrinsic value -- the price a well-informed buyer would be willing to pay. The second is the margin of safety explained by Benjamin Graham in his book "The Intelligent Investor." Value investors buy companies that are trading at a substantial discount to their intrinsic value, slashing the risk they will lose money.

"We are as concerned with the return of our capital as we are with the return on our capital," says Christopher Browne, author of the forthcoming "Little Book of Value Investing" and co-manager of Tweedy, Browne Global Value Fund (TBGVX).

Browne's fund is closed to new investors, and unfortunately so are a great many of its best rivals. The value style has been so successful since the Internet fantasy evaporated that most managers have been flooded with money.

Dodge & Cox Stock (DODGX) is sitting on $57 billion. Funds that invest in smaller companies have maxed out and closed with far less. T. Rowe Price Mid-Cap Value (TRMCX) has $5.7 billion in assets; Nicholas-Applegate US Small Cap Value (NASVX) has $113 million.

But I can suggest four ways to buy into the value boom -- a common stock, an exchange-traded fund and two mutual funds. If you haven't yet awakened to the value opportunity, this is where you should be shopping.

Berkshire's back

Berkshire Hathaway also comes in a Class B series of stock, Berkshire Hathaway (BRK.B, news, msgs), which was trading last week around $3,280 a share.

Berkshire is more like a mutual fund than a stock in many ways. Warren Buffett, who began his career as Ben Graham's savviest employee, has cobbled the company together from other companies he bought with shareholder premiums from insurance operations.

The list of Berkshire subsidiaries is long -- there are nearly 50 of them -- and emblematic of Buffett's focus on the everyday world. They range from Acme Brick to XTRA, which leases trailers, and include Geico insurance, NetJets, See's Candies and Benjamin Moore, the paint company.

Last summer I got an e-mail from a reader who owned one Class A share of Berkshire, which was then trading around $85,000. (The shares are so expensive because Berkshire doesn't split its shares or pay a dividend; Buffett invests the money in the ever-growing list of subsidiaries.)

The shares had been flat for more than 18 months, and she had become impatient. I tried to dissuade her from selling, pointing out that Berkshire was the only common stock I own myself (the B shares), and I had bought it at the very time she was considering selling. I saw that long period of underperformance as a buying opportunity.

She threw in the towel, and since then the shares have risen nearly 20%. But they've got plenty of room to grow further. Berkshire's assets include more than $40 billion in cash. As Buffett finds ways to spend it -- he's currently focusing on utility companies, but he's open to almost anything -- returns on those moneys will rise from single to double digits, and earnings with them.

Morningstar estimates the A shares are worth around $129,000 and the B shares $4,300.

An investor's best friend

With the Dow beating both the Nasdaq and the S&P 500 ($INX), the easiest way to take advantage is to buy Diamonds Trust (DIA, news, msgs), an exchange-traded index fund that's up 12.7% this year, as of Oct. 5, beating the S&P 500 by 2.7 percentage points.

The fund mirrors the Dow and has its greatest weighting in Altria Group (MO, news, msgs), the world's largest tobacco company. Other top holdings include Boeing (BA, news, msgs) and 3M (MMM, news, msgs). None of them are among the top holdings of the S&P 500 Index, which instead focuses on faster-growing companies like Microsoft (MSFT, news, msgs) and Citigroup (C, news, msgs). (Microsoft is the publisher of MSN Money.)

Since stock prices ultimately reflect earnings, most investors believe high-growth companies are better investments than stodgier firms. But that's a fallacy, because another component of price is the multiple of earnings that investors are willing to pay. High growth equals a high price-to-earnings ratio, and that multiple is the first thing to crack in a poor market.

Even in its depressed state, the Nasdaq 100 Trust (QQQQ, news, msgs) holds stocks with an average P/E of 25.8. For the Dow it is 16.8. A lower P/E means less risk. Value investing trumps growth over extended periods because it loses less in bad markets. Stocks that start out cheap don't usually end up a whole lot cheaper.

Endangered species

With so many good value mutual funds closed, it's a relief to come across Delafield Fund (DEFIX). This almost unknown portfolio -- total assets are only $454 million -- is up 12.3% this year and ahead an average of 18.5% in each of the past three years.

Delafield is a perfect fund for these times because its deep-value style leads directly to the kinds of companies that are doing best: manufacturers. While the typical value fund has 40% of assets in manufacturing, and the Dow has 50%, Delafield has 60%.

Many value rivals are handicapped by their fixation on dividends, which Delafield eschews. Since yield equals dividend divided by price, a high-yielding stock is low-priced by definition. Financial services is traditionally the highest-yielding market sector, and the typical value fund has 25% of its assets there.

Delafield has 2.5%. "Dividends have their place," says Dennis Delafield, founder and co-manager, but good corporate managers can choose not to pay them (as with Buffett). "If it turns out they should pay off debt, or make intelligent acquisitions, or buy back their stock, I believe in that," he says.

I first wrote about this fund in May 2002, near the bottom of the bear market. If you had invested in it the day that article appeared, you'd have enjoyed a 66.7% return since.

Foreign stocks can also be cheap, and Harbor International Investor (HIINX) has showered profits on investors -- an amazing average of 24.9% in each of the past three years.

Credit the keen insight of manager Hakan Castegren, who has been at the helm since 1987, and his assistants. "Castegren and his team identified the mismatch (in energy and materials stocks) between strong demand and constrained supply early on, and they continue to play that theme successfully," says Kai Wiecking, a Morningstar analyst.

Harbor International has 57% of assets in the manufacturing wing of the economy. Although assets have ballooned to $15.59 billion in the fund's various asset classes, the fact that it invests strictly in giant companies hasn't made that a problem.

Top holdings include Petroleo Brasileiro (PBR, news, msgs), Japan's Canon (CAJ, news, msgs) and Great Britain's Diageo (DEO, news, msgs), the spirits company.

My reader who sold her Berkshire share was disappointed that I could not guarantee she would realize a quick return on her investment. Who knows when the market will catch up with reality? I sure don't, but I have confidence that it will catch up eventually.

Investments like these are an excellent place to be right now. Someday growth will return to favor and value will languish, as it did in the late 1990s. But today is not that day. Today's market reminds me of the fellow who bites the coin to make sure it's not phony. Manufacturing is something you can sink your teeth into; the New Economy is not.

At the time of publication Timothy Middleton owned the following securities mentioned in this article: Berkshire Hathaway, Dodge & Cox Stock, T. Rowe Price Mid-Cap Value and Tweedy, Browne Global Value.