Donovan likes the ability of some technology-related businesses to generate lots of cash, which he believes provides a cushion against tough times. Because they are not overly capital-intensive, their rising revenues fall back to bottom-line profit, and they can use the extra cash to buy back their stock or pay out a healthy dividend. And they don't have to lean too heavily on outside credit sources.
The problem, of course, is that after the recent rally, many technology stocks have price-earnings multiples and other valuation measures well above the market averages. For that reason, Donovan prefers less expensive fare such as Hewlett-Packard, the fund's sixth-largest holding. The stock trades at a relatively tame 11 times estimated 2010 earnings, less than half of the multiple assigned to search engine Google and well under the multiple for the Standard & Poor's 500 Index.
While Hewlett does not fall into the circle of "serial acquirers" in the technology industry, those that expand almost exclusively through acquisitions, it has successfully purchased smaller competitors to extend its traditional printing product and personal computer niche. Its most recent acquisition candidate, 3Com Corporation, was announced at the end of 2009. While Donovan says it's still too early to determine whether the acquisition of the networking equipment provider will prove rewarding, he believes Hewlett-Packard is paying a reasonable price to gain instant access to a growing market.
Financials are slightly overweight in the portfolio relative to the benchmark, but Donovan says that's mainly because of the large position in Berkshire Hathaway, which the fund classifies as a financial holding. With significant holdings in property/casualty insurers and other businesses, Berkshire, run by legendary investor Warren Buffett, is much less credit-sensitive than many other financial stocks and has a stake in businesses that are worth more than the stock reflects. Still, Buffett will be 80 years old this year. "I know that the day Warren Buffett moves on to meet his maker will not be a good one for the stock, but I'm confident he has built a broad bench of talent," says Donovan.
Donovan has successfully lowered the credit sensitivity and risk in the financial group in a number of instances. In late 2007, for example, he unloaded a longtime position in Countrywide Financial because he felt the company was taking on too much risk to achieve growth. And at the peak of the financial crisis in 2008 and early 2009, the portfolio didn't own the more spectacular blowup stories such as Lehman Brothers, AIG, or Freddie Mac and was underweight in the sector. He also has positions in less credit-sensitive members of the group such as Goldman Sachs.
But occasional missteps, including the fund's late 2008 purchase of Citigroup, do occur. Although Donovan and co-manager David Pyle thought the bank's global franchise would help insulate it from credit market shocks, investors headed for the doors after the global crisis hit.
More recently the fund suffered as Wal-Mart stock remained flat throughout most of 2009. Yet Donovan still likes the retailer's sound financials and market dominance and is puzzled by the market's tepid response to it. Despite such problems, Morningstar analyst Lawrence Jones notes that the duo have "consistently hit the mark with its calls" and managed to capture gains while minimizing losses.