Only The Humble Survive: Jim Whitner -- Part I

In TradingMarkets.com's continuing series of interviews with traders, Eddie Kwong spoke with portfolio manager Jim Whitner. The title of this interview, "Only the Humble Survive," comes from Jim’s statement that only the humble survive in the markets-—a play off Andy Grove. He expands on this in Part II of the interview where he talks about money management, among other things. 

Eddie Kwong: Jim, tell us a little bit about your hedge fund.

Jim Whitner: What we have is, by definition, a hedge fund. But I like to refer to it as an investment partnership because in the traditional definition of the hedge fund, you'll go long and short. We're not really very good at going short. We don't like to experiment with our clients' money, so in learning how to go short, I'd rather lose my own money in trying to learn the "short game."

Kwong: How would you define the focus of your fund and how well has that approach worked for you?

Whitner: Last year we did 170%. I can only give you that figure as a track record since we started the fund in 1999. But during that single year, we also did 15% during the third quarter during which the market got clobbered. The Nasdaq was up 2%, the Dow was down 7%, and the S&P 500 was down 6% in that same period. We did this by using an investment strategy that not only helped you make money, but helped you protect your money in a correction. Our fund is a small, mid-cap growth stock fund. We set it up that way because we felt we could add a lot of value to a sophisticated investor's portfolio by giving him exposure to what we call the "entrepreneurial growth in the U.S. economy." Everybody has their own definition of market cap, but we like to define that area as the "sweet spot" of the small mid-cap. That is, we focus on $300 million to $5 billion as the territory between small-cap and big-cap. We'll buy stocks within that range, but we might hold them even until they get to $12 billion. If you hook into a Dell Computer, Microsoft, or Cisco you're not going to sell that gorilla prematurely if you can help it. The small mid-cap area is a dynamic area. That's where all these new companies that are coming to market with these new products and services are. It's where the new industries are developing.

Kwong: How much money do you manage?

Whitner: About $12 million overall, but within the fund there's about $4 million.

Kwong: How did you get started investing in the stock market?

Whitner: I was an econ major in college. That happened to be the one area in which I was getting good grades. From economics I gained an interest in the stock market. My family needed some help with their personal finances and they asked me to help them out and through that I got a lot of exposure to the markets. Then I went to business school in the late '80s and we did a lot of case studies and I realized that I really loved doing research. And I developed a real interest in analyzing companies. The more I read and learned, the more I realized that the classical education you get from the classroom about the stock market wasn't going to make you very successful.

Kwong: That's what I expected to hear.

Whitner: Yeah. So I decided that I was going to read everything I could about the successful money managers that has ever been written since the turn of the century. I'm an avid reader. So I took off. I read everything I could about Warren Buffett, Phillip Fisher, Peter Lynch, Gerald Loeb, Bill O'Neil. The more I read, the more I began to understand the dynamics behind the market.

Kwong: What did you wind up with when you began to synthesize the strategies of these legends?

Whitner: I started with a "value" perspective because I had always idolized Warren Buffett. . .and I still do. I think Warren Buffett is one of the greatest investors of all time. However, I think his value paradigms don't work very well in the new economy. But what he did through 1998 was just amazing. The way he managed the risk in his portfolio was head and shoulders above everybody else.

Kwong: But it sounds like your thinking evolved over time.

Whitner: As I progressed in my reading, a number of things started to become a lot more obvious. I started to get a greater appreciation for technical research as opposed to the purely fundamental approach I started out with. I began to understand how fundamental and technical research could work together to help me capitalize on certain trends in the markets.

Kwong: How did you arrive at what is currently the foundation of your trading strategy?

Whitner: I read Bill O'Neil's book. His investment model, CANSLIM, was the foundation. I liked his approach because it encompassed the views of a lot of the great past money management approaches. But it was a starting point. One of the most important things I've learned is that you have to constantly refine your investment model as the markets evolve and develop and new industries come into focus.

Kwong: How do you go about that refinement?

Whitner: I constantly study the past performance of big winners. For example, I'll go back and study the big winners of 1999, whether or not I owned them. I'll analyze all their charts. I'll study the companies' fundamentals, technicals, and group confirmation. One of the things we've discovered in our research that deviates from the pure O'Neil approach is that you've got to back off the primary focus on earnings in many cases. You had a number of companies that were huge winners whose earnings were not very strong. You didn't have an EPS rating in 1999. But what distinguished them was that they had a new product or service in markets that had huge growth potential. Wall Street was taking notice of these companies. A significant number of big winners did not have very strong earnings or revenue growth relative to other companies that also made big moves. Qualcomm's (QCOM | Quote | Chart | News | PowerRating) revenue numbers weren't that exciting at first. As economies change and new industries come into focus, you're going to realize that there are different criteria that help you separate the winners from the losers.

Kwong: Early in your career did you make any big mistakes that shaped your current approach?

