Scoring Big With Small Stocks

Not everybody believes bigger stocks are better.

"Virtually every strategist on the Street is pounding the table on mega-cap stocks," says Will Nasgovitz, co-manager of the $330 million (HRSVX Quote)Heartland Select Value fund. "When everyone is saying the exact same thing, you can be certain it won't happen."

To be fair, it's easy for Nasgovitz to stray from the pack, and not just because he is a contrarian investor. Running a multicap fund allows him to pick and choose among market caps large, small and in between.

Time to Fill Up on Cimarex, Dow Chemical

It's not simple, however, to quibble with his track record. His fund has returned almost 9% annually over the past three years, more than two percentage points better than his Morningstar category average as well as the S&P 500 Total Return Index. Over the past five years, the fund has gained an average of 14.4% per year, once again thumping the respective benchmarks.

Nasgovitz is concentrating on small- and mid-cap stocks hammered in 2007 and still under pressure. The average microcap stock was down 40% in 2007, while the Russell 2000 is down 20% from its July peak.

"The markets are oversold, so now is the time to dig in your heels and make some serious money," says Nasgovitz. "The smaller names are the first to fade and the first to come back, so that is where we are finding the best opportunities."

One midcap name he likes is natural gas specialist Cimarex Energy(XEC Quote). He says the Denver-based company is not only a potential take-over target by a major looking to expand, but has geographical and political benefits as well.

"Cimarex has safe proven reserves in North America, so the political risk is low," says Nasgovitz. "Who needs to worry about investing in a geopolitical hot spot? And environmentally speaking, politicians will choose natural gas over coal every time."

As for large-cap, diversified energy names, Nasgovitz is partial to ConocoPhillips(COP Quote), mostly because it trades at a 7 forward PE ratio, a significant discount to Exxon Mobil's(XOM Quote) 11 multiple.

The fund holds less than 50 stocks, and for Nasgovitz, the less analyst coverage the better. One of Nasgovitz's favorite underfollowed stocks is Tyco medical device-spinoff Covidien(COV Quote).

"Covidien has less than 10 analysts tracking it, compared with its competitors -- like J&J, Baxter and Medtronic(MDT Quote) -- which have full Street coverage," Nasgovitz says. "Covidien has divested its less profitable businesses and has also seen heavy insider buying. We like it a lot."

On the smaller side, the fund also has a position in LifePoint Hospitals(LPNT Quote). LifePoint, which owns 45 hospitals in rural markets, has also seen insider buying and trades at a cheap 11 times forward estimates.

Considering its contrarian bent, one might be led to believe that the fund managers would be diving into battered financial stocks by now. Nasgovitz says that's not the case.

"We have been evaluating financials but don't think they have reached a bottom yet. Expenses are still growing faster than revenue, credit quality is still declining, capital ratios are still low and consensus estimates are still too high."