
Tanous:This brings up the other interesting theoretical discussion.You know that the efficient market theorists don’t believe that over-looked securities exist. To them, as you know, everything that is knownabout a stock is in its price now. How has your experience been dif-ferent from that?
Ryback: I agree with the efficient market theorists up to a point,but Pll give you a prime example that occurs almost every day wherethe theory doesn’t always work - that’s new issues. New issues arebrought out, traditionally, through brokerage firms. They’re well dis-seminated, even touted, to the public. Obviously, the more informationthese firms disseminate while they tell the story, the higher the pricethey can get for the company and the more the brokerage or invest-ment banking firms will make. As a result, the public perception ofnew issues is quite high. There are other factors, of course. Is the issue
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hot? Is it an internet-related company, since they’re hot today? Thepublic has been well informed by the press about how great the inter-net is, so that’s an easier sale than trying to sell an oil stock today,or even a retail stock, since they’re down in the dumps. So, there’sgenerally a high [investing] public perception of new issues.
But what happens if an issue falls by the wayside very quickly?That could be the result of a number of factors, particularly if you’rebringing out a new issue when the market is near a top. Even in agood market, when you get a few 100 point down days, those newissues can fall by the wayside very quickly. They come out, they getcaught up in the general market, and they get lost. That’s when theinefficiency comes into play. These issues are quickly forgotten bythe public because the public is focused on the overall market. Sothese new issues can come out quickly, sell off, and be forgotten.
Tanous:Interesting point. You’re saying that sometimes, a newstock is overlooked because investors are distracted from the stock itselfby the market in general. That, of course, is the opposite of marketefficiency.
Moving on, another thing that I find interesting about your processis your rather unique sinking fund strategy. Could you tell us aboutit?
Ryback: I'd be happy to. A sinking fund pertains mainly to convert-ible bonds or convertible preferred stocks. That’s a different class ofsecurity issued by corporations. What happens, typically, is thatconvertible bonds have a maturity date. A company goes out and is-sues a 10-year bond. After five years, the company can start to buyback the bond. It can buy the bond in the open market.
Tanous:Does the company have to buy it back?
Ryback: Yes. It’s mandatory.
Tanous:Okay. So the buyback is part of the indenture. They mighttypically have to buy back a certain part of the issue after, say, fiveyears?
Ryback: Right. I’m using five years as an example. It does dependon what the indenture says. Traditionally, it’s about five years. I shouldalso mention that this applies not just to convertibles, but also straightbonds. The company is generally buying back 10% to 15% of the issue,so that within five or seven years, the entire issue is redeemed.
Obviously, the company is not going to pay more than par whenit starts buying its securities back, because the indenture says all they
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have to do is offer to pay par plus the accrued interest. On the otherhand, if their bond is perceived to be weak, and it is trading at a dis-count, it’s really an advantage to the company and its shareholdersthat the company can buy its own bonds at a discount. Actuarially,they’re putting dollars to the bottom line of the income statement bybuying their own bonds at a discount.
From our point of view, if we’ve done our homework and we ownthis issue, we want to own all of it. The intent is for the company tomake only one phone call every year when it wants to buy its bondsback, and that’s to us.
Tanous:! have a feeling, Eric, that you make it an expensive phonecall.
Ryback: We do. We say, yes, your bonds are trading at a discount,but guess what? The price is par.
Tanous:This tactic seems analogous to squeezing the shorts, doesn’tit?
Ryback: It is. It’s called “cornering the sinker.” I learned that in thevery early days of the Milken era of peddling what were later calledjunk bonds. [Milken called them high-yield bonds.] I can’t say that Icame up with this idea. It was a very eye-opening experience when,one day, I identified a bond in the market that I really wanted to ownand I called up and told my Drexel broker to buy these bonds. [Mi-chael Milken developed the junk bond business at the now defunctfirm, Drexel Burnham.] They came back and said, well, you can’t buyany. I asked, why not? They said, because there’s just one person whocontrols the whole issue and he’s not selling! I said, boy, I would loveto be able to do that. And I made it a personal goal from then on. Iwanted to own an entire issue.
Tanous:Let me suggest an example. You buy up the entire issuewhen the bonds are trading around 82, because in today’s market,that’s what they're worth. Right?
