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    Guest Interview:

   Baxter Investment Management

    1030 E. Putnam Ave
    Riverside,CT 06878

    Telephone: 203-637-4559
    Fax: 203-637-9652


    Interview Quarter: 3Q2003

 John Baxter


Q: Bill, your firm’s founding in 1924 must make you one of the oldest private money managers in the country. What kind of investment firm was it when you started and how does it differ today from your origins?

A: Next year will mark the 80th anniversary of Baxter Investment Management, and I am very proud of our long history of service to investors. While there have been some changes at the firm over the years, I think a key to our success has been the fact that we have remained consistent in our investment philosophy throughout our history, regardless of the economy, market conditions, or popular trends.

Our history is rooted in rigorous independent research and economic analysis. The firm was founded as the Baxter International Economic Research Bureau in 1924 by my grandfather William J. Baxter, Sr. (1899 – 1970), shortly after he graduated from Harvard Business School. In the early years, the firm issued regular news and research bulletins to clients, provided guidance on investments, and economic analysis and forecasting – analyzing price trends, supply, demand, business movements, and other economic data. During the 1920’s and 1930’s, many companies looked to outside firms such as Baxter for economic information, analysis and advice. Among our earliest clients were some of the leading corporations of the time.

In the decade following World War II and thereafter, more attention was placed on communicating the firm’s investment philosophy and advice to individual investors. The number of subscribers to the firm’s economic bulletins grew steadily during this period. My grandfather also published several books on the economy and investing during this time that were very popular with readers.

My father, William J. Baxter, Jr., joined the firm right after he graduated from Columbia University School of Business in 1957, where he studied under Professor Benjamin Graham. He was instrumental in transitioning the firm from a research, economic consulting and advisory firm to a more traditional investment advisor serving high net worth investors. In 1959, the firm became known as Baxter Bros., Inc., doing business under the name Baxter Investment Management. During the sixties, seventies and eighties, my father managed the firm and oversaw its continued growth. He also authored our investment newsletter throughout this period.

I joined Baxter Investment Management in 1989, and I now serve as the President and Chief Portfolio Manager. Although our traditional investment approach has never changed, we are pleased that our client base and total assets under management have continued to experience steady growth.

Q: How would you describe your investment philosophy? Do you use a “GARP” approach?

A: Our style can best be described as large-cap “core” with a GARP (or growth at reasonable prices) philosophy. We believe in taking a patient, long-term approach to investing. For us, individual stock selection has always been paramount, not sector or market timing. We employ a rigorous research process that is designed to identify high quality companies at reasonable prices. We look for strong balance sheets, sound management, consistent earnings growth, and the potential for long-term growth without undue risk. We pay careful attention to the valuations and earnings multiples of every company we own or consider for investment.

Q: Is this a bottom-up strategy or a top down approach to investing?

A: Our research process is primarily bottom-up.

Q: Do you use any macroeconomic factors in your investment process?

A: Our macro-economic analysis is derived primarily as a product of our comprehensive analysis of the individual companies we select for investment. By following these companies, from various sectors and industries, we have a window to the overall economy. We do not try to time the market or any sector of the market. What drives our investment process and stock selection for us, more than anything, are the valuations and fundamentals of each company that we follow.

Q: How many companies do you initially consider in your total investment universe and what steps do you go through to narrow down your eligible investment list?

A: There are several hundred companies, at the least, that potentially form our investment universe. At any given time, however, only a small percentage of those stocks may meet our watch list criteria.

Q: How important are earnings in your investment selection process.

A: For us, earnings are critically important, along with the generation of free cash flow for re-investment. In order for us to consider a stock for investment, the company must demonstrate consistent earnings growth. We are not attracted to companies that demonstrate short bursts of rapid earnings growth. Consistency and persistency of earnings, and the generation of cash for investment, are far more important to us.

Q: The past few years have been tough on companies trying to maintain or increase company earnings. How do you assess relative earnings performance during economic downturns?

