$1.2M Babson College Fund's Winning Handbook

This article was written by Stockpickr member Ira Krakow.

Boston's Babson College has a well earned reputation for its innovative programs that promote entrepreneurial leadership. The Babson College Fund (BCF) is an example of this tradition.

In February, the BCF won first place in the New England Investment Research Challenge (NEIRC) for the second year in a row, beating teams from MIT, Boston College and Boston University.So what's the secret to their success?

"The BCF is more than a student-run investment club," says the fund's program director Finance Professor Steven Feinstein. Open to both Babson undergraduates and MBA students, the BCF "is a combination of academic course, money management organization and investment portfolio, where selected students manage a portion $1.2 million of the Babson College endowment."

The BCF students are divided into four sector teams: technology, basic materials, consumer and industrials. Why? "Sector specialization provides students with a more manageable set of companies to research and understand," explains Feinstein.

He adds, "We encourage students to research and visit Boston-area companies to gain hands-on knowledge of the companies they are researching." Any guiding criteria? "Managers are encouraged to focus on small- to medium-capitalization companies that have low analyst coverage and are local to the Boston area."

Part of the course grade for all team members is based on the team's stock picking performance for the year. During the year-long program (which starts in April), the team must write and present a minimum of ten professional-quality research reports to support their stock picks."

The BCF Handbook

The BCF managers must follow strict guidelines, as detailed in the BCF Handbook. The investment philosophy adopted by the fund's 2006-07 student managers is:

"We believe there are opportunities to actively add value and take advantage of temporary mispricings that exist in the market as a result of behavioral factors, size and liquidity constraints and low analyst coverage."

"Our goal is a rate of return on each equity sector portfolio, net of fees, that exceeds the rate of return of the respective sector benchmark."

Some of the guidelines are:

1. The fund is expected to be nearly 100% invested in equities, with only a small cash balance maintained for liquidity purposes.

2. When any stock has fallen 20% from its highest price since purchase, it must be re-evaluated or sold. If it is re-evaluated and held, the date of the re-evaluation becomes the new start of the holding period for determining future 20% rule triggers.

3. No single stock position can be greater than the maximum of 5% of the sector portfolio or that stock's weight in the sector benchmark.

4. Eligible companies must have a market capitalization greater than $100 million.

5. Market-timing, sector-rotation, pure technical analysis, and day-trading, are not allowed.

6. Short selling is allowed. However, only a fully-researched stock rated "sell" by BCF may be sold short. The research must be presented publicly prior to the opening of the position. The 5% position limit applies to any short position. Each equity team may have only one short position at any time. Finally, at the time the short sale is executed, a stop-loss buy order must be entered at a price no more than 20% higher than the price at which the stock is sold short, thereby limiting potential loss on the position to 20%;

Real World Stock-Pitching

During the fund's weekly Thursday meetings, the sector teams analyze three stocks within a specific sub-group of their business areas of focus and present a report on the one most compelling stock.

The students are grilled on their stock pitches by Babson's "executives in residence" (advisors), who ask the same questions they might have asked themselves when they analyze stocks at companies like Fidelity Investments or Value Line.

At a recent meeting, the BCF's industrials team - Matthew Murray, Alexander Naboicheck, and Andrea Wolf -- compared three law enforcement weapon suppliers: gun manufacturer Smith and Wesson ( SWHC), facial recognition equipment maker Digital Ally ( DGLY) and Taser International ( TASR).

They presented Taser as a buy candidate. According to portfolio manager Naboicheck, "Taser is an attractive investment opportunity because they are first movers with a unique product in a large potential market. With no competing products on the market, Taser benefits from a 'first-mover advantage.' Taser has no debt, they own all their property, plant and equipment, and they're adept at generating cash."

The sector team's target share price: $15.

When Rick Spillane, a BCF executive advisor and former Fidelity executive, asked why cash-strapped police departments would buy Tasers in addition to their regular guns, the industrials team was able to support their case. They cited room for an increase in sales -- not only in the domestic law enforcement market (only 39% currently use Tasers), but also the growing opportunities in the U.S. consumer market (with a potential market size of 100 million units) and the potential for foreign sales, as well.

Additionally, "Because Tasers are non-lethal, compared to guns, the legal and medical expenses saved using Tasers more than justifies their cost," says Naboicheck.

Recently, the consumer team of Kristin Lorenzo, Jason Dieffenbacher, and Steven Abreu, researched three drug retailing companies: CVS Caremark ( CVS) (a current holding), Rite Aid ( RAD) and Walgreens ( WAG).

However, they were not enthusiastic about Rite Aid and Walgreens, and ended up presenting CVS as a hold.

According to the team's report, "Despite holding a dominant position in the retail drug store industry, we believe the price that CVS Caremark is trading at currently is indicative of its value now and in the future."

The team also cited "political risks, pressure on traditionally high generic profit margins and competition from large retailers, such as Wal-Mart ( WMT) and Target ( TGT)."

The team set a modest price target for CVS of $43.80.

Investment Club Watch will keep you posted on how the BCF's stock picks fare this spring.

Stockpickr is a wholly owned subsidiary of TheStreet.com.

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