Eric Marshall, CFA, co-manager of the Dallas-based Hodges Small Cap Fund (HDPSX), has a bottom-up stock picking strategy that's put his firm on the map of top performers. We spoke with Marshall to get the scoop on his top stock picks.
"Our philosophy is that stocks have prices, but businesses have values. We don't worry about foreign exchange and commodities or Greece and Spanish bond yields, we just invest in companies that are investing in business."
The firm's five analysts go out and study companies full time. "We talk to vendors, suppliers, competitors, and industry participants to size up the risk reward of the investment. We talk to management and focus on buying at a good price." When asked if his stock picking strategy has any constraints based on ratios, dividend yields, or historical performance, he replied that his firm avoids the hard-and-fast rules and screens. "Sometimes the best investments are not the most obvious."
The benefits of small caps
For active investors, small caps operate in a less efficient area of the market. If the names are less followed, information may not be fully digested in the stock price, so if you spend time doing homework, you can really find some great bargains. "In a slow growth environment, it's often that you can still find positive price growth with small caps," adds Marshall.
In general, smaller businesses are less affected by global events than big name firms. "It doesn't matter what happens to EU bond rates overnight, they're just focused on growing their own business."
Hodges currently favors energy, consumer discretionary, technology, and financial sectors, and airline, media and agriculture industries. Favorites include Belo Corp, Eagle Materials, FelCor Lodging Trust, and Faro Technologies.
Hodges is also adding smaller financial stocks like Texas Capital and Viewpoint, which it had avoided in the past four years. Marshall explains how the banks have better capital structures and more transparency than they used to, giving investors a great opportunity to capitalize on healthier banks. He also believes companies with niche technology for smaller hospitals, such as Computer Programs and Systems, are well positioned.
Let's talk specifics
The Manitowoc Company
Texas Pacific Land Trust
This brings up another good point about small caps: You often see smaller companies get bought out by larger companies to subsidize lack of organic growth in slower environments, when revenues aren't growing that fast. "They kind of leverage fixed costs, and we saw some of this activity pick up this summer. It should continue to end of year, which bodes well for a lot of small-cap companies."
Most recent purchase: Hodges recently added to their position in Primoris Services Corporation, a contract infrastructure firm "that could have some upside. There's heavy insider ownership and high earnings power."
Hodges recently sold off their position in the premium mattress manufacturer Tempur-Pedic International. "We've owned it since '09, and we bought in $20s, sold in $70s and $50s, and it's trading down in $30s today. The reason we sold that stock [is] because we [saw] pricing power deteriorate."
He explains: The premium mattress business held up in recession. It gained market share even in a different market environment. But Sealy, Serta, and other competitors have spent years trying to get into that premium business, and they finally made it. As a result, Tempur-Pedic has had to do more promoting, which they never had to do before, and offer discounts, which put pressure on their margins.
Words of wisdom
Don't try to outsmart yourself, and with all the volatility in the market these days, you are at risk if you're trying to beat the market. If you're jumping in and out, you're being risky, but if you try to get in when you think shares are mispriced, that strategy is an investor's best friend.
Remember that owning part of a company is the best way to accumulate wealth over time.
Business section: Investing ideas
Looking to emulate Hodge's Small Cap Fund's strategy and find other small-cap names where long-term growth opportunity abounds?
Compare 1-year returns:
- Texas Pacific Land Trust
- Smart Balance
- US Airways Group
- Encore Wire Corp.
- Cirrus Logic
- Atwood Oceanics
- Westport Innovations
- Group 1 Automotive
- Cinemark Holdings
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.
Kapitall's Rebecca Lipman owns shares of Shoe Carnival and Texas Pacific Land Trust.