Q&A: ROBERT SMITH "WE’VE TRIED TO BECOME A LITTLE GROWTHIER"

T. Rowe Price Associates’ golden oldie, the Growth Stock Fund, isn’t just what you’d expect of a mutual fund that’s been around since 1950: It invests in

the beefiest of the big-caps, which is unusual enough for a growth fund, but even more unusual, 20% of its portfolio is made up of foreign stocks.

As is usual with the conservative Baltimore company, the mix works.

The fund, in its second year under manager Robert Smith, has continued to outshine the competition.

While it has maintained lower-than-average risk and is beating the Standard & Poor’s 500 stock index so far this year, it hasn’t surpassed it over the three-year period. This point is not lost on Mr. Smith.

“There’s a lot more to do. The category as a whole has done well,” he says. “It’s trailed the index, which has beaten 90% of the funds, so it hasn’t done all we’ve wanted it to do.”

Mr. Smith took over in late February 1997, replacing John Gillespie, who left to start Prospector Partners LLC, a hedge fund in Hartford, Conn.

Mr. Smith joined T. Rowe Price in 1992 after a stint analyzing various industry sectors, including food and beverages, tobacco and telecommunications, for Massachusetts Financial Services.

“Bob’s greatest strength is that he can get right to the heart of the issue very quickly. He has an innate sense of what the three or four most important issues are,” says Mr. Gillespie of his former colleague.

Adds Larry Puglia, who runs T. Rowe Price’s Blue Chip Fund, a sibling rival: “He likes to collaborate with other people and get the benefit of their thinking.”

Growth Stock was the first mutual fund established by the firm’s founder, Thomas Rowe Price, and is now its fourth-largest equity fund.

Q You’ve beaten your peer group averages in your first year as a portfolio manager. How did you do that?

A It’s done reasonable. I wouldn’t say it’s been spectacular. The large-cap sector has been a good place to invest, which has helped the fund. The fund has been an average-performing fund. I wouldn’t say it’s been lightning improvement. I try to do better than the average growth fund, and better than the S&P 500.

Q With hundreds — if not thousands — of growth funds, what separates yours from the pack?

A Two things are different. One is the international component, which has averaged in the low 20% range.The average growth fund has maybe 5% to 7%.

The other thing is that it is obviously larger-cap growth. The average growth fund has in the teens of billions whereas our average capitalization is in the 20s.

An example is General Electric Co., our largest holding, which is a $300 billion company. Most growth funds are mid-cappish.

The third thing: We take lower risk. We tend to have a lower beta. We pay more for sustainable growth, not just explosive growth. Stocks like Excite and Yahoo! — we tend not to own those companies.

Tying in with that, we tend to turn the portfolio over less.

Q How has the fund strategy changed over time?

A It’s always been a conservative large-cap growth fund with an international component. The strategy hasn’t changed. The only thing that’s changed is we’ve tried to become a little growthier. We took a little money out of insurance and put it into technology or consumer non-durables. I’ve pared back holdings on the insurance side, and I’ve added names like Network Associates, Gillette Co., and increased my drug weighting.

Another difference would be that free cash flow has become a bigger part of growth for companies. Going back several decades, companies tended to plow more of it back in the business. They tended to be less good capital allocators than they are today.

Q What are some examples of these “good allocators?”

A We’ve increased our Travelers Group weighting. And Allied Signal, USA Waste Services Inc. and Bristol-Myers Squibb Co. They have good free cash flow. The returns they get on their investments are high.

A bad user of capital buys assets at a high price, drains management attention (on low-return businesses) and drags down the results of their existing business.

Danaher Corp. and Tyco International are two companies that we own that tend to generate a lot of cash and then use that cash to make acquisitions. The base businesses they’re in grow in the single digits, but because of their use of cash flow the companies as a whole can grow 15% to 20%. They’re growth companies even though they don’t operate in growth markets.

Travelers is another good example of a company which we would call a growth company, even though many of their markets are not growth markets.

We would tend to own a higher percentage of companies that grow through cash use, and we tend to pay a bigger premium for consistent earnings growth than the average growth fund.

Q How did your international component affect the fund over the last year?

