Craig Hodges, president and portfolio manager of Dallas-based Hodges Funds, believes there are plenty of opportunities for active managers to generate performance in the current environment. 

In a recent interview with ThinkAdvisor in New York, Hodges provided his point of view on the U.S. equity market and where he is finding investment opportunities.

“My thoughts on the stock market are that we are in a good market,” Hodges told ThinkAdvisor. “Because of the pessimism, because of the low investor sentiment and the low interest level amongst individuals – I feel like that makes the market not overpriced.”

Hodges, who admits he’s a bull and will “remain a bull,” said he doesn’t expect a scenario where there’s bubbles or big sell-offs.

“Every big selloff has come when there’s euphoria, and investor sentiment is great, and there’s a lot of speculation going on, and clients are calling you instead of the other way around,” he said. “And that’s the opposite of what’s going on today.”

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He’s specifically focused on small-cap stocks, as he finds them attractive currently for several reasons. According to Hodges, small caps have less international exposure, little or no currency risk, and are the least efficient part of the market, which means big pricing disconnects.

Hodges, who serves as co-portfolio manager of the Hodges Small Cap Fund (HDSPX), expects small-cap investing to require a greater degree of individual stock selection. He and his team are now focusing on a number of areas that are underfollowed or ignored by larger institutional investors. 

The following are Hodges’ top stock picks, some of which are among his fund’s top 25 holdings:

 American Eagle store. (Photo: AP)

1. American Eagle Outfitters Inc. (AEO)

Hodges thinks the consumer is “very strong” despite consistent pressure from Amazon, so many of his stock picks are retail-based.

“There’s been a lot of changes in how the consumer [shops] by using Amazon more and less of the department stores, but we’ve identified some areas that we feel like are still doing well,” Hodges told ThinkAdvisor. “That are bucking the trend.”

His first stock pick is American Eagle Outfitters, a U.S.-based clothing and accessories retailer mostly for teens.

“They’ve never missed a beat,” Hodges said. “They continue to outperform. They continue to have really, really good quarters – 6% and 7% same-store sales. But it’s thrown in with all the others and it doesn’t seem to get much traction. It’s one that we think will continue to do well.”

G-III Apparel Group is a manufacturer and distributor for brands like Calvin Klein. (Photo: AP)

2. G-III Apparel Group, Ltd. (GIII)

Another retailer that Hodges thinks is bucking the trend is G-III Apparel, which is a manufacturer and distributor of apparel and accessories under licensed brands, owned brands and private-label brands. According to Hodges, the company’s basic model is to take older and established brands, like Donna Karan and Calvin Klein, and “put them in a system where it creates a long-term cash flow.”

“They’re very good at marketing these brands and where the name really does mean something. And they’ve acquired several of these [brands],” Hodges said. Adding, “No one can do really what they do as far as taking an older brand and putting it in a situation that creates tremendous cash flow.”

Duluth Holdings website

3. Duluth Holdings Inc. (DLTH)

“An interesting retailer that doesn’t get a lot of publicity … is a company called Duluth Holdings,” Hodges told ThinkAdvisor.

Duluth Holdings is a lifestyle brand of men’s and women’s casual wear, workwear and accessories that sells under the Duluth Trading brand in the United States.

According to Hodges, the interesting thing about the Belleville, Wisconsin-based company is that about 80% of their business is direct sales.

“They don’t have a bunch of retail places,” Hodges explained. “If you look at what Amazon tends to be doing to everyone out there, hurting the brick-and-mortar ones, but these guys are ones that really don’t fall into that. The stocks have been doing well, but I think it’s very, very underfollowed.”

J.C. Penney Co.

4. J.C. Penney Co. (JCP)

J.C. Penney is Hodges’ “favorite retail idea.”

“It’s a very well-known name, but when you look at the fundamental underlying things that are going on at the company – to me, it’s a layup.”

J.C. Penney is in the middle of a turnaround strategy. Which is partly why, to Hodges, J.C. Penney is “as sure of a deal” as he sees.

“They don’t even need a gigantic increase in demand or giant increase in market share or same-store sales. Just correcting all the mistakes that were created with the old administration will generate significant EBITDA. This is a stock that used to trade in the 40s and now it’s in the single digits in the 9-10 range. It’s slightly profitable this year, but they’re refinancing a lot of their debt. They’re going to be saving a tremendous amount of money there.”

Southwest Airlines

5. Southwest Airlines Co. (LUV), American Airlines Group (AAL), etc.

Outside of the retail space, Hodges’ favorite stock pick currently is probably the airlines.

“I love the airlines,” he admitted. Adding, “I think it’s the cheapest part of the market. Most of the airlines are trading at anywhere from five to eight times earnings. To me, it’s a very misunderstood business at this point.”

Hodges says the business has finally become right-sized.

“We’ve gone from nine big airlines to basically three majors and Southwest and a bunch of regionals,” he told ThinkAdvisor. “The lack of competition is really evident now. They’re not doing the price competition like the industry has been historic to do. They’re actually making tremendous money; they’re actually returning for the first time in the industry’s history – Delta and American are actually returning money to shareholders.”

As Hodges sees it, these companies are doing “tremendously financially.”

“I don’t think people appreciate it enough,” he said. “They trade at very low multiples.”

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