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    Guest Interview:

   McHugh Associates Inc.

    259 N. Radnor-Chester Road Suite 150
    Radnor,PA 19087

    Telephone: (610) 254-2929
    Fax: (610) 254-2985


    Interview Quarter: 4Q1993

 Thomas J. McHugh



Q: Tom, I understand your investment background includes a long period when you were hired to manage the money of a single client.

A: Before we started McHugh Associates, we managed the assets of the Pitcairn Family for 22 years. The Pitcairn family controlled PPG (Pittsburgh Plate Glass Co.) and I represented them on the board until they sold their interest in 1985. My partners, Abner Kingman and Jack Weaver also worked with me at Pitcairn and we consulted the investment team at Pitcairn. When we left we had over $1.25 billion under management.

Q: What was it about your investment background that caused your employer to choose you as manager instead of hiring any number of other well established managers?

A: I think there were a number of reasons. I had a number of years of investment experience on Wall Street at Fiduciary Counsel that dealt with high net worth individuals. My other experience at the time was managing the equity portfolio for Reliance Insurance Co. I had developed a reputation of being a good stock picker. One of the stocks I had picked at the time which created some interest was a major position in a company called Haloid Corp. Haloid Corp. changed its name to Haloid Xerox Corp. and finally to Xerox Corp. So we were in at the beginning of Xerox and we made a lot of money.

Q: Where did you learn your philosophy of investment?

A: I have always been interested in quality growth stocks but our problem at Pitcairn was that we had a very large holding of PPG which was a large industrial company tied to cyclical parts of the economy. The family's assets really hadn't grown in the late 50's /early 60's so what they wanted me to do was to diversify into those kinds of companies that would offset the cyclicality and at the same time, not take any undue risks. We concentrated on large and better known growth companies and over the years the 20% of our assets that were not PPG grew to about 50% of our assets. In other words, the $50 million of non PPG assets we started managing grew to something like $600 million.

Q: Your biography notes your involvement on boards of a number of companies. How has this experience helped you as an equity analyst?

A: Over the years Pitcairn took large positions in different companies. My partners and I served on 17 boards of directors. I still continue on a few, but what it made us focus on is the caliber of management running the companies. We had the fortunate or unfortunate experience from time to time of actually having to take over and run companies which forced us to focus on the quality of management and what they brought to the party. We concluded, and still strongly believe, that unless you have a strong management you don't have a good investment. So when we buy a stock we want to understand, to the best of our ability, their business plan, who will be implementing it, and their ability, in our judgement, to carry out that plan.

Q: If there were to be just one rule you follow as a manager, what would it be?

A: Investigate before you invest. We feel strongly again, that management is the key. Unless you have some exposure to management before you make the investment you might buy more trouble than it's worth. Our stock turnover, for our clients, is low - maybe 25% for a portfolio. I think that's because we do our homework before hand. We do meet with the managers. We do understand the business they are in and we do make a judgement about their ability to meet their financial goals.

Q: Your investment style begins with a screening of a large universe of companies. What goes into that screen?

A: We use the Value Line 4000 as our screen. We screen the Value Line Universe for four criteria: 1, we want companies that have a market capitalization of at least $300 million, 2, we want companies that have a return on equity over the last five years of at least 15%, 3, we want companies that have grown over the last ten years at a 12% compounded rate in earnings and 4, we want consistency; in that, we insist on the earnings being up for at least eight of the last ten years. What we get back from that screen is probably about 3% of the Universe or roughly 100-120 companies. We then examine these companies to see if they have a strong cash flow, the price is reasonable and the businesses that they are in are ones that we understand and feel confident pursuing. At this point, we visit the ones that we think look most attractive to see whether they ought to be added to our portfolios.

Q: What do you look for in your value analysis of companies?

