Alexander Thorndike of Century Small Cap Select Fu

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.