A We currently own about 20% international. It was 28% international when I took it over. We’ve trimmed some things off. International has been a drag on performance. It’s probably underperformed the U.S. about 20%, but it’s part of what this fund is.

I tend to go to Europe two or three times a year. The companies we own we own as individual securities, not just because we want to be in the U.K. or in Italy.

In early ’97 we sold off a few percent that was in the Far East, which has worked well. We still own approximately 1% in the Far East, and that has been a drag.

Europe has had a huge run in terms of performance. Recently we trimmed some of our European stocks because of valuations. Vodafone in Britain has nearly tripled in the last year and a half. Banca Fideuram in Italy is up over 100% in the last year.

I just think the stocks are ahead of themselves. We decided to redeploy the assets elsewhere.

Q So if international hurt performance, what helped?

A Two things have happened which I think have benefited the fund. Larger cap stocks have outperformed smaller cap stocks in the U.S. market.

Internationally we have concentrated most of our investments in Europe, which has had very good performers over the last 15 months. It’s the rest of international markets that have done poorly and we have not had much of a weighting in the other international markets.

Q Can you discuss some recent purchases?

A I’ve recently bought some Eli Lilly & Co. The stock has been a very weak performer due to concerns of Evista, a women’s drug. The take-off has been slow. It’s used for osteoporosis. It’s a preventive drug. Over time we think it will be beneficial for breast cancer.

We added to Travelers. We like the Citicorp deal. I bought some Fred Meyer Inc., a supermarket company that is consolidating operations in the Northwest and California. It has a track record. We had bought Dell Computer Corp. recently. The stock had weakened earlier in the year. It is a leader in build-to-order computer technology, and we think it’s got great growth potential. We added Network Associates and we’ve added to WorldCom Inc.

My top holdings right now: General Electric, Freddie Mac Corp., Berkshire Hathaway Inc., Microsoft Corp., Bristol-Myers Squibb, Danaher.

Microsoft has moved up a bit. It’s the one technology company that will have very little impact from the Far East. It reports very conservatively. That will allow it to do well in a tough technology market. It has a lot of deferred revenue and a good product

cycle in the next two years.

Q What have you done with your Pacific Rim holdings?

A We have about 1%. I’ve actually taken it up a little bit. I had it down to about 1/2%. There are some interesting stocks in Hong Kong: Hutchison Whampoa and HSBC.

These are companies that have great balance sheets. They will buy assets cheaper than I can buy assets, so I can buy them at (price-earnings ratios) of 10 or 11 times earnings and benefit from the acquisitions they make in the mess.

Q How does your stock selection differ from other funds at T. Rowe, in particular Larry Puglia’s Blue Chip Fund?

A The international portion, which Larry’s does not have. Larry’s background is with financial service companies so he tends to own many more in that sector. I tend to have more experience with consumer and industrial companies, so I tend to have a little bit more there. We probably have 70% of the same stocks. There’s friendly competition.

Q Where do you see the economy headed?

A The slowdown in the Far East will keep interest rates relatively low. Even though Europe is picking up, I think interest rates will remain low. I think you’ll still see relatively high unemployment.Also companies that sell commodity products and technology companies are being affected by excess capacity. That will last the rest of the year. We should see a slowdown in the second half.

On the flip side, the domestic economy can stay pretty good because interest rates are low and consumer confidence is high.

Vite

Robert Smith, 37, portfolio manager, T. Rowe Price Growth Stock Fund, Baltimore

T. Rowe Price Growth Stock Fund (assets, $4.8 billion): year-to-date 19.83%; 1-year 27.93%; 3-year 27.05%; 5-year 22.15%

Lipper growth fund average: year-to-date 18.73%; 1-year 27.48%; 3-year 25.03%; 5-year 20.26%

Standard & Poor’s 500 stock index: year-to-date 17.21%; 1-year 29.07%; 3-year 29.63%; 5-year 23.14%.

Largest holdings: General Electric Co., Berkshire Hathaway Inc., Microsoft Corp., Bristol-Myers Squibb, Danaher Corp.

Figures are as of July 9 and include average annual returns for periods over one year.

Source: Lipper Analytical Services Inc.