Quick Take: The Ariel Fund (ARGFX) typically holds a relatively small number of stocks, but lately, portfolio managers John Rogers Jr. and John Miller say their universe of potential investments has also become smaller. In part, that’s because shares of the small companies they focus on have become expensive.
At the same time, investments by fund shareholders have been picking up, the stock pickers say. As a result, the $3.1-billion fund now has about 13% of its assets in cash, according to Rogers. He says he typically would keep less than 5% in greenbacks.
When they put that money to work, Rogers and Miller look for undervalued shares of profitable, financially sound companies with strong industry positions and management teams. Recently, they’ve been finding values in financial services stocks, which accounted for 26% of the fund’s holdings at the end of the second quarter.
The fund was up 9% at the end of last month. That put it ahead of the average small-cap value fund, which gained 2.4%, and the Standard & Poor’s 500 index, which inched up 0.4%. For the five years ended in August, the fund returned 13.5% on average, while similar funds rose 12.8%, and the index dropped 2.1%.
The Full Interview:
S&P: What do you look for in buying stocks?
ROGERS: We’re focused on smaller companies that we can own for the long term. We want to buy these companies while they’re out of favor. That’s when we often find a high-quality franchise at a bargain price. We look for stocks selling at a discount of 40% or more to the company’s intrinsic value.
That’s our core approach. Underneath that, we like to make sure we’ve got a high-quality management team, a superb balance sheet, and a company with true barriers to entry. That makes the franchise really solid and allows for 10% or more growth in the future.
S&P: You limit the portfolio to 35-45 stocks. Why do you concentrate it?
ROGERS: We think that there are not that many great companies, and we think that the markets are so efficient that the only way to outperform is to follow a relatively small group of companies that you know better than your competition so you can make better decisions about those companies — when to buy and when to sell. This lets you get more significant contributions from your winners.
S&P: Can you cite a recent purchase that illustrates your approach to stock picking?
MILLER: In February we started a position in Argosy Gaming (AGY), an operator of riverboat casinos.
In terms of valuation, Argosy is a company that, when we initiated the position, was trading right around 13 times our forward 12-month earnings estimate, and it was at what we felt what a sophisticated buyer would pay for this franchise.
It’s in an industry where we feel we have a lot of expertise. We are currently a shareholder in Caesars Entertainment (CZR), which is being acquired by Harrah`s Entertainment (HET).
S&P: Could you name another new addition to the portfolio?
MILLER: We’re really paying a lot of attention to identifying opportunities in the financial services sector. It’s interesting how the market is just ignoring this area.
A good example would be S&T Bancorp (STBA), which we purchased within the last couple of months.
Here’s a company that’s trading right around 10 times forward 12-month earnings. As interest rates continue to rise, they’ve done a really terrific job in terms of matching the assets and liabilities on their balance sheet to offset any impact from rising interest rates.
S&P: The biggest chunk of the fund’s assets — 26% — were in financial services stocks on June 30. Do you have any favorites in that group?
MILLER: Markel Corp (MKL) is a large holding. It’s a terrific niche insurer. Their expertise is in smaller markets, like summer camps for kids and the horse industry.