Ryback: Right.
Tanous:And the guy calls you up and says, you know, we’ll makeyou a bid. And you say fine. I'll sell at 100 - par.
Ryback: That’s right. I don’t want to belabor the point, but for theDividend Fund in particular, which holds a lot of these securities, thatreally reduces the beta [volatility]. Here we have an instrument, thebond, that has maybe five or seven years left to run. If we own thewhole thing, there is no volatility. Since we own the entire issue, all
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we're doing is peeling off a certain percentage every year back to thecompany. It’s wonderful.
Tanous: Utilities, dividends and income go in lock-step don’t they?
Ryback: They do.
Tanous: Yet you know better than I that almost every other managerjust hates utilities. Let me give you an example: One of the people Iinterviewed, who is a terrific manager, is Foster Friess of theBrandywine Fund. [See page 229.]
Ryback: I know who he is.
Tanous:! asked Foster, in our interview, what sorts of things henever buys. I'll quote him. Foster says, “We have a hard time gettingexcited about utility companies because that’s a politically-drivenprofit picture. You cannot grow beyond the demographics of a givenarea, except if you’re able to get good pricing. If you start showingtoo much profit, the political process will take those prices away.”Which of you guys is right?
Ryback: There’s a lot of truth to all that. The other side to that ar-gument is that the utility industry is becoming deregulated, andthrough deregulation there is the opportunity to downsize the numberof utilities or merge utilities, the bad with the good. Ultimately thegood will prevail. Now there’s always an interest rate factor that in-fluences the price of the stocks. That’s undeniable. So there is atendency, over the long haul, to trade utilities.
Two years ago, the Dividend Fund had minor exposure to utilitiesbecause rates continued to drop. When utility regulators go up infront of the [public service] commission, their case to raise rates isweak when interest rates are declining. Obviously it works to theirbenefit when rates are rising, because then they can go and say, look,the fixed costs are such and the cost of borrowed money is such, andwe need to raise rates. Under those circumstances, the commissionsusually look the other way and say, go ahead. So, yes, there is thatfactor: utilities tend to be proactive on declining rates and reactiveon rising rates. There’s a lag effect, and it hurts utilities. But there’salso consolidation going on now, which, | think, is a positive, an ad-vantage to owning them.
Tanous:As you pointed out, deregulation is an important part ofthat.
Ryback: Yes, it is.
Tanous:Eric, you’ve been so successful in your strategy that the
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readers of this book are going to be very interested in your process.Could you walk us through, from the way a stock gets discovered, tothe time you push the button and it gets into your portfolio?
Ryback: The initial process involves screening for yield. We lookfor the highest yield possible - higher than the yield on the S&P 500.We'd like to get yield at least 200 basis points higher than the yieldon the long bond [30-year treasuries]. We screen on a wide basis forthat. The candidates we screen then go through our fundamentalvalue process. We’re looking for a strong balance sheet, income issecondary. The company doesn’t really have to be earning money,but it has to be covering the interest and dividend payments. We lookon a historical basis, at least five years, and we project forward aboutthree years or more, based on the historical five-year average of theirrevenues and income stream. If there is no income stream, we lookat cash flow. We plot this information in graphic form. I’m going tobe a little bit vague here because it is a proprietary process.
Tanous:Aha! In that case, we'll sharpen our questions.Ryback:Right. Kurt developed the process back in the early fifties as a CPA,and it’s a numbers-driven formula.
Tanous:But it is a formula?
Ryback: Oh yes!
Tanous: Wait a minute. There’s a formula that is proprietary thatguides your selection process?
Ryback: Yes. Absolutely.
Tanous:That’s interesting.
Ryback: I would be lying if I told you otherwise.
Tanous:It’s not a black box, is it? [Black box” is Wall Street jargonfor a computer program or formula that comes up with ways to beatthe market. There hasn’t been a completely successful one yet.]
Ryback: It’s kind of a black box. We put the numbers through. Allthe companies go through that screening process. We did it by handuntil I bought the company three years ago, and then we put it onacomputer. Kurt was very concerned that if it went on a computer,anybody could get access to it. We’ve tried to alleviate that problem.
