"ONLY AN IDIOT WOULD PAY ATTENTION TO BOOK VALUE"

L. Roy Papp returned from a late 1970s stint as director of the Asian Development Bank in the Philippines with a passion for the potential of overseas investment — and an equally strong aversion to foreign markets.

So, he figured out a way to have his growth and keep his capital, too. His Papp America Abroad Fund, which boasts a 23.3% annualized return the past five years, invests in U.S. multinationals that do a significant portion of their business overseas.

“More growth, less risk,” says the straightforward founder of Phoenix-based investment manager L. Roy Papp & Associates.

Mr. Papp, who manages $1.3 billion in five mutual funds and in separate accounts, is equally blunt about the recent underperformance of his large-cap growth portfolio: “temporary,” he says. As for newly hot value stocks? “Crap.”

Q Describe your investment philosophy.

A We buy growth stocks with a three- to five-year horizon. We want the top company in an industry. If we can’t get the top we want the second. More important: We want the innovator, not the biggest sales.

Q For example?

A IBM was the biggest in the 1980s, but it wasn’t the innovator. We bought Microsoft.

Q How did your time in Asia affect your investment outlook?

A It’s not just the investment outlook. It affected me personally. We realized pretty quickly that the pace in Manila clearly wasn’t the same as New York or Chicago. Everyone took their time, saw things on a longer horizon. At that time, the New York Stock Exchange was never open when we were awake. We got the Wall Street Journal five days late. You had to make long-term investments, so I developed a higher degree of interest in quality, in the top companies.

The other thing was, I found out I made more money in Manila than I ever did on LaSalle Street. (Mr. Papp was a partner at Chicago investment manager Stein Roe & Farnham for 20 years before being appointed to the Asian Development Bank by President Gerald Ford.)

It also helped me in my personal life. I don’t get excited. We probably move at about 80% of the pace of New York, but accomplish 95% as much.

Q Tell me about the idea behind the America Abroad Fund.

A I had been getting pressure in the late 1980s and early 1990s to buy foreign stocks, and of course I knew a lot about a lot of foreign companies — more than some of these young people managing international funds.

I finally had so much pressure from so many people I started thinking maybe I can buy something in Swiss. So I looked up Nestle, which I knew a little bit about because we had owned Carnation (which Nestle bought). I discovered that just 4% of their sales were in Switzerland and 40% in the United States. So what I would be doing is taking my money to Switzerland so they could bring it back here.

It dawned on me that I could buy American multinationals and get 50% foreign and 50% U.S., but then I don’t have the foreign currency problem. I don’t have the bank custodian problem, the funny accounting problems. I don’t have sunset and mature companies.

People ask me why I don’t invest directly in these companies. They’re cheaper than U.S. Well, they ought to be. Don’t compare them to Microsoft or Merck or Pfizer. Compare them to cement companies or machinery companies or heavy industry. Then the multiples are about the same.

Also, when you go abroad you lose Securities and Exchange Commission protection. Having lived two years in Asia, I know there’s a lot of difference in the morality codes. That’s not to say they’re dishonest. But they are different.

Q There’s been talk that value is coming back.

A Once or twice a year that theory is put forth, and then they get over it in about a month. But I’m in favor of value. Who isn’t? We own Microsoft, we’re even buying some now that the stock price is down about 20%. But we bought most of it at a much lower price.

Q What price/earnings ratio is appropriate for a growth stock?

A If the market multiple (of Standard & Poor’s 500 stock index) is 30, then high tech stocks that are 30 or 35 are quite attractive.

You have interest rates at 5.25%, which means you pay 18 to 19 times earnings to buy a five-year Treasury. Stocks have given you four times the return of bonds. So what’s the multiple for a good, high-quality growth stock? A lot higher than 19 times earnings.

These “value stocks” used to be called cyclical stocks. Nongrowers. Then they put them all together and called them value.

Ben Graham was a great thinker, but he was active in the 1920s and ’30s and ’40s. Back then book value was important. Today, only an idiot would pay attention to book value. It’s been killed by 30 years of inflation. In the best companies today, the book value walks out the door at 5 p.m.

The multiple of cash flow to earnings is what’s important now. Book still has some meaning for utilities, until they’re deregulated. Or maybe banks.

Q Your performance hasn’t been so hot lately. Why?

A Part of it is the move to value in the last month. Part is the increased concern about multinationals in the last year. And the growth stocks have had an enormous run, particularly the large caps. Long term they will still be the winners.

Q What’s your outlook overseas?

A I feel pretty encouraged. Time magazine said (outgoing Treasury Secretary Robert) Rubin and (incoming Secretary Lawrence) Summers saved the world from a depression. There never was a damn depression.

Q What about Japan?

A The worst is over but that doesn’t mean it’s going up tomorrow. They still have fundamental problems. I would not want to buy companies with a lot of business in Russia, Brazil, Africa or India.

Q Tell me about your theory on recessions.

A Most of the worst recessions in the past 50 to 100 years — they happen every 3.5 years or so historically — were inventory adjustments. Now we have computers that tell you what was in the stores yesterday — real time inventory — so it’s hard to have an inventory recession.Since 1982 we’ve only had nine months of recession. I’m not saying we won’t have another one, but it won’t be an inventory recession. It could be an economic asset boom trigger like Japan did, but we’re not even close to that.

Q What are you buying?

A We’re buying Microsoft for the first time in years.

We also like State Street Corp. We love it. If you look at all American companies for the last 15 years, and you took only those that had consistent double-digit growth for 15 years, No. 1 would be Wal-Mart, Coke is No. 2 and State Street is three. But it sells at a lower P/E than the S&P 500. The entire U.S. Treasury debt market comes to $3 trillion. State Street has custodianship of over $5 trillion.

We started buying IBM six months ago. We rethought that one. I like that they now have 20% to 25% of revenues from service. And they’re no longer a country club for executives. It’s a hard-working company now.

Q What are you selling?

A We’re selling the value stocks. Since 1991 we’ve had nothing but good markets. The minute we get something different, the cyclicals will get hit worst.

Q What’s your big picture outlook?

A I think 10% growth will be the norm, it’s not going to keep going at 20%. I think the good companies will continue to grow at 12%, 13%, 14%. That kind of company is worth a lot more than a so-called value stock.

Vitae

L. Roy Papp, 71, chairman, L. Roy Papp & Associates, Phoenix.

Papp America-Abroad Fund (assets, $281.8 million): year-to-date, -3.98%; 3-year, 19.48%; 5-year, 23.73%

Papp Stock Fund (assets, $92.9 million): ytd, -2.94%; 3-yr 21.39%; 5-yr, 21.67%

Papp America-Pacific Rim (assets, $13.4 million): ytd, -3.02%; 3-yr, N/A; 5-yr, N/A

Standard & Poor’s 500 stock index: ytd, 6.47%; 3-yr, 26.96%; 5-yr, 25.86%

All numbers through May 31

Source: Morningstar Inc.