Mutual Fund Monday

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Fund Managers Covet These Cheap Stocks

Lawrence Carrel

But as these players rushed to unload anything liquid in their portfolios, some mutual funds have been scooping up the resulting bargains.

"I think most managers have been buyers in this correction," says Larry Puglia, the portfolio manager of the $11 billion T. Rowe Price TRBCXBlue Chip Growth Fund (TRBCX). "Earnings growth prospects for many companies are still quite sound, and the valuations have gotten more attractive."

Few mutual fund managers have the leeway to sell all of their holdings and move into cash, so their stock-picking skills really come to the fore during market crises like this. That's particularly true for managers who elect to lighten up on some stocks to make room for others.

Jeff Tjornehoj, senior research analyst at Lipper, says investors, particularly large institutional accounts, use mutual funds to play a particular role in their portfolio, and so prefer that they stay fully invested. "Investors also want to see them make an effort to make money rather than take the know-nothing route and park it it cash," he adds.

Here's a look at where four fund managers see bargains.

Puglia looks for companies with free cash flow growth, leading market position, seasoned management and strong fundamentals, especially a high return on invested capital. If a company's fundamentals remain strong, he's willing to keep buying on the way down, on the theory that his costs will average out over time.

The manager has been buying a mix of industrials, technology and consumer staples stocks, including General ElectricGE, MicrosoftMSFT, PepsiCoPEP, Procter & GamblePG and GoogleGOOG. He has also been buying financials, including Goldman SachsGS.

That's right, Goldman Sachs, the investment bank that injected $2 billion into a hedge fund that lost 30% of its value in a week. The company's stock is down more than 20% from its 52-week high, but Puglia believes it will perform well over the next two years.

Financial services companies in general have led the market's selloff as more subprime borrowers find they can't make their mortgage payments. The mortgage lenders who make these loans, the investment banks that repackaged them into securities, and the hedge funds and other investors who buy them have all been hit by a credit crunch as the market struggles to determine what they are worth.

Puglia has unloaded some financial services stocks, but not all. In addition to Goldman Sachs, he also likes American Express AXP, Morgan Stanley MS and Charles Schwab SCHW.

Puglia isn't buying indiscriminately, however. The fund manager has sold energy stocks, and thinks natural resources shares are only now beginning to look cheap.

As of Friday's close, his fund was up 6.8% year to date, outperforming the S&P 500. Over the past three years, it has returned an annualized 11.91%. It doesn't charge a load, or sales commission, and carries an annual expense ration of 0.81%.

Colin Glinsman, manager of the $1.86 billion Allianz PDLAXOCC Value Fund(PDLAX), says investors need to look at individual stocks and determine if the market has overreacted to the mortgage crisis.

Like Puglia, Glinsman thinks some -- but not all -- financials were oversold last week. In general, "if it doesn't have exposure to the credit crunch, it's cheap," he says.

"We look for companies where the stock overshoots on the downside because of fear, but is fundamentally sound. These are the ones that will go up after this period," says Glinsman.

Of course, he has to sell something to free up cash first. So he scans his portfolio for stocks that are trading at levels close to their long-term fundamental value and have less upside potential. "I sell those and deploy funds to stocks which have [more] upside," he says.

Glinsman especially likes MBIAMBI and Ambac FinancialABK.

OCC Value is up 0.3% year-to-date, but has returned an annualized 11.35% over the past three years. It has an expense ratio of 1.11% and a front-end load of 5.5%.

Clark Winslow, manager of the $900 million MainStay MLAAXLarge Cap Growth Fund (MLAAX), is adding to his holdings of some stocks while aggressively selling those that no longer fit his investment criteria.

While some commentators believe the U.S. economy is headed into a recession, Winslow believes growth will merely slow. He expects that a rise in unemployment and a reduction in capacity utilizations will lower inflationary pressures, allowing the Fed to drop interest rates. That should help the stock market recover next year.

With the S&P trading at a reasonable 15 times next year's earnings, the fund manager believes this is a good time to look for companies with weak valuations and good growth prospects.

Among his top picks are Cisco CSCO, which was the fund's biggest holding as of June 30, according to Morningstar. The maker of network equipment just reported a favorable quarter and Winslow expects it to be a "major beneficiary of world economic growth," with rising revenue growth and profits climbing 20% a year.

Another pick is pharmacy manager Medco Health SolutionsMHS, which is capitalizing on the trend of generics replacing high-priced proprietary drugs, says Winslow, predicting 20% earnings growth.

The MainStay fund was up 9.6% year to date as of Friday, with a three-year annualized return of 14.22%. It has an expense ratio of 1.4%, and a 5.5% load.

"Everyone is worried about the next shoe to drop, but these periods of volatility give us a chances at stocks that weren't available a couple of months ago," says Russell Croft, co-manager of the $24 million Croft CLVFXValue Fund (CLVFX). "Our goal is to beat the market with reduced risk."

A long-term value-oriented investor, Croft's time horizon is one to three years and he invests in companies of any size in any sector. Right now, he likes industrial adhesive company 3MMMM and timber firm WeyerhaeuserWY.

The no-load fund is up 11% year-to-date and has returned an annualized 17.44% over the past three years. Its expense ratio is 1.5%.

Will Nasgovitz, co-manager of the $350 million HRSVXHeartland Select Value Fund (HRSVX), has been looking to buy stocks of companies of any size that trade at low valuations, such as 13 times next year's earnings. But he won't touch a company at any price unless he has a clear understanding of how much exposure it has to subprime mortgage crisis.

"We're focused on businesses with good balance sheets," Nasgovitz says. "We don't want to be worried. We're selling winners whose balance sheets have deteriorated because we don't want companies that are significantly leveraged. Those are not your friends now."

He especially likes railroad company Union Pacific UNP, which is down 17% from its 52-week high in July. He predicts it will have earnings of $10 a share by 2010, up from $5.96 for 2006.

Up 7.9% year-to-date and 18.31% annualized over the last three years, the no-load fund has an expense ratio of 1.25%.