Tanous:But it’s obviously not so complex, since it used to be donewith a bunch of calculators.
Ryback: Calculators and by hand. Anyway, once we get this earn-ings stream, we can then arrive at the intrinsic value of a company.Since we’re going to invest in common stocks, we’re also going to
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try to get a time value of the money; basically what we would earnif the money was invested in, say, treasury bills, instead, or someother government instrument. That will lead us to the intrinsic valueof the company over the period of time we think we'll be holding it.The next step is to arrive at the sell target-price. Then we discountthat to what we might want to make in that company, say, a 30% or40% return, and we back into our buy-target-price.
Tanous:Presumably these are moving targets, are they not?
Ryback: You're absolutely correct. Because as the company earnsmore money every quarter, which we hope for, then that profit targetwill move upwards. If the company remains the same, the target goesnowhere, unless interest rates are doing something that would leadto another adjustment. Or, if the company is earning less than whatour model perceived, that would cause a downward adjustment.
Tanous:This sounds like it’s part of the formula.
Ryback: It is.
Tanous:It does start to make sense.
Ryback: Right. We’re trying to stay ahead of the curve here. That’swhy we've got this interest rate factor in there. Because, with our lowbeta and our safety factor, if we decide that we can go into treasurybills and make money...1 mean wouldn’t it be lovely if we could beall in treasury bills and the market cracked 20%? Well, that’s kind ofwhat we’re hoping the model will do for us, although it’s not perfect.
Tanous:But the model presumably is not predicting overall marketmovement, is it?
Ryback: It’s not a market-driven model. But there is a high correl-ation between interest rates and markets. We’ve seen that in thismarket.
Tanous:Does your model attempt to predict interest rates?
Ryback: No, but it has an interest rate influence that, we hope,anticipates these moves in a broad sense. That should mean that weare selling while everybody is in a climactic buying stage.
Tanous:That’s interesting.
Ryback: It’s not foolproof, by any means. But that’s the real intent.
Tanous:How much does this process contribute to your success?
Ryback: It’s the foundation of the whole firm.
Tanous:Has it evolved since Kurt died?
Ryback: No. We still use it and we will always use it. We were allindoctrinated into this approach and we are highly influenced by it.
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We believe in it very strongly, so it’s really the main driver for allthe managers here.
Tanous:Eric, I understand you don’t bother visiting companies ortalking to managements. That strikes me as bizarre.
Ryback: Some would say that, yes. If there’s been any looseningup, it’s probably been in that area. We still do not visit companies.But we do talk to them over the phone.
Tanous:! noticed that one of your largest holdings is an OccidentalPetroleum preferred stock issue. It is 1.6% of your portfolio. I mentionthat in part because I’m on the board of Cedars Bank in Los Angelesand Ray Irani, Occidental’s dynamic chairman, is also a director. Areyou saying you never spoke to him?
Ryback: I’ve never talked to the company. It’s a highly liquid issue.There’s a lot of stock out. The yield is quite attractive. | bought itdown in the low fifties and it closed today at sixty and change. Youknow, I'l stay with it until it starts looking at me funny. Then I'll getrid of it. For now, I’m very content with it.
Tanous:Please define: “looking at me funny.”
Ryback: Well, if it starts acting a little strange. Not the way I thinkit ought to act.
Tanous:Why aren’t you eager to visit companies?
Ryback: This goes back to Kurt’s days of going out and auditingcompanies as a CPA. It’s hard to really cover up things in an audit.Part of it, I think, was his awareness that any company would dothings if they could get away with them, to a certain extent.
Tanous:Do what?
Ryback: Well, you know, inventory...Back in the ’50s, they mighthave put the auditors up in the top floor without air conditioning todo an inventory count. And you know, their attitude might be, let’sforget the rest of this. Get me down from here! So a little bit ofskepticism and realism emerged. Companies will tell you anythingyou want to hear. I’m not trying to paint them as unethical, but it’shuman nature.