A: We are interested in our companies' P/E ratios and their yield. We are basically looking for companies that we think are well managed, that have consistent growth, but we do not want to pay too high of a premium for that growth. We will not pay more than a 50% premium over the market for any of the stocks we are going to buy. That means, if the market is selling at 14 or 15 times earnings, the most we would pay for any stock is 20 times. What we are trying to do is buy stocks at the market P/E that we feel can grow their earnings at more than twice rate of the S&P 500. Historically, we have been able to purchase that kind of a growth rate while paying only a slight premium (maybe 10%) over the market.

Q: Tell us something about your fundamental analysis and what characteristics you favor most?

A: Again, we feel management is the key; unless you have a good management you really don't have a good investment. The other thing we are looking for in the nineties is global exposure. We seek our global exposure through domestic companies. 95% of the world lives outside of the United States. Unless a company has the management know-how, financial resources and marketing skills to take its domestic franchise and export it overseas (i.e. Gillette or Pepsico), we are not interested. We think the U.S. economy will be struggling domestically for the next three or four years and if you want growth in your portfolio you have to get it, in our judgement, overseas. We do not buy foreign stocks for a number of reasons: we do not want to take the exchange risk that is inherent in investing overseas, we would rather have domestic companies manage that for us; managers of companies overseas are not as accessible as domestic ones; and we don't believe the accounting standards are as sound overseas. It is interesting that the SEC is prohibiting the New York Stock Exchange from listing more foreign companies for exactly that reason - they don't feel the stockholder is adequately informed.

Q: How much weight do you put on the importance of management compared to the earnings potential of the companies' products or service?

A: I think there are plenty of examples of companies with strong franchises that management has screwed up because it was not up to the task . One example is American Express with all the problems the board was having with Robinson. That franchise has experienced an increase in competition in recent years. The value of that franchise has certainly gone down. On the other hand, Disney in the early 80's before Eisner and Wells took over went sideways for four or five years. They have taken that company and its franchise and have done a tremendous job with earnings up probably 8 or 10 times and the stock up 8 or 10 times as well. So, there are two good examples of how franchises have reacted to different types of management.

Q: You favor companies producing long term increases in sales, earnings, and dividends. What tools do you use to make those assessments?

A: We analyze the industries and the position of those companies in those industries in comparison with their competitors. The past performance may or may not be a prologue to the future. We want to interview management and see their offices so that we have the confidence in their ability to continue to grow the company at the rate they have in the past.

Q: Would you give us an example of something you feel is important from a company visit that other Wall Street analysts might overlook?

A: I think the fact that we have served on several boards and, have at times, had to meet the payrolls when we ended up running some of these companies. So we look more critically at earnings projections in the light of that experience. Marketing people are always very optimistic and give projections of what they can do that may or may not be realistic. An example would be when Akers of IBM took over in 1986. He made projections that he could double the sales and earnings of the company over the next five years. As we looked at it we realized they were doing $50 billion in sales and to grow the business they had to grow it $10-12 billion a year. That didn't seem realistic and what really turned us off was that he needed to hire and train 50,000 people a year to generate those kinds of sales. We thought that was an unrealistic projection of their capability and as we all know it didn't work out.

Q: How would you describe your typical portfolio? How many companies could it have, how diversified would it be, and are the companies generally recognizable to the public?

A: Presently we have 23 stock positions, most would be recognizable. We have Gillette, Kellogg, Merck and companies equally well known. We also have some not so widely known companies such as Unum and Crown Cork but, generally, it's the large capitalization companies - our median is $4.5 billion. We are looking for consistency of growth. We are not always parallel to the S&P 500 allocations. Although it's part of the S&P 500, the airline industry is lacking in consistent growth and therefore, we are not invested in any airline stocks. We invest in those areas where consistency of earnings is believable.

Q: Are you generally a long-term, intermediate, or short-term holder?

A: We look for the potential of a company over the next 2-3 years. We think that's as far ahead as we can comfortably predict. If the companies continue to make their goals we don't sell after two or three years, as long as the company can continue to grow at an above average rate.

Q: Do you have a method of assessing whether the market is over or undervalued?

