Quick Take: After finishing in the red in its first two full years of operation, Turner New Enterprise (TBTBX) has rebounded lately.

The $16.8 million fund, which lost 38.4% in 2001 and 47.2% in 2002, is up 91.9% so far this year. Its return through the end of October put it comfortably ahead of the Standard & Poor’s 500-stock index, which had risen 20.8%.

What’s different this year?

Chris McHugh, the lead portfolio manager of the fund, says the growth stocks that Turner New Enterprise prefers have returned to favor with investors. The recent rally by small-cap stocks has also helped, he says. The fund can buy any size company, but it’s biased towards those with market caps of $500 million to $10 billion, McHugh points out.

In picking stocks, McHugh and his team look for industry-leading companies with increasing profits and revenues, and for which analysts are raising earnings estimates.

McHugh also helps run Turner Midcap Growth/I (TMGFX), which uses the same investment strategy as New Enterprise, but which focuses on larger companies.

The Full Interview:

Like their colleagues at Turner Investment Partners, the managers of the firm’s New Enterprise fund believe that earnings expectations drive stock prices, says Chris McHugh, who leads the team that runs the portfolio.

The fund’s trio of stock pickers scans for companies for which analysts are ratcheting up estimates, and that meet or beat those projections. They like to see increasing profits and sales, too, although they have no hard and fast growth targets.

More important, the managers prize companies that hold the No. 1 or No. 2 position in their industry or niche. “If you’re executing in a downturn and you can gain that market leader position, it’s only going to help you exponentially when the market comes back,” says McHugh.

Turner New Enterprise can buy companies of any size, but it leans towards those with market caps of about $500 million to $10 billion because, McHugh says, they tend to grow their top and bottom lines faster than big companies.

Only 30-40 stocks make it into the portfolio. This concentration makes it easier to follow companies, McHugh says. He adds that Turner Investment Partners Inc., the investment adviser to the Turner Funds, doesn’t see many focused funds that play in the small-to-mid-cap arena, and thinks “that’s an area that we can take advantage of.”

McHugh cites NBTY Inc. (NTY) as being typical of the fund’s investments. He describes it as the top manufacturer and retailer of vitamins and nutritional supplements. The company, formerly known as Nature’s Bounty Inc., churns out “good, solid” profits but its shares trade at only 13 times projected fiscal 2004 earnings, according to McHugh, who prefers to buy reasonably priced stocks.

McHugh and his team are willing to pay up for a stock, however, if they think its growth potential justifies that. For example, take Sonus Networks (SONS), which provides hardware and software for telecommunications services providers. “It’s expensive,” he says. “But if you look at where they’re positioned, it’s a company you just want to own.”

Sonus’s revenues jumped 285% in the third quarter, when it posted its first-ever profit of one cent per share. McHugh expects it to match that slim profit in the fourth quarter, but sees earnings climbing to $0.10-$0.15 per share next year, and $0.30-$0.35 in 2005. He envisions Sonus benefiting from increased corporate spending on wireless and traditional telephone networks.

Technology and telecom stocks like Sonus make up about 42% of the fund’s assets. A favorite of McHugh’s in the sector and one of the fund’s major holdings is Lam Research (LRCX), which makes equipment for manufacturing semiconductors. During the dry spell that tech companies suffered through over the last three years, Lam research restructured its operations and contracted out more work, enabling it to become more efficient and profitable, McHugh says. As a result, he expects the company’s earnings to rise to their previous highs now that corporate spending on information technology is picking up steam.

Elsewhere in the sector, McHugh likes communications equipment maker Comverse Technology (CMVT), which he foresees returning to profitability either late in fiscal 2004 or by the following year.

Technology stocks have been some of the fund’s best performers this year, McHugh says. In addition to Lam Research, which is up about 65% so far, New Enterprise has gotten boosts from optical fiber maker Corning Inc. (GLW), which has risen about 70%, and chip gear manufacturer Applied Materials (AMAT), a 45% gainer, McHugh says.

The fund’s winners also include Marvel Enterprises (MVL), which is also up about 45% and is another one of McHugh’s pet stocks. The company stands out because its library of more than 4,700 comic book characters provides it with a reliable, consistent stream of revenue from licensing agreements, he says.

Success, though, does not guarantee that a company will stay in the fund, since McHugh and his team will sell stocks if they appreciate too much. For instance, a run-up in its share price led them to sell China Yuchai Intl (CYD), a Chinese producer of diesel engines and diesel power generators, earlier this month, he says. The stock had held the top spot in the portfolio at the end of September. Its total return for the year to that point was nearly 677%.

The manager’s willingness to sell stocks and redeploy the gains, as well as the fund’s focus on smaller stocks, can make New Enterprise volatile, McHugh agrees. The fund’s turnover rate for the year ended in September was 755%. More typically, it stands at 200%-400%, McHugh says.

The team has no qualms about giving the fund a rapid face lift if they think it will benefit shareholders, McHugh says.

If the managers can take profits when appropriate and reinvest the money in stocks that become undervalued, then “we’ll take that turnover all day long because I think it’s something we can take advantage of,” McHugh says.