Thomas Soviero uses a real estate analogy to illustrate the rationale behind the Fidelity Leveraged Company Stock Fund (FLVCX) that he runs.
A person who uses mostly borrowed money to purchase a house in a market he expects to heat up can sell it for a big profit later on if the area becomes desirable, the portfolio manager explains. Similarly, the companies Soviero buys can pay off if they churn out cash and reduce their debts.
“You could get magnified returns when the financial leverage starts working in your favor,” Soviero says.
Soviero looks for what he judges to be attractively valued stocks of companies that issue high-yield, or so-called junk bonds, or that carry other debt. He hunts for those with strong cash flow using a formula that takes into account a business’s earnings before taxes, depreciation and amortization, as well as its capital expenditures.
Companies do not have to profitable to gain entrance to the portfolio, says Soviero, who’s willing to buy those he thinks will eventually start generating earnings. He also keeps an eye out for a catalyst, like a new product, that can drive a stock higher.
About 150 companies with market caps of $1 billion to $10 billion wind up in the fund, but the top 50 holdings account for more than half its assets, Soviero says. This concentration leads to the best value for shareholders because it puts “the most money in your best ideas,” he says.
Since Soviero took over Leveraged Company Stock in July 2003, he has kept it out ahead of the competition by a comfortable margin. The $3.5-billion fund was up 17.5% last year, compared to a 9.7% gain by its mid-cap blend fund peers, and a 4.9% return by the Standard & Poor’s 500 index. The Fidelity offering returned 42.1% on average for the three years ended in December. Similar funds rose 19.9% during that span, and the index traded up 14.4%.
Soviero cited Service Corp. International Inc. (SCI), a funeral home operator, as an example of a typical investment for the fund. The company generates “very healthy free cash flow,” says Soviero, who was also drawn to Service Corp. because of a new management team. “They’re approaching the business with a different mind-set that’s healthy for overall revenue and earnings growth,” he says.
Service Corp. held the No. 4 spot in the portfolio at the end of the third quarter last year. Another of the fund’s top ten stocks at that time (Soviero declined to discuss his year-end holdings) was OMI Corp. (OMM), which ships oil and natural gas with a fleet of tankers.
The Stamford, Ct.-based company looked good because its stock was trading for about six or seven times projected earnings, making it cheap relative to the overall market, Soviero says. He adds that OMI generated lots of free cash and had been aggressively buying back its shares.