Big Things from Small Caps


In the harrowing market of the last three years, at least one set of mutual-fund managers has succeeded in picking stocks that have done "extremely well," in their own words. The managers are Rick Giesen and John Richardson of the Munder Small-Cap Value Fund (MCVCX), which has about $100 million in assets and outperformed the market in the first three months of this year.

Giesen and Richardson apply a value strategy, picking stocks based on profitability, growth, and a good balance sheet. Richardson notes that smaller companies grow faster than larger ones, and Giesen adds that small-caps typically lead the way for a year to 18 months coming out of a recession. They also make the point that small-caps don't have some of the accounting and corporate governance "baggage" that has been seen in big companies.

These were some of the points the two managers made in an investing chat presented Apr. 17 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from this chat. A complete transcript of this chat is available from BusinessWeek Online on AOL, keyword: BW Talk.

Q: So how do the managers of Munder Small-Cap Value see the current market?

Richardson: When we look at the universe of names of potential investments, we find a bunch of companies that seem to be attractively valued.... Clearly, in a period where we've been in a bear market for three years, and we focus on the Iraqi war and economy, there's a lot of skepticism as to what the future holds. If you think the end of the war will bring back normalcy, you'll likely be right. However, we've been in a really tough environment. The average stock in our portfolio over the last three years has done extremely well, even in a tough environment.

Q: Can you tell us how you pick stocks for your fund?

Richardson: We're truly stockpickers from the bottom up.... As a value manager, looking for turnaround companies or companies that are cheap isn't what we focus on. Our companies are defined by how profitable they are. We want to see them executing on their business plans, and we want to see that they're at an attractive price. We're looking at each company as if we were to own the company in our personal account.

Giesen: To add to what John just said, our mandate for the companies we own is straightforward. We like to see that they're capable of growing their business or franchise in combination with an appropriate balance sheet, and we want to see them have a return of capital that's proportional to their cost of capital. The approach overall is no different than if any one of us were looking to buy a car or a house -- where you want the best quality at the least expensive price possible. The same thing goes with owning a company.

Q: Why small-caps now? Don't they tend to lag larger stocks in recovery?

Richardson: No. Historically, small companies do best when the economy is doing well.... We can find small companies that are valued at extremely attractive levels, and they grow faster than large companies.

Giesen: Coming out of a recession, small-caps lead large-caps by a significant amount for, typically, 12 months to 18 months. I would say that there has been a lot of concern about the credit quality and trustworthiness of large companies like Enron and Global Crossing. Small companies don't have the same baggage.

Q: Can you give us five small-caps bound for success in the next 12 months?

Richardson: Hopefully, we can give you about 80 or 90! It's hard to really pick one or two or five. But I would say American Axle & Manufacturing (AXL) is one. Ryland Group (RYL) is another. Lastly, I would say New Century Financial (NCEN), which is our largest holding in the fund and just reported earnings up over 100%.

Giesen: I would add Amerigroup (AGP), Hanover Compressor (HC), and a third one would be WebMethods (WEBM).

Q: What has your fund's performance been over the last three years?

Richardson: First quarter this year, we outperformed the market by about [three percentage points]. In 2002 we were down 8%. In 2001 we were up 26%, and in 2000 we were up 16.5%, but we didn't manage the fund in the first quarter, when it actually underperformed.

Q: When do you sell a stock?

Richardson: Well, there are several times. The best time is when it gets too big as a percentage of the portfolio. As a value manager, we also sell when a stock becomes overvalued from our perspective. The most important time is when it no longer has the financial characteristics that we bought it for. We'll sometimes hold a stock even when the environment's tough, as long as management is still executing.

Q: How large is your fund in terms of assets? How much cash are you currently holding?

Richardson: We're holding less than 5% in cash, and the fund is approximately $100 million in assets.

Q: You mentioned top holding New Century Financial (NCEN) -- why do you like it? And do you own many other financial names?

Richardson: First of all, on the financial names, we benchmark to the Russell 2000 index, and they own about 30% financial names. We'll always own a good amount just because of that. Century, specifically, is extremely profitable. It's growing very rapidly, it's gaining market share, sells at less than five times earnings, and it's generating a huge amount of free cash flow that it can use.... Finally, there is a lot of skepticism on Wall Street, which creates the opportunity in our mind.

Q: Why small-caps over midcaps for best performance?

Richardson: We'd like to think the midcap sector of the market is also attractive, and actually, there's an overlap. The bottom of the midcap overlaps with the top part of the small-cap, so 20% of our portfolio would likely be considered midcap by some definitions.

Q: What about the consumer sector? Any names you like there?

Richardson: American Axle we mentioned. Ruby Tuesday (RI) has been a great stock for a long period of time. They continue to execute very well.

Giesen: Another one I would put in there is Hibbett Sporting Goods (HIBB). It's a little above our valuation target right now, but fundamentally we still like the name a lot.

Q: I see you have a hefty percentage of industrial stocks, some 16.3% -- what are some of them?

Richardson: We have a diverse number of names there. Among them are Graco (GGG), Orion Tech (ORTC), Genesee & Wyoming (GWR), Headwaters (HDWR), Oshkosh Truck (OSK) (one of our favorites). That's just a few.

Q: What have been some of your biggest stock success stories?

Richardson: A lot of them have been in the financial area: New Century Financial, as we mentioned. Also, Correctional Properties (CPV), Newcastle Investment (NCT), Polymedica (PLMD), Old Dominion Freight Line (ODFL), and Penn National Gaming (PENN).


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