Whitner: In the beginning I wasn't very good and had just average returns. I was trying to blend growth and value strategies together. I was also listening to others' opinions too much. One of the things that really helped my performance was that I stopped reading everything I could about what was going on in Wall Street and avoided the weekly articles that appeared in Forbes. That's not to say that the information wasn't worthwhile. Rather, I decided that I had to rely upon and make decisions on the basis of my own research. If I was going to follow anything, it was going to be research and information sources that were in harmony with my approach. In this business, you have to manage information-overload. In the information economy, we all have to deal with that. I realized that I needed to maintain a focus. I learned that past successful money managers were focused. They didn't let the noise of the Street distract them.

Kwong: You mentioned earlier that you analyze past winners in order to build a model of what will be successful in the future. Tell us about how you applied that model in 1999. What exactly did you look for in a stock in order to produce the 170% return you earned?

Whitner: We try to focus on those industries that are benefiting from fundamental trends in the economy. We're looking for companies that are bringing new products and services to market and that have the potential for tremendous growth over the next few years. We also want to see that growth evidenced in their quarterly earnings and revenue numbers. We're looking for companies that are in business experiencing dramatic growth as a result of a new product or service or new industry trend.

Kwong: That probably requires a lot of research, doesn't it?

Whitner: Definitely. You have to focus on the dominant trends unfolding in the economy right now, whether it's broadband data applications, e-commerce, or e-business. Once you understand what's going on in those areas you can relate to telecom equipment companies, Internet software, Internet security solutions, ISP hosting, ASP service providers, and wireless broadband applications. You can even get into biotech and genomics. With this model, we're looking for companies that are part of dynamic industries whose growth is driven by powerful economic trends. I look for companies that are evidencing this growth through very strong quarterly earnings and revenue numbers. Then we'll check on the story on these companies and see how they fit in with their industry groups.

Kwong: What do you do with this model that seems to focus primarily on fundamental analysis?

Whitner: We'll use technical analysis to help us pick our buy and sell points as well as to manage the risk. Let me use a couple of examples to illustrate how we do this. My two biggest winners of the year fit the criteria very well. One was MicroStrategy (MSTR | Quote | Chart | News | PowerRating) and the other was i2 Technologies (ITWO | Quote | Chart | News | PowerRating). These were two stocks that had significant earnings and revenue growth together with e-commerce applications. The enterprise software group was hot. It was one of the big leading groups in the market. These were two companies with strong fundamentals and the technical situation looked very promising. So we started building positions in them.

Kwong: What did you like about the technical situation? Let's start with ITWO.

Whitner: We were catching these stocks breaking out of good solid bases. That's always the key. You don't want to chase extended stocks or stocks that have already risen a substantial amount from their bases; those are going to be the first to pull back against you. If you can start off from a winning position, then you're much more able to ride out the next correction. We first bought i2 on Oct. 27, 1999. It had broken out a couple days before on big volume out of a base around 45 or so (chart below is adjusted for 2/1 split -- Ed). Then it formed another little base and broke out again. It jumped from 56 to 60 and that's where we took our first position. That was a pretty good breakout. The market was just getting ready to take off. (ITWO | Quote | Chart | News | PowerRating) was a company with funds running into 35% of the float at the time; they were well covered by a number of good firms. They had just recorded a real solid quarter on the earnings. In the previous quarter, earnings were up 300% and revenues were up 53%. For the previous couple of quarters they had exhibited very strong quarterly revenue numbers.

Kwong: What about MSTR? Similar setup? Looking at the chart I can see that the stock broke out in late November.

Whitner: MSTR was a similar setup. We actually started buying MicroStrategies on Sept. 23, 1999, which was right in the middle of the third-quarter market correction. If you look at it on a weekly chart, it was just starting to break out. They had very strong earnings and revenue numbers on a quarterly basis.

Kwong: That's interesting that you mustered up the confidence to buy MSTR during a market correction.

Whitner: One of the things that's important about the investment model is that if you go back and study the characteristics of past winners, it's so much easier for you to step up to the plate and open up a position in the next good idea that fits your parameters--even in a correction. You've seen it happen time and time again. If you understand that a company fits the parameters of the past Dells and Microsofts, you feel a lot more comfortable doing this. That's one way in which a money manager manages the risk in a portfolio: They put money into the best ideas they can get a hold of. Admittedly, I missed a lot of the biotechs in the last two months mainly because it was really hard for me to wrap my hands around those companies when they were going from 20 to 80. That's not to say I didn't think they could be big winners. Rather, the issue was more in managing the risk.

Kwong: In other words, you couldn't see examples of past winners that the hot genomic group within the biotech sector resembled, right? 

Whitner: That's it. We didn't understand this particular industry as well as we understood Internet-related companies. But we're starting to learn a lot about biotechs and we'll be in a position as we go forward to step up to the plate. Right now the biotechs seem to be pretty extended so we've got to wait for them to form new bases.

Coming in Part II on March 11:

• Stocks he currently likes

• How Jim exits bad trades, i.e. stops.

• Market timing

• Money management

• Walking into a trade

•  Psychological issues