A: It clearly has been a difficult period, with earnings down and relative valuations remaining high. As a result of these high valuations and poor conditions for economic growth, we have maintained a larger cash position over the past three years. We are finding attractive opportunities to re-deploy that cash now.

Q: What do you look for in evaluating the strength of a company’s balance sheet?

A: In a word, we look for redundancy. We want management to have enough capital not only to survive difficult periods, but to be able to take advantage of them. We carefully simulate the good and bad scenarios that a company may face, and then we spend a great deal of time determining capital requirements given the potential outcomes.

Q: How do you go about assessing the quality of management?

A: It is fairly easy to identify the very best and very worst in the world of corporate management. But that is a really small percentage of our investment universe. The real challenge is evaluating the vast majority of corporate managements that make up the middle of the bell curve. We try to imagine ourselves as absentee owners. We then grade managers as if they were our operating partners. We carefully consider the incentives that are faced by management and we look for experience and integrity. We try to put ourselves in the shoes of management during difficult periods that have happened in the past, and try to objectively assess (without using the benefit of hindsight) what we would have done in the same situation. This is an important exercise and a valuable tool to assess the quality of management.

Q: You avoided the excesses of the 1998-to-2000 stock market bubble. Did you feel pressure from clients to change your long-term investment strategy?

A: At any given time, but especially when valuations in the equities markets are at their extremes, there are likely to be pressures on a manager from certain clients to adopt a different strategy or approach to a portfolio that is more popular. And we did experience some of this from a few clients, particularly in 1999. But I think our experience with this was not nearly as difficult as it has been for many other similar-style managers. I think because of our long history and the constant effort we undertake to communicate our investment discipline and philosophy to our clients, we experienced less turnover or dissatisfaction among our client base than many other managers during that time.

Q: Do you ever raise cash if you think the market is due for a correction?

A: We will sell and hold cash if we feel any of our equity investments are overvalued and there is no attractive alternative store of value in equities at that time. Individual valuations, not market or sector timing, will typically dictate what we do.

Q: How do you go about your investment research? How much research is done in-house versus going to outside providers?

A: Our research is done in-house and we rely primarily on SEC documents and discussions and interviews with managements, suppliers, customers and competitors.

Q: Do your portfolios tend to be uniform for all your clients or do you try to adjust them for their individual investment objectives.

We do not use a model portfolio approach to portfolio management. We individually customize each portfolio to meet the needs, tax circumstances, and investment objectives of each client.

Q: If a client wants a portion of their portfolio in fixed-income can you accommodate them?

A: Absolutely. In fact, most of our clients maintain some portion of their portfolio in fixed income throughout all market cycles. For many clients, this is an effective way to manage risk and reduce volatility in their portfolios, and we will rebalance that allocation somewhat over time and depending on market conditions. Of course, the precise allocation between equities and fixed income will depend on the client’s individual circumstances, risk tolerance and investment objectives.

Q: How would you describe your typical client?

A: Our typical client, whether they are an individual, family, trust, endowment, or other type of client, would most likely have a minimum total investment of not less than $1 million. Our clients tend to be entrepreneurs, sophisticated both in education and investment experience, but lacking the time or resources to manage their capital. Most of our clients are interested in long-term, tax-efficient growth, without undue risk, and expect us to treat their investments as if they were our own.

Q: We live in an increasingly complex world where communication and change seem always to accelerate. Do you think your strategy is going to change or do you think the tenets of your investment philosophy will remain valid?

A: Our greatest strength has been our philosophical consistency and our unwavering reliance upon rigorous fundamental research—independent, unbiased research. Investors will always seek returns from undervalued assets. We all want to find that bargain. Whether you are buying stocks, bonds, art, real estate, or any other investment, doing your homework, engaging in careful research, reduces risk and increases your likelihood of finding an undervalued asset that can provide long term gains.

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