March 16, 2004

Matthew Fahey of Marshall Mid-Cap Value Fund

S&P Rank: 4 StarsFeb. 26, 2004Buying When The Street Says "Sell"

Quick Take: The Marshall Funds:Mid Cap Value/Inv (MRVEX) hasn't run away from its competitors over the last few years, but it has consistently stayed ahead of them.

The fund, which has total assets of $411 million, rose 35.9% last year, versus 35.8% for the average mid-cap value fund, and 28.7% for the Standard & Poor's 500 index. For the ten years ended in December, the Marshall fund returned an average annualized 13.2%, compared to 11.6% for similar funds, and 11.1% for the index.

Matthew Fahey, who began managing Marshall Mid-Cap Value in 1997, seeks companies whose stocks have gotten beaten down because of a problem he thinks can be solved within two years. He looks to hold shares until the company recovers, then sell as growth-oriented investors move in and boost the stock to excessive valuations.

The Full Interview:

Don't expect Matthew Fahey to stick around for the last out of a ball game.

"We get in early, in the second or third inning, and we leave in the seventh, knowing that they will keep going up in the eighth and ninth," Fahey says, referring not to baseball but to stocks. The analogy illustrates how he manages the Marshall Mid-Cap Value fund.

Fahey likes to buy companies when they're struggling, hold their stocks until they recover, then sell when the resulting improved share prices attract growth-oriented investors, who can push valuations higher than he wants to go.

In picking stocks, Fahey looks for those that are being overlooked or are temporarily out of favor because of some short-term problem that he thinks can be corrected within a year or two.

He prizes shares that are inexpensive compared to a company's earnings, sales, or book value, among other value measurements. "We read the 52-week low list in the paper, not the 52-week high list," Fahey says of himself and analyst Gregory Dirkse, who joined the fund in 2001.

Solid balance sheets, strong cash flow, and large market shares are on Fahey's wish list, too, as are seasoned management teams with successful track records.

Where Wall Street estimates come into play, Fahey, who describes his investment style as "somewhat contrarian," prefers stocks that most analysts' have soured on. "To me, that's very positive," he says.

The fund typically owns 50-70 companies with market caps of $1 billion-$13 billion. Businesses of this size still have room to grow, but are less risky than smaller fare, Fahey maintains.

Late last year, Fahey bought a stake in Coca-Cola Enterprises (CCE). At the time, investors were fixated on the technology sector and other racy stocks, leading them to ignore the soda maker, says Fahey. The money manager says he was drawn to the stock because it was trading at seven times earnings before income taxes and depreciation, and was generating cash. In addition, Fahey thought producers of soft drinks were on the verge of being able to raise prices, which would benefit the company.

Among stocks that have been in the portfolio for a long time, Fahey cites Bausch & Lomb (BOL), one of the fund's top holdings, as typical of the kind of investment he likes. The company, which makes contact lenses and related products, sports a well-known brand name and looks good right now because its margins have been working their way higher, Fahey says.

The fund's No. 1 stock at the end of last year was Countrywide Financial (CFC), a financial services company that primarily provides residential mortgages.

Countrywide's stock is priced at about eight or nine times earnings, which Fahey thinks is "just too cheap." He adds that although the company has been meeting analysts' estimates, "the market doesn't believe they can continue to put up the earnings they have" posted.

A stock that helped the fund's performance last year, Fahey says, was Brunswick Corp (BC). Shares of the company, which makes recreational boats and engines, and bowling products, rose more than 60%, he says.

Marshall Mid-Cap Value also got a major contribution from Manor Care (HCR), a health care company whose stock climbed more than 80% in 2003, Fahey says. Manor Care has "flawlessly" executed its "strategy of increasing earnings" and cash flow, he says.

When it comes to selling, Fahey will unload stocks when they reach the price target he sets for them and there appears no reason for them to rise further. That led him to eliminate Covance Inc (CVD), a provider of laboratory testing services, from the fund about two months ago.

Fahey will also sell companies when their financial fundamentals weaken. That, he says, was what caused him to banish Cooper Cameron (CAM) from the fund in January. The company, which makes equipment for land-based and offshore oil and gas rigs, saw its stock drop late last month after is earnings lagged its own expectations. The company said revenues from subsea systems projects missed its target and it suffered late delivery penalties because the products were behind schedule.

In theory, Fahey says, he should hold stocks for two years. That breaks down to two quarters when the company is troubled; four quarters as it begins to right itself; and two quarters when it has returned to operating the way it did before encountering difficulties and is humming along. In the last stage, growth investors should start moving in.

In practice, stocks enter and leave Marshall Mid-Cap Value less frequently than they do similar funds. Fahey's fund had a turnover rate of 39% last year, compared to 74.7% for the average mid-cap value fund.

Assessing the stock market, Fahey thinks it could strengthen further if the economy continues to grow by about 4%, giving corporations a chance to improve profits. By the end of the year, he says he envisions stocks rising above their current levels, but "not by very much."

-- Richard Diennor

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