Dec. 9, 2003 — The Berwyn Fund (BERWX) gravitates towards cheap stocks, but that doesn’t mean it can’t kick up its heels with businesses whose profits and sales are rising, says portfolio manager Robert Killen.
“We don’t think that value investing negates the ability to buy companies that are growing,” Killen says of himself and Lee Grout, who came on board as Berwyn’s co-manager in late 2001.
Killen, who has run the fund since its inception nearly 20 years ago, says he won’t touch a stock unless he thinks he can double his money in it over three or four years.
“We’re looking for triples and home runs,” he says. “We’re not looking for a lot of base hits.”
Although Berwyn stumbled rounding the bases in 1998 and 1999, and again in 2002, it has been on a winning streak lately. The $37.4 million fund returned 40.8% this year through November, while its small-cap value fund peers were up 37.3%.
In picking stocks, Killen and Grout look for those priced low compared to the company’s earnings and free cash flow, or that are trading for less than the business’s intrinsic value.
Killen has no hard and fast targets for earnings and revenue growth, he says, adding that he is more concerned with spotting strong returns on equity and invested capital.
Sound balance sheets and low debt levels are on the managers’ check list, too. Companies whose executives have a sizable equity stake in the business will pique their interest as well. Killen and Grout also want to find companies with leading market shares or other competitive advantages.
As a rule, the fund hunts for companies with market caps of $125 million to about $300 million, Killen says, but it currently holds a few with caps of about $1 billion.
The managers typically limit the portfolio to 40-45 stocks to facilitate analysis, according to Killen, who says he and Grout do all their own research.
Despite their bias towards cheap stocks, the managers are willing to own relatively pricey ones if a company seems to fatten its top and bottom lines faster than its competitors, Killen says.
For example, take EPIQ Systems (EPIQ), which makes software for lawyers and companies involved in bankruptcy proceedings. The stock is trading at about 19 times projected 2004 earnings for the company, says Killen, who concedes that’s a bit higher than he would normally prefer. However, the multiple is merited in light of the company’s “very commanding position” in its field, says Killen, who notes that EPIQ is the only publicly traded company of its kind.
Killen also points out that EPIQ’s sales have increased more than eight-fold since 1997, and while that pace is unsustainable, its growth rate should remain “attractive,” says Killen, who bought the stock in October this year.
In November, the fund invested in LifePoint Hospitals (LPNT), which operates 29 hospitals in the U.S. The company stands to benefit from recently enacted legislation to overhaul Medicare, Killen says. Analysts have said that the bill, which offers incremental reimbursement for hospital companies, could boost their earnings.
At the same time, LifePoint sports a good good earnings record that Killen believes the market “hasn’t fully exploited yet.”
Another stock that entered the portfolio last month is DQE (DQE), a Pittsburgh-based utility that supplies power and light to communities in southwestern Pennsylvania. Killen says he was drawn to the stock by its 5.6% dividend yield.
Among the fund’s biggest holdings, a favorite of Killen’s is Courier Corp. (CRRC), a book printer and publisher that ranks third in the portfolio. The company has a conservative balance sheet and has been able to grow “dramatically” over the years, in part through acquisitions, Killen says.
The No. 1 stock in the portfolio, and, Killen says, one of its best performers this year, is FPIC Insurance Group (FPIC), an insurer whose products include liability coverage for doctors, lawyers and dentists. The stock, which traded as low as about $5 in February, was hovering between $19 and $23 this month.
Killen says two of Berwyn’s other big winners this year are Quidel Corp. (QDEL), a maker of medical diagnostic tests, and Barnes Group (B), which manufactures springs and components for aircraft engines and provides related repair services to the airline industry.
Industrial companies like Barnes account for the largest chunk of the fund’s holdings — about 19%. Berwyn’s holdings in the sector also include Drew Industries (DW), Ducommun Inc. (DCO), Ennis Business Forms (EBF), and Hardinge Inc. (HDNG).
Another 17% of the fund’s assets are in consumer discretionary stocks like Blair Corp. (BL),IHOP Corp. (IHP), Kenneth Cole Productions`A` (KCP) and La-Z Boy (LZB).
In recent months, Killen says, he and Grout have been holding slightly fewer stocks than they normally do (36), and have built up a cash position of about 6%-7%, because they have been wary of Wall Street traders’ behavior. Investing has seem to become more speculative since the late summer, he says.
“Generally speaking, we’re fully invested, but we have not been anxious to commit more money to this market,” Killen says. “We’ve been very selective.”
Still, Killen is optimistic about the future for small-cap stocks, which have been rallying this year. “I would expect a pause here, another consolidation,” he says. “Then I would expect further gains at some point, maybe in late 2004.”