Quick Take: Dennison Veru dislikes companies that constantly turn to the stock and bond markets for funding. Instead, he prefers those that generate enough cash for their daily operations.

The GE Funds:Small Cap Value Fund/A (GASCX) has been shunning telecommunications companies because they are capital intensive, says Veru, a member of the team that manages the portfolio. Avoiding that sector, which has been bruised in recent years, helped the performance of the fund, says Veru, who goes by “Dan.”

In addition to businesses that don’t have to sell equity or debt securities to keep going, Veru looks for small firms that dominate their industry or niche and generate strong free cash flow. The fund, as its name implies, focuses on undervalued stocks.

GE Small-Cap Value lost 15.5% this year through September, while the average small-cap value fund was off 16.4%. For the three-year period ended in September, the $46-million portfolio gained 15.8% annualized, versus 5.9% for its peers.

The Full Interview:

Dan Veru will not dip his toe into a company unless management lets him get a foot in its door. Having access to top executives, key personnel, and facilities is critical for him.

“There are a lot of companies that choose to not interact very much with Wall Street, and that’s fine, that’s more of a style thing,” says Veru. “But they won’t find a home in our portfolio.”

While Veru listens to what corporate officials say about their enterprises, he prefers those that big brokerage houses are silent on. In part, that’s because these issues can move up when mainstream analysts begin tracking and recommending them.

In addition, Veru, a co-investment officer at Palisade Capital Management in Ft. Lee, N.J., says he primarily relies on his own analysis, as well as data provided by independent researchers since it gives him a “more unbiased viewpoint” than research from firms that may have investment banking ties to companies.

Once a stock has cleared the initial barrier, Veru tries to identify small-cap companies that don’t rely heavily on the capital markets for funding. What’s more, he favors those that lead their industry or niche because this can give them pricing power.

In assessing a business’s performance, Veru looks first for strong cash and free cash flow. He thinks this is a more reliable indicator of financial health than earnings, which are for him a secondary consideration. The stocks in his portfolio are increasing profits by about 17%-18% per year on average, he says.

While his holdings are growing a bit faster than those in the Russell 2000 index, they are slightly cheaper, according to the value-oriented Veru. The fund’s stocks are trading at about 15 times forward-looking earnings, he says.

As an example of the kind of company he invests in, Veru cites Covance Inc (CVD), which helps drug companies develop products. It also does laboratory testing for chemical and food producers.

“Their business is growing nicely because of demand for their services,” says Veru. As a result, he expects Covance’s free cash flow to reach about $36 million this year, and nearly $60 million in 2003. The stock has risen 18% since he began buying it about two months ago, Veru says.

Around the same time he moved into Covance, Veru established a position in Schweitzer-Mauduit Intl (SWM), a specialty paper producer that supplies to cigarette makers. The company looks good because its margins are expanding and its free cash flow is “tremendous,” while its debt load is “very modest,” Veru says.

Health care companies accounted for 12.3% of the fund’s assets a week ago, including Cooper Cos (COO), its No. 1 stock. Although he has cut back on these stocks lately because they have appreciated, Veru says he likes the sector because it features companies with predictable earnings that have tended to be immune to the weak U.S. economy.

Cooper, a specialty contact lens manufacturer, stands out because it dominates its competitors, Veru says. The Pleasanton, Calif.-based company makes lenses to correct astigmatism, as well as cosmetic lenses that change eye color.

The fund’s second-largest holding is Genesee & Wyoming Inc. (GWR), a holding company for railroads that operate short freight lines in North and South America, and Australia. Veru says he likes the company because it “generates a lot of excess cash,” which it has been using to make acquisitions that can lift its bottom line.

Veru adds that he wants to own railroads and other transportation stocks because they are in position to prosper if the economy strengthens and companies start shipping more products and materials.

Steel maker Gibralter Steel (ROCK) ranks third in the portfolio. The company’s attributes, Veru says, include an “excellent record of growth, a very solid balance sheet,” and an attractive valuation. The stock is trading at about 13 times projected 2002 earnings, he says.

Although technology stocks have been battered over the last two years, Veru owns two that he thinks have the potential to shine.

The fund has a stake in DRS Technologies (DRS), which makes sophisticated electronic systems for the military. The company has benefitted and should continue to benefit from increased defense spending by Washington, Veru says.

The fund manager is also invested in Inforte Corp (INFT), a consulting firm that helps companies to integrate and to manage computer systems. Although the stock has been off lately, Veru says, he sees it as having a “nice upside,” since Inforte has been able to generate cash despite the weak economy.