Tanous:!’ve run into another side of that argument in my interviewswith other managers. Many investment fund managers have a sort ofsixth sense, a hard-to-define feeling, or very good people instincts.They want to meet company managers to get a sense of their aggress-iveness, their forcefulness, their sincerity. Fund-managers want tojudge whether or not company executives are good managers, and a
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lot of that has to do with the human dimension. Now, your approachis different, yet very successful. Yours is more quantitative than theirs,but do you see how this other approach might be useful, too?
Ryback: Yes I do. I can concur with some of that. It really comesdown to two human beings meeting, and being able to size one an-other up and, hopefully, you as a portfolio manager, have the innateabilities to be able to judge the managers of the business you're goingto visit.
Tanous:But you, Eric, don’t get that opportunity.
Ryback: No we don’t. We have, on rare occasions, but, yes, [ wouldsay the far majority of the time we don’t. We do pick up the phonenow and talk to them.
Tanous:That’s a change in your strategy. What do you get out ofthat that you didn’t get before?
Ryback: More communication. Not just strictly going by the num-bers like a racehorse with the blinders on. Sometimes we've found ithelpful to just pick up the phone and get an explanation. If it soundsreasonable, it does affect what we do with the stock.
Tanous:Getting back to process, can you summarize your approachto the Dividend Fund. What is it that makes this approach so success-ful?
Ryback: What makes the Dividend Fund unique is its four compon-ents. It has a cash component, which we put in treasury bills whilewe're waiting to buy a security. It has a bond component, and acommon stock component, and a convertible component. The realsuccess of the fund is the four different components and the percent-age allocation, which is dictated by what interest rates are and wherewe think they are going. We juggle these four components over along term view of what interest rates may be doing. By long term,we mean three or four years.
Tanous:And the secret formula aids in this process, right?
Ryback: The secret formula is the foundation that it sits on. I thinkthe key to our success, our long-term record picking out the fallenangels in bonds and convertible preferred, is that we are buying yield-to-maturity for very long periods of time. So our turnover is verylow. We ride through overreactions in those issues. By-and-large,we're buyers when there are panic sellers out there.
Tanous:! presume your expense ratio is pretty low, too.
Ryback: Very low.
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Tanous: What is it?
Ryback: Zero point six one percent.
Tanous: That is low. Part of that must be because your turnover isso low. [The transaction costs are reduced.]
Let’s talk a little bit about your performance. The Lindner DividendFund is a nice, conservative, yield fund. We’re not trying to shoot thelights out here, yet the five-year performance is over 15%. The ten-year performance is 12%, The performance since inception is 17%. Idon’t know what to say. I’ve been in this business a long time andI’ve never seen anything like this. I’m not sure what question I oughtto ask you? Help me out.
Ryback: We do it with low volatility.
Tanous:! know. You’re just making my job a little bit harder. Myneat question was volatility. I remember a few years ago, one of thebig magazines picked the best mutual fund of all times, and it wasyours! Remember that?
Ryback: Yes. We’ve been the number one Best Buy stock fund inthe Forbes list since they started their ranking back in 1992. The onlyyear we were not number one was the year the fund was closed.
Tanous:That’s right. You closed it for a while, didn’t you?Ryback:Yes, we did.
Tanous:I think I know why you closed it. [It was growing toofast.] Why did you reopen it?
Ryback: Well, because we perceived that there were some greatbuying opportunities. We had closed it [The Lindner Dividend Fundwas closed from March 4, 1993 to November 8, 1993. Minimum in-vestment is $2,000.] because we had grown a billion dollars in a year.It was getting out of hand. You know, I’m not going to knock thecover off the ball, as you mentioned earlier. | just want consistent,very low-risk growth for the shareholders. [ built up a very loyal coreof investors. I continue to get new investors daily, and I think it’s atmarket times like this that we will outshine our competition. We’renot going to be number one in a bull market, but we are certainlygoing to do well in down markets. We’re quite resilient. Believe it ornot, I do try to enhance the performance. Hey, I would love to havedone 35% last year and keep it all and do better, but that’s hard todo on a consistent basis and still have the low volatility. So I’m goingto continue to give the investors what they want. What I think theyreally want is to go home and sleep every night; they want to get
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their nice dividend on a quarterly basis and not have to worry aboutthe fund.
Tanous:But the performance is awesome because it exceeds thebarometers you set for yourself - which is to provide, what, 200 basispoints above long bonds? I mean, you’re way over that...
