One way to find value: Buy the ugly ducklings

Portfolio manager Kent Croft looks beyond all the negative macroeconomic market noise to concentrate on one thing: finding out-of-favor stocks.
“Most people right now are worried about everything that can go wrong at a time when you’ve got a lot of great companies selling at attractive multiples,” said Mr. Croft, who manages the Croft Value Fund Ticker:(CLVFX) as president of Croft Leominster Inc., which manages $900 million in assets.
“We tend to be more optimistic in how we look at things because we’re looking at what can go right,” he said.
Mr. Croft’s strategy follows three basic paths toward value investing.
“From a contrarian perspective, anything that’s down piques out interest,” he said. “An out-of-favor industry like natural gas over the last few years is an example.”
Auto parts manufacturing is another example of where Mr. Croft was not afraid to move in when much of the market was moving out.
The bankruptcies and de-leveraging that occurred after the market collapse in 2008 has led to “fewer players getting a bigger piece of the pie,” he said.
One example in the auto parts space is Dana Holding Corp. Ticker:(DAN), which gained more than 1,300% during the rebound of 2009, followed by a 58% gain in 2010.
The stock lost 29% last year as part of the sluggish economic recovery, but it is up 12% so far this year.
The second part of finding out-of-favor stocks and industries involves identifying a catalyst that will spark a recovery.
“Sometimes you have to sit on something and wait for a long time, but we will buy something if we see it trading at a significant discount, and we think those values will get closer to one over time,” Mr. Croft said.
The third piece of the research process involves looking for growth at a discounted price, which is where the portfolio can sometimes stray beyond traditional value boundaries.
“This will lead us to companies that are trading at reasonable multiples, but have strong earnings over a number of years,” he said. “That’s where you will see some higher valuations, but also some higher growth rates.”
Following that logic, a few years ago Mr. Croft bought some shares of Apple Inc. Ticker:(AAPL).
“It’s not typical of a value manager to buy a growth stock like Apple, but when you see something that’s trading at around 13 times earnings, with good earnings and good growth potential, you have to buy it,” he said.
The fund is technically considered all-cap, but tends to favor companies with market caps of at least $500 million.
The portfolio of about 85 stocks has an average annual turnover rate of just 20%, reflecting a serious commitment to investment decisions.
The fund has gained 17.3% from the start of the year, compared with 17.9% for the S&P 500 and 15.9% for the large-cap-blend category, as tracked by Morningstar Inc.

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.

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