A: Yes. It's somewhat qualitative. We focus on interest rates, and P/E ratios and there is a correlation. Historically when interest rates are high, i.e. the early eighties, you had the multiples below 10. Currently with interest rates on the long end at 7%, your market multiple is about 16. When interest rates start moving dramatically in one direction, you're going to get an adjustment in the market's P/E.

Q: You have several portfolio managers. Do you manage by committee or is each portfolio manager making decisions independently? Are all your portfolios the same and, if different, how and why?

A: My partners are Ab Kingman and Jack Weaver. Ab has been with me since 1972 at Pitcairn and Jack since 1980. We have functioned as a team for a pretty long time, which is unusual in this business. We manage by consensus; we all have to agree on what we're buying and what we're selling. Our portfolios reflect that consensus and each portfolio owns the same securities.

Q: I see your investment performance for 1989 and 1991 were particularly good years for you. What led to these big gains?

A: We are a growth stock investor so as interest rates were coming down and the economy was faltering, there was more emphasis in the market on consistently growing companies. Our stock selection was such that even in that favorable environment we did outperform most of our competitors and we did it by staying with the big cap companies and not the over the counter market. We did not change our philosophy; we selected stocks that did the best in that type of market.

Q: What considerations do you use for structuring your balanced accounts?

A: We try to gear our clients such as pension funds, endowment funds and foundations to a heavier commitment to equities over the long term. They have a more permanent asset base so they should be looking out over the long term. Historically, our experience has been that well selected equities will have the highest return over a long period of time. We believe we can buy companies at reasonable valuations that can grow 12% or more a year. The client is better off with that type of security as opposed to one which generates income of 7% a year. We always know and satisfy the income requirements, but our advice to clients is that in the long run, they are better off sacrificing some of their current income needs and investing for longer term appreciation.

Q: Who are the other investment managers in the firm and what are their backgrounds?

A: Ab Kingman was in Canada and attended McGill University. He worked in Canada for Canadian Business Service. However, he was more interested in the U.S. market so he moved to Boston and went to work for David L. Babson in Boston where he became a partner. He married a girl from Philadelphia and moved into our area. I was able to talk him into joining me at Pitcairn. Jack Weaver is a Harvard Business School graduate. He worked for Mellon Bank in Pittsburgh for 14 years where he was the head of their research department and managed 30 investment analysts.

Q: Where have most of your new clients come from in the past few years?

A: Primarily referrals - we have not had, until recently, anybody marketing McHugh Associates so our client base has generated most of our clients. They're primarily in the East coast area. We are working with the brokerage community which has been a good source of clients for us and has taken us more into the institutional markets.

Q: At your current size of over $280 million and about 80 client relationships you're at the point where larger pension clients are finding you attractive. Where does your firm go from here?

A: We obviously would like more assets under management which would give us the financial where-with-all to build the kind of team we would like to have in place over the next three to five years. We think with our background of managing over $1 billion, managing substantially greater assets than we have today would not be a problem. Our ideal is the client who has the same time horizon that we do. One that realizes it's not a short term, quarter-by-quarter performance game. When you hire an investment manager you should realize that it will take 2-3 years for the investment approach to reap the full rewards.

Q: Tom, you've been in the investment business many years. What was your best investment for your clients over the years?

A: That's an easy one for us. We invested at the bottom of the market in 1974 in Quotron Company. With the market break in 1974, Quotron looked like it was not going to make it. The price of the stock started off the year at around $5 a share and by the end of the year the stock was selling at $0.10 a share. We were able to purchase 350,000 from a large financial publishing institution that wanted the stock off its books because they thought it was going to go bankrupt. Well, Quotron did not go bankrupt and slowly started to turn around; subsequently, the stock split 10 for 1, so our $0.10 share cost was then a penny a share with a total investment of $35,000. We finally liquidated our remaining position by selling our interest to Citibank in New York for $17 a share. I think for the Pitcairn family and related interests we made about $80 million on that $35,000 purchase. That's far and away our best investment.

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