Ryback: Yes, we are.
Tanous:! believe that your performance competes with the S&P 500even in the bull market we’ve been in for so long.
Ryback: My personal goal is to do 20% per year, if | can. However,some markets don’t allow me to do that. I try like bejesus to do it,but it doesn’t happen. I’ve rigged this fund to be extremely defensiveright now, probably the most defensive it’s been in a long time.
Tanous:ls that a reflection of your view of the market?
Ryback: Yes. The bond portion of the portfolio is three years dura-tion. And the average yield is 10.5%. With the long bond rising dra-matically, to about 6.75%, it’s not even close to where my return is.But I’m very uncomfortable at this time. I’m very happy on one side,but uncomfortable on the other.
Tanous: You’ve expanded your business, Eric, to include a lot ofdifferent kinds of funds. For instance, the farthest thing I can thinkof from what you do is small-cap. Talk to us about that strategy andtell us how you have done with it.
Ryback: Last year the Small-Cap Fund lagged the Russell 2000.This year [1996] it’s outperforming it. We started the Small-Cap be-cause the Lindner Growth Fund grew to $1.5 billion. The Growth Fundhad tremendous performance through the ’80s and then started lag-ging. About two years ago, we took a close look at it. We decided wehad too many issues in there, too many different names. We were upto about 240 names. A fund this size shouldn’t have that many names.We were still applying our fundamental approach, but we were gettingtoo cute. We had names in there that represented only 0.2% of thetotal portfolio. These things could double and triple and it stillwouldn’t have any effect on the fund overall, because the positionswere so small. So, we’ve taken about two years to whittle it down toabout 160 names. The fund is now starting to perform the way wewant it to.
Tanous:Now which fund are we talking about?
Ryback: The Lindner Growth Fund. I know you asked me about
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the Small-Cap Fund. We started the Small-Cap to absorb the namesthat we could no longer buy for the Lindner Growth Fund.
Tanous:! see.Ryback: Last year I had my hands full. In January ofthis year, we finally got a comanager for the Small-Cap. I’m happyabout that and it’s already doing quite well.
Tanous:Another peculiarity, if I can call it that, is that your ratherconsiderable success - your Lindner Dividend Fund has $2.2 billionin it - has come without the benefit of advertising. I mean, pick upany of the dozen or more magazines devoted to investments, and everyother ad is for a mutual fund. But not yours. Why?
Ryback: We do not advertise. We want to keep our expense ratiolow. Kurt always believed that if you perform well people will invest.We want to adhere to that. It’s certainly not our intent to advertise.
Tanous:That’s not going to change.
Ryback: No.
Tanous:There’s no chance I might pick up an issue of Forbes orFortuneand see a full page ad for your fund.
Ryback: No.
Tanous:! think you have a total of $4 billion under managementin all the funds? Do you manage any private accounts?
Ryback: No. I got rid of them when I took over the business. It waslike having 60 more mutual funds. I didn’t need it.
Tanous:I know. And sometimes they call every day!
Ryback: It was just too much for the managers here.
Tanous:Let’s go back to the subject of process one last time. Yourforte, and this is the way you were brought up, is manifested in yourextraordinary success with the Dividend Fund. But a small-cap is acompletely different animal and requires a very different investmentapproach. What skills will help you succeed with that fund?
Ryback: That’s a fair question. When I came here, I worked on theDividend Fund and the Growth Fund. Now it’s just a matter of apply-ing our value approach to smaller issues. | used to contribute a lot ofsmall names to the Growth Fund over the course of the years, and Iwill direct the Small-Cap Fund in the same fashion. I’ve got all theconfidence in the world that it will really be a duplicate of the GrowthFund during its heyday in the ’70s and ’80s, when it well outperformedthe S&P 500. I think I lost some focus last year because I may havehad my hands too full, but I think that focus has been regained withour new person.
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Tanous:Would it be safe to say that the majority of the investorsin the Lindner Dividend Fund are tax-free accounts, like retirementand pension accounts?
Ryback: Oh boy. Surprisingly, we do have IRAs, but we don’t haveas many as you might think, given the type of fund that it is. Thefund has attracted a lot of older people. We were just out at the LouisRukeyser investment conference in Las Vegas.
