Quick Take: The Shepherd Street Equity Fund (SSEFX) is a mixed bag.
David Rea and the fund’s two other co-managers invest in companies with rapidly growing earnings, as well as in undervalued stocks.
Holdings in the portfolio range in size from financial services giant Citigroup Inc (C) to Given Imaging (GIVN), a medical equipment maker with a market cap of less than $300 million.
For the three years ended last month, Shepherd Street Equity lost 6.2% annualized. That put it ahead of its peers, which fell 10.3% over the same period. The fund gave up 20.8% this year through July, while the average large-cap blend fund was off 20.3%.
The Full Interview:
David Rea didn’t have to go very far to find Triad Guaranty (TGIC), a major holding in the Shepherd Street Equity fund. The company’s headquarters are just blocks from his office in Winston-Salem, N.C.
The stock of the residential mortgage insurer, which ranks second in the portfolio, has risen about 20% this year, making it one of his best performers, Rea says.
The $13-million fund currently has the bulk of its assets — about 30% — in financial services businesses like Triad. Rea likes the sector because it features the reasonably priced stocks of growing companies that he favors.
What’s more, some of his investments in this group are potential takeover targets, says Rea, who keeps an eye out for companies in industries that are consolidating. He cites Pinnacle Financial Partners Inc. (PNFP) as an example.
The money manager says he also began investing in the Nashville-based bank holding company about two months ago because its profits are fattening rapidly, but the stock trades for just a bit over book value.
Another bank stock, Southern Finl Bancorp (SFFB), which holds the third place position in the portfolio, has financial characteristics similar to those of Pinnacle and, like Triad, has risen about 20% this year, says Rea.
Rea looks for companies he thinks can grow earnings faster than their industry peers when picking stocks. He prefers high margins and return on equity, low debt, and a large market share. The fund mixes growth- and value-oriented investments, and owns companies of all sizes. It doesn’t own many, however.
“We look at a lot of names, but we do our most intensive research on our top 30-35,” says Rea, who typically invests in that many stocks. With a larger portfolio, “it just seems as though you’re diluting your chances of outperforming the S&P 500 over the long haul,” Rea reasons. Focusing on a handful of stocks also makes it easier to analyze them, he says.
Rea’s top holding is software maker Microsoft Corp (MSFT), which has been in the fund since it was started four years ago. The company’s attributes, he says, include a dominant industry position, and a strong balance sheet and cash flow. Rea says those qualities also drew him to semiconductor manufacturer Intel Corp (INTC), another long-time holding in the fund.
Although technology stocks have been badly bruised over the last two years, Rea hopes that for these two companies “the worst is behind them and earnings will start to improve.”
Health care companies comprise about 19% of the fund. They include Pharmanetics Inc (PHAR), a maker of diagnostic products used to determine how well drugs work. The stock rallied today after the company got clearance from the Food and Drug Administration to market its Enox test for detecting the anticoagulant effects of enoxaparin sodium, a heart drug sold under the Lovenox name.
The approval also triggered an undisclosed payment from Aventis ADR (AVE), which developed the test with Pharmanetics.
Rea also has stakes in pharmaceuticals makers Johnson & Johnson (JNJ), Merck & Co (MRK) and Pfizer, Inc (PFE). Growth prospects for all three are bright, and the trio stands to benefit as the population ages and needs more drugs, according to Rea.
The fund manager, who will sell a stock to clear space in the portfolio for one that he thinks is better, bought Johnson & Johnson about a month ago. He preferred it over Hewlett-Packard (HPQ), which he unloaded.
At the time, the health care giant’s stock had fallen to an attractive price, Rea says. This was because of a lawsuit by a former employee accusing the company of falsifying records at a plant in Puerto Rico. The federal government said this week that it will not intervene in the suit, which Johnson & Johnson says is without merit.
Another stock Rea recently eliminated from the fund is Shaw Group (SGR). The company, which provides products and services to power companies and builds power plants, was the fund’s No. 4 holding at the end of July. Rea explained that he thought Shaw’s financial foundation was weakening because plans were scrapped for some of the facilities it had been hired to construct.
Rea thinks the stock market should improve in coming months because corporate earnings appear to be getting better, while interest rates, inflation and consumer spending are holding steady. Whether or not the major indexes move into positive territory by the end of the year is another story, he says.
“It would take an awfully strong move in the next three or four months to get us out of the red,” Rea says. “But that doesn’t mean we can’t have some nice returns on stocks.”