Quick Take: What distinguishes inexpensive stocks from one another is a company’s performance in the long run, says Christopher Leavy, who helps run Oppenheimer Small Cap Value/A (QVSCX).
In picking undervalued stocks, Leavy and lead manager John Damian look for companies they think stand the best chance to increase earnings and cash flow over a period of three years.
Since taking the reins of the $666 million fund about three years ago, Leavy and Damian have kept it ahead of similar offerings. Damian attributes that partly to an overhaul of the portfolio carried out by the pair, who decreased the fund’s holdings and eliminated growth investments. Adding a trio of analysts to the fund, which Damian says had none previously, has also helped boost its performance, he says.
Oppenheimer Small Cap Value gained 46.1% in 2003, versus 42.3% for the average small-cap value fund. For the three years ended last year, the Oppenheimer fund returned 13.6% on average compared to 12.6% for its peers.
The Full Interview:
The Oppenheimer Small Cap Fund has undergone more than a few changes in the last three years.
Since they began managing it in 2001, Christopher Leavy and John Damian say they have shrunk the portfolio to 70-100 holdings from 500 and culled its growth stocks, leaving it focused on companies whose shares appear undervalued.
The transformation extended to the fund’s management team, which previously had no analysts but now gets assistance from three, Damian adds.
“We took about five or six months to kind of really get it into order,” Leavy says, referring to the face lift.
Leavy leads Oppenheimer’s value team, which oversees the Small Cap Fund and four others. Damian is primarily responsible for Small Cap’s investment decisions.
Initially, Small Cap’s managers use a computer program to screen for stocks with valuations lower than that of the Russell 2000 value index.
Next, they look for companies with the potential to produce better-than-expected earnings and increased cash flow over the long term. “We think what really separates cheap stocks from each other is how the businesses unfold over the next three years or so,” Leavy says.
In addition, the team wants companies with strong market positions whose products or services are highly sought after.
Although it owns some larger ones, at least 75% of the companies in the fund have market caps of $2.9 billion or less, according to Leavy.
Among the fund’s major holdings, Leavy likes Frontier Oil (FTO), a petroleum refiner that he says has an edge over others in the sector because its capital spending needs are less onerous.
The fund’s No. 1 stock is Platinum Underwriters Hldg (PTP), a reinsurance holding company that Leavy says is “well positioned to outperform” its competitors because of its “high exposure” to the market for casualty insurance, where prices have been rising.
Compared to similar companies, more of Platinum’s revenues from casualty coverage go straight to its bottom line because Bermuda-based Platinum is less heavily burdened by costs for health care coverage and pension benefits for retirees, Leavy says.
The absence of these so-called “legacy costs” is part of what make Steel Dynamics (STLD) look good to him, says Damian, who began buying shares of the steel maker last November. He expects the company to post earnings of $0.70 per share for 2003 and $1.60-$1.70 per share this year as it benefits from increased production volume and the addition of painted and galvanized steel to its product mix.
A favorite stock of Damian’s, and another one he has been buying lately, is Take-Two Interactive Software (TTWO), which makes video games and related accessories. Take-Two’s shares are attractively priced at about eight or nine times earnings, says Damian, who sees its profits rising about 10% within a year as people upgrade their game hardware.
Late last summer, Damian invested in Kroll Inc (KROL), which offers consulting services to help companies lower risks. The stock had fallen to a bit less than $20, Damian says, because investors were skeptical of the company’s forecasted results. But after speaking to Kroll’s executives, Damian says he was confident they would deliver. Damian has seen his faith rewarded in a stock price that has risen to around $27 this month.
Among the fund’s other winners last year, Damian cites Scientific Games Cl`A` (SGMS), which makes equipment for the lottery and gaming industries. The fund’s shares cost $9.73 on average, he said; they ended the year at $16.97.
The fund also got a boost from restaurant chain Ruby Tuesday (RI), Damian says. The fund paid an average of $18.51 for its shares of the company, he says; the stock closed at $28.49 on Dec. 31, 2003.
Ruby Tuesday, one of the fund’s top holdings, said this week that it expects profits in its current third quarter to rise 15% from a year ago. Damian, however, calls that estimate conservative. “There’s still upside in the name,” he says.
– Richard Diennor