Quick Take:James Margard, lead manager of Rainier Investment:Small/Mid-Cap Equity Portfolio (RIMSX), hunts for growing companies whose shares he considers reasonably priced in the small- and mid-cap space.

In picking stocks, Margard and the other members of his team trawl for companies whose bottom lines are fattening faster than their competitors, but whose shares are cheap compared to their own history, their peers, or the overall market.

That approach led the $539-million fund to a 13.4% total return for the 1-year period through Jan. 31, 2005, versus a gain of 10.0% for the average mid-cap blend fund. For the five years ended in January, the Rainier fund gained 8.4%, on average, versus 6.6% for its peers.

The Full Interview:

Before gaining entry into the Rainier Small/Mid Cap Fund, companies have to grow profits faster than others in their industry or sector.

Along those lines, lead portfolio manager James Margard and the other members of his team are keen on earnings estimates that get revised upwards either by the company itself, or analysts.

Valuation is another key factor in determining whether or not a stock gets bought. The team wants shares that are priced low relative to their own history, or their peers and the market.

The stock pickers prefer businesses with little debt and sufficient cash flow, enabling them to pay dividends, buy back shares or make acquisitions.

The team also scans for companies with strong competitive positions. Then they look for a catalyst, like a new product or a restructuring, that can boost a stock.

The fund invests in companies with market caps of $100 million to $12 billion, and keeps between 95 to 130 of them.

Margard cited American Pharmaceutical Partners Inc. (APPX), one of the fund’s biggest holdings, as an example of the kind of company it buys.

The stock had been volatile in recent months as investors weighed whether or not the drugmaker would get approval from the Food and Drug Administration to sell a re-engineered, less toxic form of the breast cancer treatment Taxol. The okay for American Pharmaceutical’s Abraxane product came through last month, helping the stock to move higher, said Margard. He expects further improvement in the company’s bottom line, and sees earnings doubling this year, and rising another 30%-35% in 2006.

The fund’s No. 1 stock currently is Joy Global Inc. (JOYG), a manufacturer of mining equipment, that Margard believes will benefit for the next few years from rising demand for coal. Joy Global’s earnings will more than likely double in fiscal 2005, and grow by 30% the following year, Margard said. The stock remains reasonably priced, however, according to the manager. It’s trading at about 19 times projected earnings in the current year and about 15.5 times projected earnings in fiscal 2006, he said.

Another of the fund’s top stocks is Getty Images Inc. (GYI), which Margard likes because it’s the leading provider of stock photography and images. He described the Seattle-based company as a “strong grower.” Getty’s earnings have topped estimates in each of the last seven quarters, and its revenues increased by about 21% in the first three months of this year, he said. Sales growth may ease next year, but it should stay in the mid-teen range next year, Margard said.

The company’s results, he added, will be underpinned by its entry last year into Japan, the world’s second-largest advertising market.

Getty Images, Joy Global and American Pharmaceutical were among the fund’s biggest winners in 2004. The fund’s returns were also helped by F5 Networks Inc. (FFIV), which makes software that lets companies manage Internet traffic; General Growth Properties Inc. (GGP), which owns and operates shopping centers; and Internet search company InfoSpace Inc. (INSP).

Although the managers focus on small and mid-sized companies, they won’t automatically sell stocks that move into large-cap territory. They will, however, unload companies whose financial health looks like it may take a turn for the worse, or whose stocks become pricey.

Late last year the fund liquidated its stake in Sterling Financial Corp. (WA) (STSA), Margard said, because he and his colleagues feared the savings and loan holding company would be hurt by rising interest rates, and because they thought its share price had gotten “fairly extended.”

“Their underlying fundamentals are okay,” Margard said of Sterling. “But they’re not getting any stronger.”

The fund’s turnover rate usually hovers around 130%, Margard said (it was 134.5% last year, compared to 64.4% for its peers.) About half of the turnover, or more, is a result of the managers trading within a position, rather than wholesale changes in the portfolio, he said.

To control risk, the managers keep the fund’s sector weights in line with those of its benchmark, the Russell 2500 index, Margard said.

In addition, they avoid illiquid stocks, which they define as those with less than $2 million in daily trading volume. The team also shuns stocks it considers speculative. “We may, on occasion, own one or two of those,” Margard said. “But it would be a pretty small weighting.”

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.