Tanous:! heard there were 9,000 people there!
Ryback: It was just amazing. People wanted my tie! It had a bulland a bear on it. They thought we were giving it away. Talk aboutthe herd instinct. I spoke in the auditorium where they hold the prizefights, where Tyson’s going to be. So they had this elaborate projectionsystem, where the speaker's image was displayed on these hugescreens. They could see this tie. When they came running out of theconference after that session, they came up to me and said, oh, lookat the tie! Where can we get one? I said, my six year old daughterbought it for me for Christmas, so you can’t have it!
Tanous:Now you know what it feels like to be a rock star, right?
Ryback: Oh, man. I guess.
Tanous: You’re a relatively young guy. You’ve been very successful.I don’t know what they teach at Idaho State [where Ryback went toschool], but it must be pretty good. Your hiking experience is some-thing that people like me who have lived in large cities all their livesare in awe of. What tempts you down the road as you look to the nextphase of your life?
Ryback: I just want to win. I come to work every day to try to win.That sums it up all right. First, I have to tell you that I tried real hardto get the formula out of him, but I didn’t succeed. I never was a bigfan of black boxes, but here is a case where the investment processteally shines.
Let’s look at two issues that come to mind after spending time withEric Ryback. First, if you and I think that there is a particular typeof person who has a better chance to succeed as a money managerthan others, I think we can quickly disabuse ourselves of that notion.Certainly being smart helps a lot, but do you have to go to the rightschools? Apparently not. Eric Ryback didn’t need a prestigious businessschool, high-powered connections, or a Wall Street environment tolearn to be a great money manager. In fact, he is the most un-Wall
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Street-like person I think I have ever met, maybe because he neverworked in New York. But he is smart. And disciplined.
Now look at the process. He uses a well-defined, thorough processtaught to him by his mentor, Kurt Lindner. When Eric Ryback tookover the business, he continued applying the very same precepts andprinciples he had learned from Lindner. He expanded the business toinclude other investment vehicles, and, while they have done well, theshining star in this Missouri firmament is the Lindner Dividend Fund.Using their famous formula, and the investment skills of Eric Rybackand his team, they continue to deliver a very low-risk, high-returninvestment vehicle. We learned about as much as anyone knows aboutthe process and how they do it, black boxes aside. The process is clearand sensible. I honestly think that this is one type of investing thatmost of us could do on our own, if we were willing to apply ourselvesand rigorously follow the procedures you just read about. Of course,why bother? We can just buy the fund and let them do the work.Happy trails.
190MERTON MILLER
Merton Miller’s illustrious academic career started at Harvard, fromwhich he graduated in 1943. He spent the next few years in Washing-ton, D.C. working at the U.S. Treasury and the Federal Reserve. Heearned his Ph.D. from Johns Hopkins in 1952. The following year,he joined Carnegie Tech, in Pittsburgh, where he taught economichistory. At Carnegie Tech, Merton Miller first encountered another,somewhat older, economist, Franco Modigliani. Their subsequentcollaboration was destined to become part of economic history.Modigliani won the Nobel Prize in Economic Sciences in 1985. Inturn, Merton Miller won his in 1990. The product of their collabora-tion, which was quickly dubbed the “M&M theorem,” is still widelydiscussed and argued among economists and corporate finance types.
If you thought economists were dull, Merton Miller will changeyour mind. He has a well-known sense of humor, and we'll put it tothe test. While the M&M theorem is not directly about investing instocks, it does have some very real application to valuing a company.By the time we’re finished, I think you'll agree that everyone interestedin the field should know something about it. We ask about his viewson market efficiency and investing generally, and we get into areasfew people have ever explored with Professor Miller. Here we go.
Tanous:How did you first get interested in stocks?
Miller: Well, I don’t know, because it was so long ago! They arepart of the atmosphere. I was in economics even as an undergraduate.Stocks were part of the environment. How did you get interested instocks?
Tanous:! was an economics major at Georgetown. In my first eco-nomics class as a freshman, our professor, Dr. Gunther Ruff, askedthe students why they were taking the course. I