Jonathan Simon of JP Morgan Mid Cap Value Fund

In picking the 70 to 90 stocks that make up the portfolio, Simon focuses on companies that generate above-average returns on invested capital compared to their rivals, and that produce strong free cash flow. Low debt is high on his list, and he also prizes franchises that are walled off from competition.

Once he identifies an investment, Simon prefers to buy it on the cheap. Currently, he is finding companies with the financial characteristics that he wants whose stocks are trading at less than 15 times projected 2003 earnings. Occasionally, though, “we’re prepared to pay a slight premium for a truly exceptional company,” he says. The fund manager will accept a price-to-earnings ratio of up to 20 for businesses he believes possess “clearly superior characteristics.”

The five-year-old fund can buy companies with market capitalizations of $1 billion to $20 billion, but 90% of its holdings right now have caps of $10 billion or less, according to Simon. “That’s where we’re finding the best combination of quality and value,” he says.

As an example of the kind of company he hunts for, Simon cites Charter One Finl (CF), a bank holding company that he began buying in November. Charter One’s units have been expanding their lending and deposit businesses while taking market share from bigger banks, Simon says. The subsidiaries serve consumers in Ohio, Michigan, Illinois, New York, Vermont and Massachusetts.

Simon says he has been drawn to similar medium-sized banks because he feels they can make inroads on large lending institutions by providing personal service to individuals. His fund also has stakes in North Fork Bancorp (NFB), TCF Financial (TCB), Cullen/Frost Bankers (CFR), and Wilmington Trust Corp (WL).

Rural telephone company ALLTEL Corp (AT) is a favorite for the portfolio manager. Simon sees it benefitting from the FCC’s proposal to end a requirement that local phone companies rent their networks to long-distance rivals cheaply, a move that could cut competition in the local phone market.

The No. 1 stock in the fund is Clayton Homes (CMH), which builds, finances and insures so-called manufactured homes. That industry is experiencing problems, but Clayton is a “survivor” that will be “in a very strong position to make a lot of money” when conditions improve, Simon says. In the meantime, the stock is trading at a small premium to the company’s book value, he says.

An oil and natural gas company, Devon Energy (DVN), ranks second in the portfolio. Simon applauds the Oklahoma City, OK-based company because it grows by making opportunistic acquisitions, buying companies when they are inexpensive because oil and gas prices are depressed. Devon completed its last buying round in mid-2001, and as energy prices have risen since then, it has been able to sell peripheral assets and use the proceeds to pay down debt, Simon says.

Although the stock market itself has suffered three consecutive years of losses, Simon sees it ending 2003 in positive territory because he feels equities are now more attractively valued than bonds. Good news about the economy and corporate profits probably won’t surface until later in the year, but stock prices can rise in anticipation, he says.

“I think we could get a 20% rise out of the Standard & Poor’s 500,” he says.