Chasing Cheap Stocks-Kiplinger

FUND WATCH


Chasing Cheap Stocks

Stacy Rapacon

Pinnacle Value manager John Deysher uses a successful strategy of buying out-of-favor shares of small companies.



Some fund managers have been riding out the recent market turmoil by sitting on a pile of cash. One of them is John Deysher, manager of Pinnacle Value. The $64 million fund, which invests in tiny, undervalued companies, currently has about 50% of its assets in cash. The problem, Deysher says, is that he can't find enough cheap stocks.

Deysher's conservative approach paid off last year and has helped so far this year. In 2007, Pinnacle gained 15.4%, whipping the average small-company value fund by nearly 22 percentage points. In 2008 through January 23, the fund lost 3.2%, beating its peers by an average of 5.2 percentage points.

The secret of Deysher's success lies in buying out-of-favor stocks from among the smallest companies. Deysher, who spent 12 years with Royce & Associates, a leading small-company value shop, gets many of his new ideas by scouring the list of stocks hitting their 52-week lows.

Wall Street analysts and other pros tend to ignore microcaps and what Deysher calls nano-cap companies, the smallest of the small. The average market value of his holdings is just $150 million, and his fund holds a couple of companies valued at less than $20 million.

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Most of Deysher's picks are not only under-followed but also out-of-favor. He looks for stocks that sport low price-earnings ratios and other indicators of value. To ensure that a company that interests him doesn't remain permanently undervalued, Deysher looks for a history of consistent earnings, capable executives and significant insider ownership.

He also looks for a catalyst that could energize a stock. This might come in the form of new management or a more activist shareholder base looking to boost the stock. A catalyst could also come in the form of a new product or a new distribution channel. Or it could simply be a cyclical rebound in earnings.

One Deysher pick that worked out well was Conrad Industries. He invested in the shipyard operator, which specializes in the construction and repair of ships and barges, about three years ago for nearly $2 a share.

Conrad had many of the qualities Deysher looks for, including a strong balance sheet and capable leaders who held significant stakes in the company. "When you put that combination of factors together," he says, "it just lead us to think that eventually we could make money if we were patient enough." Conrad (symbol CNRD.PK) gained 138% last year and closed January 24 at $13.70.

With the stock market in turmoil, Deysher is finding plenty of beaten-down stocks in a number of industries. He's been checking out banking and insurance stocks, as well as some retailers and real estate stocks. "Any of those industries have catalysts that could make the stock prices go back up," says Deysher.

But he insists that he doesn't make calls on sectors. "We're agnostic in terms of industries or representation in the portfolio," he says. "We'll just go where the values are and let the results speak for themselves."

For most of this year so far, locating good values has been much like looking for Waldo -- just when you think you've got him, it turns out to be a dog in a candy-cane shirt. If stocks once again descend, Deysher will actually become more optimistic: "As the market comes down, we tend to get more and more bullish."

Deysher has plenty at stake. He has a significant (but undisclosed) amount of his own money in the fund: "There's an extra level of thoughtfulness and concern that goes into the management of the portfolio because I am where the buck stops and I am the largest shareholder."

Pinnacle invests in some of the riskiest stocks in the market. Deysher's focus on mitigating risk is a good thing and makes this fund worth considering for the part of a portfolio dedicated to small, undervalued companies. The fund (symbol PVFIX) requires a $2,500 minimum initial investment and levies 1.49% in annual fees.




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