Little Dogs With Big Fight
As Mark Twain said, "It's not the size of the dog in the fight; it's the size of the fight in the dog." Many thought that after beating the big guys for the better part of this decade, small-company stocks wouldn't have any fight left in them. But thanks to a surprising upswing that began in May, the pups are still barking. And so far this year, Heartland Value Plus (symbol HRVIX) leads the pack.
The Milwaukee-based fund has come out swinging in this rough market. Year-to-date through August 20, Heartland Value Plus gained 12%, while the Russell 2000 small-company index and the Russell 2000 Value index lost 4% and 2%, respectively. For the year, the $502-million fund is in first place among all diversified U.S.-stock funds, according to Morningstar.
Lead portfolio manager Brad Evans beats the market with an arsenal of small and unloved (many unknown) companies. With co-managers Adam Peck and Mike Petroff, he prowls his "hunting ground" of domestic companies with market values ranging from $300 million to $3 billion. "U.S. small companies are a contrarian place to be right now," says Evans. "Most people are still stuck on that large-company bandwagon, but quietly, small companies are outperforming."
One explanation, he says, is the recent strength of the U.S. dollar. A rising greenback often hurts U.S. companies that book a lot of business overseas, and those companies tend to be large. Also, although the domestic economy appears to be growing, albeit slowly, Evans thinks the U.S. was the first major nation to enter a recession and will be the first to come out of a downturn. Investing in small U.S. companies, he says, will be the best way to "get exposure to an improving U.S. economy."
The managers, Evans says, build the portfolio with a "maniacally focused" adherence to Heartland's standard "10 Principles of Value Investing." With help from a dozen other professionals, they screen for companies whose shares are priced cheaply in relation to earnings, cash flow and book value (assets minus liabilities). They also look for companies with little-to-no debt, strong management (preferably with significant insider ownership) and a catalyst that could prompt a turnaround, such as a restructuring.
What distinguishes Value Plus from the other Heartland funds is that more than 80% of its stocks pay dividends. Evans says dividend-paying stocks mitigate risk associated with small companies and lead him and his colleagues to "more mature small companies." But don't look to Value Plus for a fat payout. The portfolio's holdings yield about 1.5%, on average, but that's before taking into account annual expenses of 1.21%.
Werner Enterprises (WERN), one of the nation's largest trucking companies, has been a big contributor to Heartland's 2008 gains. Evans's team first met with top Werner executives a couple years ago at the company's Omaha headquarters. "We liked the management a lot," he says. "We liked the strategy, but we didn't think the timing was right in terms of where they were in the cycle."
But when they met again early this spring, the timing was better. "We saw the supply of trucks going down and the freight environment just slowly starting to improve," says Evans. He predicts that as business picks up for large retailers, such as Wal-Mart, trucking companies will be "one of the first to benefit from any improved economic activities." Value Plus, which requires an initial investment of $1,000, bought the stock in March at about $18. The shares closed August 21 at $23, and the Heartland team thinks they could reach $30 over the next year.