Let's start with three fun facts and one big bummer:
1. Over the past 10 years, investors in the BridgewayUltra-Small Company (BRUSX) fund have been treated to a total return of just over 714%. To put that in terms of dollars and cents, a $10,000 investment over the period would have been worth nearly $82,000 at the close of business on Halloween 2005.
2. Over that same stretch of time, shareholders of Vanguard Health Care (VGHCX) would have earned more than 415% -- and a nest egg of roughly $51,500.
3. Last, but not least, folks who were savvy enough to buy into Fidelity Low-Priced Stock (FLPSX) 10 years ago have gained 339%. Their initial $10,000 is now worth almost $44,000.
OK, those were the fun facts. Ready for the big bummer? Here goes: Each of those fine funds is currently closed.
Too bad, not so sad
But you know what? Even if they were open, I wouldn't be inclined to give 'em the nod in the pages of my Champion Funds newsletter service. Don't get me wrong. I respect each of the managers and shops behind the funds. Still, good funds close for good reasons, and my aim in the newsletter is to make forward-looking recommendations.
When it comes to that particular task, past performance will take you only so far. So how, exactly, does a savvy fund investor go about finding future mutual fund standouts? An excellent question. Here's the answer:
Buy low! Sell high!
That's the time-tested maxim that's frequently trotted out as a punch line for jokes about banal investment advice. I mean, duh. That's what every investor aims to do, right? The hard part is actually doing it -- and that applies to mutual funds as well as stocks.
How so, you ask? Well, that's another good question. A mutual fund's net asset value (NAV), after all, has precious little in common with a stock's price. Yes, NAV represents the price per share you'll pay for a mutual fund. But unlike stock price, you can't use NAV to gauge whether a fund is -- to stick with our punch line -- selling "high" or "low." Indeed, NAV is simply an expense-adjusted figure that represents a fund's total assets divided by the number of shares in circulation.
And unless a fund has closed, there are always more shares available. Unlike with stocks, then, there's no direct supply/demand dynamic that drives a fund's share price.
Under the hood
But while NAV isn't an especially useful way of getting a bead on a fund's relative valuation, there are other techniques. First and foremost, you can look under the hood and check out the average valuation stats -- you know, such things as price-to-earnings, price-to-book, and price-to-cash flow -- of the fund's underlying portfolio.
Comparing those numbers with the broader market's or a fund's peers' will go a long way toward telling you whether a fund is richly -- or cheaply -- valued.
Beyond that, you can check out the relative performance of Morningstar and Lipper peer groups. Indeed, doing just that is a terrific way of taking the market's temperature and zeroing in on those pockets that may be studded with undervalued keepers.
Judging from performance over the past five years, for example, large-cap core funds -- which invest in the likes of Hewlett-Packard
Care for a game of darts?
But while large-cap funds as a group seem attractively valued these days, you can't just throw a dart and expect to hit a winner. And that's precisely why Champion Funds exists. In the newsletter, we focus on just those funds that have what it takes to deliver outsized gains in the future.
Among other things, I'm looking for heavy hitters with cheap price tags, talented and proven management teams, and sane-stock picking strategies that won't keep you up at night. Risk aversion, after all, is one of the main reasons more than 90 million of us invest in mutual funds.
And so far, so good. Our best performer -- Dodge & Cox International Stock (DODFX) -- has galloped to a gain of more than 51% since I recommended it, and, all told, the newsletter's picks are outperforming the market by a significant margin.
How significant, you ask? Yet another good question -- and the answer to that one is just a mouse click away.
This article was originally published on May 31, 2005. It has been updated.
Shannon Zimmerman, editor and analyst for Motley Fool Champion Funds, doesn't own any of the securities mentioned. You can take arisk-free 30-day trialof his newsletter. Microsoft is an Inside Value recommendation. The Motley Fool is investors writingfor investors.
