Artisan Value's Affection for Unloved Stocks

In their search for large, undervalued, financially sound companies, the managers of Artisan Value (symbol ARTLX) often gravitate toward out-of-favor stocks. The contrarian strategy has worked well: The fund's three-year annualized return of 10.4% is better than 76% of all large-company value funds, though it narrowly trails Standard & Poor's 500-stock index.

Sertl, Satterwhite and Kieffer start the hunt for winners by screening for stocks with low price-earnings or price-to-cash-flow ratios, among other measures. Their screens also identify stocks that have fallen dramatically and those experiencing a lot of selling by corporate insiders. "We're value guys," says Sertl. "We have to go where there's some fear and uncertainty in order to find low expectations and a good risk-reward ratio."

Once the managers have pinpointed a promising beaten-down stock, they get down to the nitty-gritty. They tear apart a company's balance sheet and income statements to come up with their own assessment of the concern's value. To make it into the fund, which at last report held a trim 35 names, a stock has to pass three main criteria: It has to trade at a discount to the managers' estimate of a company's true value; it must have a pristine balance sheet; and it must have a history of generating a solid return on capital as well as free cash flow (cash profits left after the capital expenditures needed to maintain a business).

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This kind of analysis can take months — even years. Sertl says he followed Burger King (no longer in the portfolio) for almost four years before an opportunity came along to invest in it.

The managers are just as disciplined about selling. At the end of the analysis, they set a target range of how high they think a stock can go If, say, the managers think a stock should trade from $26 to $33 a share, says Sertl, "we'll start trimming at $26 and at $33 a share, we'd be out the stock." Of course, their estimate of a stock's value can change, depending on developments at the company.

That self-restraint helped with their investment in Apple. The managers first started buying the stock in 2010, at about $300 a share. In 2012, as shares rocketed past $550 on their way to more than $700, they started to sell. "We trimmed it to below 3% of assets, and it would have been 13%-plus if we hadn't sold," says Sertl. When the share price dropped below $500 late last year, the managers started to buy Apple again — and they've been buying as the stock has continued to drop. "Apple has the top brand in world," says Sertl. "It has the best balance sheet in the world, it pays a higher dividend yield than the market, and it keeps piling up cash."

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It's not unusual for Artisan's managers to be buying when seemingly everyone else is selling. One of the fund's top holdings, energy exploration and production firm Apache, has dropped 23% over the past year, mostly because of political troubles in Egypt (home to 20% of the firm's production and 10% of estimated reserves). But while others were selling Apache shares, the Artisan managers were buying more, believing that the stock had fallen far more than its exposure to the troubled Middle Eastern country warranted.