Guns, Funeral Homes and Colleges as Investments

NEW YORK ( TheStreet) -- The Russell 2000 Index of small companies is hitting new highs, heightening awareness of Capella Education ( CPLA), Sturm, Ruger ( RGR), Service Corp. ( SCI) and other stocks, says Jonathan Moody, manager of the Touchstone Small-Cap Core Fund ( TSFAX).

The $199 million mutual fund has returned 10.4% this year, putting it in Morningstar's ( MORN) 34th percentile for small-blend funds. Over the past year, the fund has risen 22%, also better than two-thirds of its rivals.

Welcome to TheStreet's Fund Manager Five Spot, where America's top mutual fund managers give their best stock picks and views on the market in a five-question format.

Why should investors chase small-cap stocks if they are hitting new highs?

Moody: When we look at the overall equity space, equities are way undervalued relative to bonds. Cash on corporate balance sheets today is at 50-year highs. A lot of companies are going to have a hard time showing organic growth, so they are going to put that cash to work by buying smaller companies. Most of that M&A will occur in small to mid-sized names.

For-profit education stocks have come under a lot of scrutiny from the government, so why do you like Capella?

Moody: Capella is a best-in-class operator. It's about an $800 million company with around $200 million in cash. It generates a nice amount of cash flow. And when we look at their student profile, we see that about 80% of their students are at the graduate level. That means they are probably already employed and going back to school to get advanced degrees to increase their earnings. We also like the fact that they are 100% online so it's almost like a publishing model where they have high incremental returns on capital.

Why is now a good time to own gunmaker Sturm, Ruger?

Moody: We like Sturm, Ruger because management there has done a phenomenal job in transitioning that company to lean manufacturing. That's important for the company because it increases their ability to manufacture new products. If you look at the most recent quarter, about 29% of their sales came from new products. Last year, it was 25%, so they are doing a good job generating nice amounts of cash and returning that excess cash to shareholders.

The funeral-services business is fragmented and plagued by unsuccessful roll-ups. Why should an investor want own Service Corp. -- or be in that space at all?

Moody: Service Corp. is one of the largest players in the death-care business. What we like about them is that they have been facing a declining death rate, but the fact of the matter is that 65-and-older is the fastest age group in America. So, eventually, Service Corp. will benefit as the death rate ticks up, and it has in the last few quarters. We like that it is generating a huge amount of cash with about a 9% free cash flow yield. They are taking that excess cash flow and buying back stock and delivering. They are very well-positioned.

Everybody is talking about Lubrizol (LZ) because of the big Berkshire Hathaway (BRK-A) purchase, but you like its competitor NewMarket (NEU).

Moody: We have owned NewMarket for some time. They are a close competitor to Lubrizol. It's an oligopoly, so the pricing is stable. They make lubricant-fuel additives that are used in engine oils and transmission fluids and things of that nature. Despite the price of the stock being bumped up when Berkshire bought Lubrizol, NewMarket has a long way to go. It's generating a tremendous amount of cash. They are buying back stock. They just increased their dividend by 36%. It's a very well-run company, and management seems to run it in a very shareholder-friendly way.

-- Reported by Gregg Greenberg in New York.

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