Look how far a Successful Investor Sees Stocks Falling

Former hedge fund manager Chris Litchfield likes quality growth stocks that outperform in down markets.

Chris Litchfield, former manager of hedge fund Stringray Partners and now a private investor, has a conservative investment philosophy.

He aims to outperform the market when it’s falling and come close to matching the market when it rises.

That strategy has worked out well. A $10,000 investment in Litchfield’s fund when it began in 1992 was worth $38,300 in 2007, when he retired from fund management.

Litchfield discussed his investment philosophy and his views about the current stock-market environment in an interview with TheStreet.com. Here are excerpts.

TheStreet.com: How would you describe your investment philosophy?

Litchfield: I’m a conservative, medium- to long-term investor. I try to own a portfolio of really good companies. I now have about 30 names.

I trade around those names from time to time, as they get more or less expensive. I add to positions when they’re doing well and reduce them when they’re not. That’s the opposite of what people tell you. But catching falling knives isn’t a good investment strategy. You don’t know how low a stock will go.

TheStreet.com: How do you define “really good” companies?

Litchfield: It’s quality stocks, ones with strong balance sheets and financials that don’t have too much debt and do have positive cash flow, likely good free cash flow.

I don’t like companies without earnings. I like growth companies rather than cyclicals. But I don’t like technology much. I think it’s overrated as a group. Technology companies require massive capital for ever evolving efforts to find new products.

Intel  (INTC) – Get Intel Corporation Report, for example, has destroyed shareholder capital with bad acquisitions and management. There are a lot of companies like that. Of course, there are exceptions like Microsoft  (MSFT) – Get Microsoft Corporation Report and Apple  (AAPL) – Get Apple Inc. Report.

TheStreet.com: Where do you think the stock market is headed now?

Litchfield: I’ve been negative on the market since last November. My view is simple, don’t fight the Fed. You want to lay low when the Fed is raising rates. And when the Fed floods the system with money, like it did the last six to eight years, it’s a tailwind.

My target for the S&P 500 is 3,300. Average bear markets go down about 30%, and we are down about 20% now. We’ve got a considerable way to go [to 3,300, with the S&P 500 recently at 3,756]. But the market could go quickly once it starts back down. I see that happening within the next six months.

I have been at minimum equity positions for most of the year, though I like to play rallies. I think there could be another rally before the market falls. We might be in one now.

Chris Litchfield

TheStreet.com: When will you increase your stock positions?

Litchfield: I avoid the temptation to call the bottom and be a hero. I’m waiting for the Fed to appear finished raising rates, when it’s more than just Internet chatter about pivoting.

I’ll miss the first 10% of the rally, but I don’t really care. As the market goes up, I’ll slowly get fully invested.

TheStreet.com: What are some of your biggest holdings?

Litchfield: Stryker  (SYK) – Get Stryker Corporation Report, UnitedHealth  (UNH) – Get UnitedHealth Group Incorporated (DE) Report, Northrop Grumman  (NOC) – Get Northrop Grumman Corporation Report, Berkshire Hathaway  (BRK.B) – Get Berkshire Hathaway Inc. Report, General Dynamics  (GD) – Get General Dynamics Corporation Report, Honeywell  (HON) – Get Honeywell International Inc. Report, Costco Wholesale  (COST) – Get Costco Wholesale Corporation Report, Home Depot  (HD) – Get Home Depot Inc. (The) Report, Accenture  (ACN) – Get Accenture plc Class A (Ireland) Report, Lockheed Martin LMT. There’s also the ETF ProShares S&P 500 Dividend Aristocrats  (NOBL) – Get ProShares S&P 500 Dividend Aristocrats ETF Report.

I like defense companies, as you can see. They have stable businesses, with the government a large part of that. They also have lower-than-average multiples and higher-than-average growth.

TheStreet.com: What do you like about Stryker (a medical device company)?

Litchfield: I bought 100 shares for my mother at about $27 in the 1979 IPO. I inherited half of it, and now it’s my largest position. It’s such a good company in a growing industry. It’s very well run. And you’ve got the greying of America—hip, knee, shoulder operations.

TheStreet.com: What is your thinking on the Dividend Aristocrats ETF?

Litchfield: Over time, about 50% of stock returns come from dividends. So to the extent you can get that income, it’s a good start.

A rising rate environment [can turn some investors off from dividend stocks, because that environment makes bond yields more attractive relative to stocks’ dividend yields]. But it’s the pace of stocks’ dividend increases that’s important.

TheStreet.com: What’s a stock you bought recently?

Litchfield: Kroger  (KR) – Get Kroger Company (The) Report. It has a stable business with low margins, but giant sales. It trades at 12 times earnings, which is about half the multiple of Microsoft. But its yield is 2 percentage points higher than Microsoft.

Its return has been the same as the S&P 500 since it went public, with about half the volatility. If we’re in a recession, which I think we are, staples and necessities will do better than other sectors.

TheStreet.com: Have you been buying bonds recently?

Litchfield: Yes, I think rates are headed higher. So I’ve been buying high-quality paper with short maturities. When we get to higher levels on rates, I can lengthen those maturities and maybe scale back in quality. That will be a better time to lock in rates [for a longer period].

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