Heartland Select's Wide, Open Spaces
In the late 1990s, large-capitalization stocks ruled the markets. Then in 2000-2002 the stock market bubble burst. The air came whooshing out of over-inflated big-company shares. Mid-cap stocks sprinted ahead, and then, in the past few years, small caps have taken the lead. Large-cap shares have limped. How is an investor to determine what cap class of stocks will carry the baton?
One way to approach this problem is to leave it up to a professional manager who can invest in companies of any size. Consider Heartland Select Value (symbol HRSVX). Ted Baszler, co-manager of the Milwaukee-based fund, says the multi-cap mandate gives him the freedom to roam the markets and determine where value resides. For instance, Heartland had 55% of its eggs in the small-cap basket in 2002. The economy was coming out of recession, Baszler recalls, and small-company stocks tend to recover most sharply in the early stages of economic recovery. Today, the economy is slowing, so Baszler is seeking more safety and liquidity in large-cap shares. Heartland Select Value now has just 24% of its assets in small-cap stocks.
Select Value has done well for shareholders. Over the past five years, to September 1, the fund returned 12% annualized. That beat the average fund that focuses on undervalued companies of all sizes by an average of four percentage points per year and Standard & Poor's 500-stock index by an average of seven percentage points per year.
Like most value investors, Baszler looks for companies selling at low price-to-earnings, price-to-cash flow and price-to-cash flow ratios. But he also seeks enterprises that are undervalued because they are temporarily out of favor. For example, he sees value in HR Block, the dominant tax-preparation outfit. HR Block's stock slumped because it made a couple of distracting acquisitions. But the politicians never make our taxes any simpler, and tax-preparation prices rise every year. Baszler reckons that Block stock is worth far more than 11 times estimated 2007 earnings.
In the small-cap camp he likes Universal Corp., a tobacco-leaf processor based in Richmond, Va. It doesn't sound like a glamorous business, but that's the point: No new competitors are entering this industry. Some poor tobacco crops hit the stock, but demand for cigarettes made from higher quality tobacco continues to mount steadily overseas.
Among large-company stocks, Baszler has a fondness for banks. He reasons that banks fell out of favor as the Federal Reserve was boosting short-term interest rates, actions that compress the banks' interest rate spreads and hurt profits. Now he believes that cycle is reversing and that the Fed will soon start cutting rates. One of his top holdings is SunTrust Banks, an Atlanta-based super-regional that has a strong footprint in states with briskly growing populations and economies, such as Florida and Georgia.
What will lead next, big or small caps? When you purchase a flexible multi-cap fund, you can delegate that decision to a pro.