Morningstar Advisor - Fall 2007 - 58

Undiscovered Managers One thing I love about Bill Miller is the idea that his process should evolve over time. You don’t ever want to be dogmatic. Dennis Lynch How To: Dig for Cash Cows with Economic Moats Besides excess returns on invested capital and competitive advantages, Dennis Lynch looks for healthy cash flows. You can search for similar stocks in Advisor Workstation and Principia. Because we’re cheap, we added a criterion that the stock has to be undervalued. Use the following screen: Cash/Total Assets % . 5 Free Cash Flow/Sales%–Trailing 12 Mo. . 5 Free Cash Flow/Sales%–Year 1 . 5 Free Cash Flow/Sales%–Year 2 . 5 Free Cash Flow/Sales%–Year 3 . 5 Economic Moat 5 Wide Morningstar Rating > 4 movements and thinking about whether to add or trim a stock on the margin. So the team limits most of its trades to one time a month. Portfolio turnover on each of the team’s strategies has come down steadily in recent years, and Lynch expects it to drop further. Self Awareness: The Ego Killer with a larger organization,” he says, “but I think it’s more than offset with the resources.” Given the success of the Lynch team and its location in heart of midtown Manhattan, there is a surprising lack of ego running through the hallways of Lynch’s office. His walls are adorned with hand-drawn pictures made by his children. “The Matrix” is loaded and ready to go in the DVD player, and boxes full of books crowd the floor. Borrowing a page from Davis, Lynch has a “wall of shame” in the office highlighting the team’s biggest missteps. To Lynch, being self-aware and always thinking critically about one’s own weaknesses and biases are critical to the team avoiding those types of missteps. He doesn’t want big egos or preconceived notions clouding their judgment and sending the team down the wrong track. “Every day is another battle,” comanager David Cohen says, “so I don’t think any of us feel like we can really relax.” Except, maybe, while curled up with a good book. K Karen Dolan is a senior mutual fund analyst with Morningstar. Lynch built his investment career at Morgan Stanley, but most of what has influenced him has come from outside of the firm. Some of the people he considers mentors— Miller, Warren Buffett, and Davis Selected’s Christopher Davis—he’s met briefly or not at all, but he has read practically everything they’ve written. The person, however, who ranks highest on Lynch’s list is his father, who goes by the same name and is also an investor. The senior Lynch founded an asset management firm named Lynch & Mayer in the 1970s. His investment style was starkly different than what his son does today, largely because the market environment was different at that time. The senior Lynch helped pioneer investing concepts such as earnings estimate revisions. Despite their differences, the son got to see firsthand from his father how small investment firms function. His father’s firm influenced his decision to create a small, tight-knit team atmosphere inside of a behemoth organization such as Morgan Stanley. Lynch says that he’s not interested in running a business and managing big groups of people. He wants to invest. And despite the executive level turnover and a sales-minded culture that we have observed at Morgan Stanley over the years, Lynch points to Morgan Stanley’s hands-off approach. “There’s always going to be a little bit of friction Value’s famed skipper as a role model. “One thing I love about Bill Miller is the idea that his process should evolve over time,” he says. “You don’t ever want to be dogmatic.” One example of his evolution is that his funds have become more concentrated over the years. He came to the realization that he doesn’t want the team’s best ideas to be watered down by stocks in which the team has less conviction. The team’s large-cap funds, for example, are avoiding big banks because they don’t fully grasp the risks lurking in their balance sheets. The same holds true for biotech companies in the smaller-cap portfolios. Lynch also adjusted the way the team trades. He wants everyone focused more on investment ideas than watching daily stock Listen to Dennis Lynch discuss investing at http://MorningstarAdvisor.com 58 Morningstar Advisor Fall 2007

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Morningstar Advisor - Fall 2007

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