The less glamorous a company is, the more likely fund manager Jim Larkins is to find it exciting. And that's an approach that certainly has proved successful for him.
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Larkins manages the
Wasatch Small Cap Value fund, one of the best-performing funds in the top-performing fund category so far this year: small-cap value. Larkins has delivered a 33.3% return in the first half of this year, making his fund the fourth best-performing fund of all small-cap funds and the seventh best of all domestic equity funds. His fund also boasts a 28.6% annualized three-year return, vs. an 8.2% annualized return for his peers.
Larkins tells Daily Interview how he finds and researches the unusual companies he invests in.
TSC: You have some very unusual and esoteric companies in your portfolio -- among them, a tobacco and wool dealer, a phone company in the U.S. Virgin Islands, a maker of clothes for large-sized women and a real estate investment trust that specializes in medical facilities. How do you go about finding these companies?
The reason why these names seem so disjointed, or esoteric, is because we really are a bottom-up stock-picking shop. We spend a lot of time visiting companies throughout the country. We'll run screens based upon geographies where I may be heading to look for companies in the surrounding area that have interesting valuations and profitability models, and I'll go and visit these companies. That's how you find companies that don't have a lot of sponsorship by Wall Street analysts. This is how we construct our portfolio, which is why you see so many diverse and interesting companies.
TSC: What are some of the more unusual companies you have visited or places where you have traveled?
I flew on an overnight express cargo plane to investigate the workings of a company that flies cancelled checks around the country. I've driven across Illinois in the middle of the night to see a company in Peoria. I've gone to a distribution center for an automotive parts manufacturer in Bethlehem, Pa. My analysts and I have gone to all kinds of trade shows. One of my analysts just went to a maintenance, repair and overhaul conference in Dallas for jet engines. I'll do things like that to get an idea about how a company really works. It's one of the most fun aspects of my job. I really enjoy doing that type of work.
TSC: What are some of the holdings you believe make a compelling story?
I don't like to talk about stocks we are buying because I don't want Wall Street to know what we own, but one name that I think is real interesting is
. They manufacture after-market jet engine replacement parts. Jet engines are required by the government to have certain parts replaced every certain thousand hours or cycles, which are take-offs and landings, so what you are essentially buying is a razor-blade business with some steady demand.
Also, you are required to have
Federal Aviation Administration
approval to sell these parts, which creates a nice barrier to entry, so there are not a lot of manufacturers that have the R&D to go out and reverse engineer parts that are made by
Pratt & Whitney
and then sell them on the open market.
TSC: Did you visit the company?
I did visit the company. Most of what you get from these visits is a qualitative feel for
what the company is. I think very rarely do you stumble onto inside information. Typically what you look for is a company with passion for its business. You look to see if they are in lavish offices. Do they spend a lot of money on themselves rather than investing it in the business for their shareholders? Heico is a company that very much fits this profile. They have reasonable office space. You can go in there and see that they have invested money in engineering.
TSC: So if a company has lavish executive suites, you shy away from it?
It throws a red flag up that you have to be really careful. Are these guys really looking out for shareholders? If you look at our large holdings, you are not going to see companies that spend a lot of money on themselves. They really are more interested in reinvesting that capital for the benefit of shareholders.
TSC: Is there anything you do that is different from other value managers?
There are a couple of things that we think are really important about our value discipline that have helped us to have superior returns. First, we have a fallen-angel strategy, which is looking for companies that at one time were Wall Street darlings but because they have stumbled, Wall Street had shot them in the street. Those are names that we like to go into and determine whether it's a bump in the road or the middle of the road.
We think that we have a pretty good institutional memory and knowledge of the small-cap companies that are out there, and that memory helps us very well in sorting through the wreckage of some of these names, especially in a market that was driven by momentum so much over the past five to 10 years. Whenever a company disappoints, you will find that the momentum investors will sell at any price. But we look to see if it's a one-time miss or a one-time event, or endemic of something much more systematic in the company.
If you can pick up these names on a stumble, you'll buy the company below some intrinsic value. Wall Street, meanwhile, will eventually realize that they are not going out of business, and the multiple will come back to some type of a reasonable valuation. That's the first phase of performance in a stock.
The second phase of performance is when their earnings growth begins to recover and the stock begins to move in line with this earnings growth. We believe that earnings growth is the primary driver of performance in any stock.
The third phase is when the stock has recovered and analysts pick up coverage and it's off to the races again. And that's when we are looking to sell the stock, just as the momentum crowd begins to jump on the bandwagon. And it's usually attained a premium valuation. This is how we are able to achieve superior returns -- by owning stocks through these three phases.
TSC: There are a number of stocks in your portfolio that have triple-digit returns, and yet you still own them. Americredit( ACF), which provides car loans to those with poor credit, is up 121%. Crossmann Communities( CROS), a homebuilder in the southern and central states, is up 107%. American Healthcorp (AMHC) is up 233%. It seems a bit unusual that you would continue to hold onto stocks that have had such fantastic returns, especially given what you just said about getting out of a stock once it has recovered.
The secret to our success is that we will hit a couple of those every year that have spectacular returns, the reason being that you buy it at such an undervalued price and inherently it is a company with tremendous earnings power. When that earnings growth recovers, you get a slingshot effect off the bottom where you have both multiple expansion and accelerating earnings growth.