Quick Take:Alexander Thorndike and his team at Century Capital Management Inc. look for companies with “strong franchise characteristics” for the Century Small Cap Select/Investor Fund (CSMVX). These include predictable, sustainable earnings growth, and a steady stream of revenue from existing clients.
The $25.6-million fund usually holds 40-50 stocks of small and medium-sized businesses and focuses on service companies, which Thorndike feels lend themselves particularly well to the kind of financial analysis his firm practices.
The fund generated a total return of 6.2% in the first quarter, versus 2.3% for the average small-cap blend fund. Century Small Cap Select, which began operating in February 2000, gained 5.9% last year, while its peers lost 3.2%. The fund has returned 29.1% since inception.
The Full Interview
Manufacturers don’t play a prominent role in the Century Small Cap Select Fund. The managers prefer companies that serve businesses.
In part, that’s because Alexander Thorndike, chief investment officer of Century Capital Management Inc., feels the firm’s skill in analyzing a service company’s books in particular gives a clearer picture of its financial condition than generally accepted accounting methods. His firm scrutinizes things like the extent that options dilute a stock’s value, and how businesses compute revenues and expenses, he said.
In addition, companies that do work for other businesses rather than make products tend to have the attractive valuations and growing profits that Thorndike, who’s known as Lanny, and the fund’s co-manager Allan Fulkerson prize.
“We’re kind of a quirky shop,” Thorndike said. “We describe ourselves, rightly or wrongly, as growth investors in value industries.”
One of those industries is health care, where the fund has the biggest chunk of its assets at 23%. One of its most recent investments in health care is Charles River Labs (CRL).
The Wilmington, Mass.-based company provides equipment for drug research. It also supplies mice, rats and other animals for tests. That segment of the business is likely grow nicely over time, according to Thorndike, who bought the stock about a month ago when it was priced lower than it is now. Charles River’s shares have been trading for $28-$29 lately.
Another company added to the portfolio this year is Philadelphia Consol Hldg (PHLY), an insurer Thorndike likes because it has made money in good times and bad over the last ten years. Thorndike, who declined to specify what he paid for any of the stocks he owns, said he bought a stake in the company last month and has seen the investment appreciate since then. The stock has been trading for $42-$43 per share in the last week.
Among his latest investments, Thorndike cited Online Resources Corp (ORCC), which he bought within the last month, as a favorite. The company provides Internet-based financial services, primarily to banks. Online Resources is generating cash, despite the bursting of the technology bubble. Although it is not posting earnings, Thorndike expects the firm to become profitable next year. In addition, the stock is trading at about 13 times expected 2003 earnings, a multiple Thorndike finds attractive.
In picking stocks, the managers gravitate towards those whose valuations are lower than their industry peers. On average, the portfolio’s holdings are trading for about 13.7 times next year’s projected earnings, Thorndike said.
They also hunt for companies that can increase profits by 20% annually or more over a three-year period. “We’re big fans of high recurring revenues,” Thorndike said, adding that the managers like to see companies that can derive 70% or more of their sales from existing clients.
For example, Iron Mountain (IRM), another of Thorndike’s favorite stocks, garners about all its revenues from contracts it has already secured, the manager said. The company stores and records data on paper and electronically.
Additional requirements for admission to the portfolio are high returns on equity, expanding margins, strong cash flow, and experienced management with a successful track record.
The managers focus on companies with market caps of up to $2 billion. They typically invest in 40-50 stocks, which allows them to get maximum contributions from winners while making it easier to research companies, they feel. Besides going over a company’s books, the fund’s analysts visit companies and their vendors and competitors to help evaluate a business.
The fund’s top holding is another health care-related issue, Schein (Henry) (HSIC), which provides software for managing medical practices, and distributes medical, dental and veterinary products. Schein’s attributes include robust cash flow and “very disciplined” management, Thorndike said.
Thorndike also likes Sunrise Assisted Living (SRZ), which runs residential facilities that provide the elderly with medical services and assistance in routine activities, such as eating, bathing, and dressing. The company, the largest one in its industry, stands to benefit as the U.S. population ages, Thorndike said.
Dominant market share is also a factor that appeals to Thorndike about Stericycle Inc (SRCL), which collects and disposes of medical waste. The company currently ranks fifth in the portfolio.
Financial services companies account for about 15% of the portfolio. The fund’s biggest investments include Amer Capital Strategies (ACAS), a buyout and financing company Thorndike likes because of its approximately 7% dividend yield. The largest holdings also include HCC Insurance Hldgs (HCC), an insurer; and Investors Finl Svcs (IFIN), which provides administrative services to asset management concerns, including mutual fund complexes.
Century Small Cap Select’s cash position, typically about 5%, has hovered between 11%-14% over the last two months, Thorndike said. It had risen because the fund sold some stocks at a profit and had pulled in about $1.6 million in new money from investors since the end of the first quarter, he explained. Thorndike said he is waiting for some stocks he has been eyeing to drift down to better prices so he can snap them up. He expects the fund’s cash level to drop below 10% over the next month, as a result.
Small-to-mid-sized companies tend to do well at the start of an economic recovery, Thorndike said. Because of that, he believes the stocks in his portfolio should prosper in the near term.
Thorndike, however, doesn’t expect the broader stock market to pick up steam until later this year, when he anticipates that corporate profits will look better compared to the same periods in 2001. “We think by the second half of the year we’ll really begin to see growth,” he said.