It's a Gas

One of the keys to investing—and making big money—is recognizing fundamental change, then getting in at the right time. Think of auto company stocks in the early 1900s, personal-computer companies in the early 1980s, and more recently, oil and gas. If you were on the right side of the doubling of oil prices in the past two-plus years, you made a lot of money in the stock market.

Ulland Investment Advisors in downtown Minneapolis has been on that right side. Over the past three years, James Ulland, the firm’s founder and senior portfolio manager, and his colleagues have been outperforming their Russell 3000 benchmark—the broad index that comprises about 98 percent of the total capitalization of the entire U.S. stock market—by more than seven percentage points. (The Russell 3000 is up 55.2 percent.)  Ulland is more than six percentage points ahead of the benchmark over the 12 months ending last March—the firm’s “Intelligent Blend” of large-, mid-, and small-capitalization stocks was up almost 21 percent during that time period.

{Q} We’re all hearing that this has been a pretty good time—the past couple of years, anyway—for small-cap companies. Have you found that to be true?

Small companies in different sectors have come back at substantially different rates. For instance, small banks, in a rising interest-rate environment, haven’t done very well. Small oil companies have been fabulous. The small technology companies have been spotty. Companies that were at $100, then fell to $2 a share, have moved up to $4 a share, so they’ve had a 100 percent increase! But a lot of them still aren’t profitable. In telecom, particularly, with the continued collapse of long-distance pricing, it has been very difficult.

{Q} But aren’t people beginning to spend money on technology?

Yes, but the money being spent on technology is more on the retail side—the iPod being a great example. On the computer side, the margins and pricing pressures are very difficult. We just bought four computers from Dell. The price of the four computers combined was the same as one computer four years ago. And this is with flat panel screens thrown in.

{Q} There’s been some talk that the tremendous amount of investment that was made before Y2K will be both fully amortized but also in need of an upgrade. Are you investing in any of these companies to anticipate that?

Not yet. [Massachusetts-based data-storage company] EMC [NYSE: EMC]—at the height of the Nasdaq, when it was at 5,000 [in March 2000]—was $100 a share. It dropped to $5. It’s now at $13. They are having 15 percent revenue growth and 20 percent earnings-per-share growth, which is very average [for EMC]. They deal with eBay, Yahoo, Google, all companies that are just eating storage 24 hours a day. So there’s a big demand for storage—but here again, the price of the technology has fallen dramatically. So even if you get this replacement demand, you get it at such a lower price and a lower margin that technology is not as charming as it was 10 years ago.

{Q} What do you like?

We like oil and gas a lot. We do like health care technology—and here we like the small caps versus the large caps. We like financials, such as investment firms that are participating in the private equity market and publicly traded money-management firms, such as AllianceBernstein [NYSE: AB]. We’re avoiding banks, though. We like homeland security, and finally we like the exchange-traded funds.

{Q} What about oil and gas isn’t priced into the market right now?

We’re focused on natural gas more than oil. The ratio between gas and oil on heating value suggests to us that natural gas is still significantly undervalued. So with oil at $67 a barrel, gas should be at $10 per million cubic feet. Well, gas is at $6.70. If you were able to convert all your oil to natural gas [in terms of thermo units to dollars], natural gas would be selling at about twice its current value.

{Q} Are you buying natural-gas companies, then?

No, actually. We are in a pause as far as buying natural-gas companies. We had a very warm winter and we have some very high levels of natural-gas inventories right now, so prices are depressed. We are waiting until June [or] July before we again buy natural gas. July and August are heavy natural-gas usage months for peaking electrical generation plants; those are also hurricane months and getting-ready-for-winter months in the area of natural-gas storage. So it’s typical that natural gas hits a peak of value in December, anticipating a cold winter.