Fund Manager Profile
Interview: One-On-One with Scott Black

Fund Manager Profile
Scott Black is founder and President of Delphi Management, Inc. Mr. Black has over 30 years of financial and general management experience beginning with corporate finance and international treasury positions at Xerox and Joseph E. Seagram. At Merrill Lynch he rose to head of Corporate Development, where he was responsible for the holding Company's diversification activities. He joined William O'Neil Company in 1978, before managing equities for Sunkist Growers, Delphi Management's oldest account.

Scott graduated from Johns Hopkins University with a degree in Applied Mathematics and Economics. After completing his U.S. Army active service obligations he received his MBA in Finance at Harvard Business School.

Mr. Black has guest lectured on investments and corporate finance at Harvard, MIT and Stanford. He has been featured in Fortune, Business Week, Forbes and The Wall Street Journal. Additionally, Mr. Black has appeared on CNN, CNBC and Wall Street Week, and has participated in Barron's annual roundtable.

Among his civic activities, Mr. Black serves on the advisory boards of the John F. Kennedy School of Government at Harvard, Johns Hopkins University, Northeastern University, the Museum of Fine Arts (Boston), and the Portland Museum of Art.

One-On-One with Scott Black

Eric Kobren: Scott, can you take a few minutes and explain what your thought process is when you are picking stocks for the E*TRADE Delphi Value Fund?

Scott Black: Well, there are really two main decisions I make...first, is the company a good business? And second, can I purchase this business at a cheap price in the marketplace? My research on the first question is based on a quantitative screening process which is actually made up of six factors.

EK: Can you give us an idea of what these six factors are?

SB: Sure...on average, the company should earn a minimum 15% after-tax return on equity. For a cyclical business, the corporation must achieve this 15% target on its recovery earnings.

I look for companies that grow both revenues and earnings faster than inflation over a 3 to 5 year time horizon. I understand that not all companies grow along a straight line...but I want to see real growth, not just nominal growth, over time.

For non-financial companies, I perform a free cash flow analysis to determine if a firm can finance its growth from internally-generated operating cash flow. I eliminate non-recurring items such as divisional spin-offs, or divestiture of assets to obtain a true cash flow. Also, I analyze the areas of capital intensity such as inventory turns, days of receivables, and sales to fixed assets.

EK: You've mentioned cash...what about debt? We've all seen how dangerous it is for a company to borrow too heavily for growth...

SB: Well, I look for companies with low debt/equity ratios. Approximately 40% of my portfolio holdings are virtually debt-free.

As far as value is concerned, I am an "old school" Benjamin Graham-type value investor…I insist that all purchases for the fund should be made at a substantial discount to a conservatively estimated liquidation value.

EK: Do you look at any of the accounting methods that may be used...sometimes a company can be made to look better on paper...

SB: Exactly...I insist on conservative accounting practices be used in the companies I am considering purchasing. I don't want any surprises.

EK: This seems to me like a sound strategy for looking at the numbers. But what about the people running the business...the numbers don't always tell the whole story...

SB: That's actually an important part - maybe the most important part - of the Delphi research process...After a company meets the quantitative criteria, I have a rule that, in all cases, we must either telephone or visit with the management of the company. I like management with a high degree of integrity...I want a person who willingly communicates what the problem areas of the company are...I try to avoid individuals who tout their stock with promotional literature or fancy slide shows.

EK: You mentioned earlier that there are two main factors to the investment process: finding good companies and buying them cheaply. How does this process work in the E*TRADE Delphi Value Fund?

SB: I divide this issue into 2 categories: earnings power plays and asset plays.

First, earnings power plays are companies with consistently high returns on equity every year with relatively few breaks in reported earnings. Under no circumstances do I pay more than 12-times next year's conservatively estimated earnings. And the second category is...

Asset plays. These are companies which may be currently depressed due to short-term conditions. They have, however, earned 15% return on equity in the past and can reach that figure again - with the likelihood of reaching that figure again. But currently they sell at a significant discount to liquidating value.

EK: With all of these strict guidelines that you use to pick stocks for the fund, do you ever find that there are not enough stocks for sale that meet these criteria? ...Can the fund stay fully invested under your methods?

SB: It is difficult - you're right - but over the years I've been able to find enough bargains...I generally like to stay fully invested...with 85% - 100% equity exposure...at all times.

EK: Thanks, Scott.

SB: You're welcome.