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Robert Costomiris of Strong Small Company Value Fund

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Quick Take: Robert Costomiris, the portfolio manager of the Strong Small Company Value Fund (SCOVX), wouldn’t mind if stocks went nowhere for the rest of this year. “We’re apt to do better in a market that’s boring,” he says.

That’s because funds like his that buy undervalued stocks tend to lag when growth investments become fashionable and push equity indexes higher, Costomiris says.

In running the fund, Costomiris looks for profitable small companies whose debts are under control and whose assets don’t fluctuate widely in value. He hunts for shares that are inexpensive compared with the company’s cash flow. He likes to buy stocks that are not widely followed by analysts, or that are out of favor with them and investors, because these investments can appreciate when Wall Street discovers and embraces them.

Costomiris has managed the $112 million Small Company Value Fund since its inception two years ago. In that time it has stayed well ahead of its rivals. The fund returned 62.5% last year, while the average small-cap blend fund was up 44.0%. The Strong fund was the top performer in its category through the first half of this year, gaining 16.3%, versus 6.8% for its peers. The fund is too new to be ranked by Standard & Poor’s.

Costomiris uses the same investment approach in running the Strong Mid Cap Disciplined Fund (SMCDX), which invests in mid-cap stocks, and the Strong Advisor US Value Fund/K (SEQKX), which focuses on large companies.

Wells Fargo (WFC) recently agreed to acquire Strong Capital Management, which runs the Strong Funds, and is expected to to consolidate some of them, but it has not yet decided which ones. Shortly before the deal was reached, Strong Capital and its founder agreed to pay more than $140 million to settle charges related to improper trading of the funds

The Full Interview:

All else being equal, Robert Costomiris would prefer that people loathe a company he’s investing in.

Costomiris, who manages the Strong Small Company Value Fund, likes stocks that are relatively unknown on Wall Street, too. “But it’s actually equally as impressive to us,” he says, “if the company is well followed, but all the analysts hate it.”

Stocks that are unloved or that fly below the radar screens of big brokerage houses can soar when the investment community begins tracking and warming up to them, he points out.

Buying stocks when others have soured on them is one part of Costomiris’s investment strategy. When it comes to financial criteria, he wants to own profitable businesses with what he describes as “manageable” debts, whose shares are priced low relative to the company’s cash flow.

If a company isn’t generating earnings or cash, that’s all right, the fund manager says, provided he thinks it will soon.

“As long as we’re not paying too much for it, we love companies that have leading market shares,” Costomiris adds. He also favors companies in industries that are growing rapidly and that have what he calls “solid” assets, that is, the kind that don’t fluctuate a lot in value.

Costomiris hunts for stocks among companies with market caps of less than $2 billion and usually keeps 60 to 80 of them in his portfolio.

A typical investment for the fund, and one of its major holdings, Costomiris says, is Reader`s Digest Assn (RDA), a media company known for its flagship magazine, Reader’s Digest.

The company is followed by only four analysts, three of whom currently have “hold” ratings on the stock, according to Costomiris; the fourth is recommending that people buy the shares, he says.

Costomiris, who sets high and low price targets for stocks, based on their cash flow, thinks Reader’s Digest shares, which have been trading for $14 to $15 lately, can reach $24 within two years. In addition, the company has generated $1.60 per share in cash in each of the last two years, he says.

The fund manager cites Sola Intl (SOL), an eyeglass lens maker, as another example of the kind of company he invests in. The company, which is among the fund’s top stocks, features a large market share, and “throws off nice earnings and cash flow,” Costomiris says. The stock has been trading for around $16 recently. Costomiris doesn’t think it will go lower and he envisions it hitting $24 within two years

A favorite of Costomiris’s among his top holdings is food and pet food maker Del Monte Foods (DLM), which he says is a “wonderful free cash flow story.” The company’s shares have been trading around $10 this month, and Costomiris thinks they can reach $14 within two years.

Two major contributors to the fund’s performance this year, Costomiris says, have been Cosi Inc. (COSI), which operates a chain of restaurants, and video game manufacturer Midway Games (MWY). Both stocks have more than doubled for him, Costomiris says.

Costomiris says he hasn’t been finding many attractive stocks in the last few months, however, so instead he’s been keeping 10% to 20% of the fund’s assets in cash. “Material” cash inflows from investors have added to his collection of greenbacks, he says.

“I don’t really feel that there’s a lot of value, broadly speaking, in the market,” Costomiris says.

Contact Robert F. Keane with questions or comments at: [email protected].


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