Investor's Business Daily, May 17th, 2007
The managers of Heritage Mid Cap Stock Fund take a classic GARP approach to picking stocks.
"We're a growth fund that looks for quality stocks," said co-manager Todd McCallister. "But we don't want to overpay."
Seeking growth at a reasonable price is the best way to find the stocks he and his colleague Stacey Thomas want, he says.
Those are growth-oriented companies, which can sustain their gains in part because they've got a competitive advantage.
And if a stock is truly healthy, its undervaluation can be a sign that it is not yet widely recognized by the Street -- not that it has been spurned for good reason. That leaves room for the share price to catch up with earnings potential, says McCallister.
This tack usually works well for the $1.6 billion fund HMCAX. Going into Thursday, the fund was up 11.23% this year. Its mid-cap growth rivals tracked by Morningstar averaged a 9.62% gain. The S&P 500 was up 7.51%.
Over the past three years, the fund's annual average gain was 16.91% vs. 14.84% for its peers and 13.46% for the S&P 500.
The managers aren't rigid about valuation. Sometimes they'll pay up for growth. "We'll do that when we find a stock whose asset growth and return on assets are high," he said.
The fund cuts risk by diversifying. It usually stays within 7% of the Russell mid-cap index's sector weights.
Good stocks can be undervalued for many reasons. Some are shunned by investors focused on problems that have already been solved, McCallister says. Or their ability to overcome hurdles may be overlooked.
Celanese CE was undervalued late last year when the fund began to buy, McCallister says. That's because many investors dismissed it as a commodity stock.
Two key products are acetic acid and vinyl acetate monomers. "Those are building blocks for many goods," McCallister says. "They're in construction materials, bottles, hair spray and cosmetics. Their biggest exposure is probably in paint."
Painting Profits
Some investors worried about paint sales being hurt by ailing home builders.
"But Celanese is international," McCallister says. "So domestic home building is not a big part of their business. Yet they are one of only a few firms globally that make this stuff. It's hard to make. And they're the lowest-cost maker. So they can act like an oligopolist."
Celanese, a top buy of the fund in its latest reporting period, is up 37% so far this year. It posted a loss in 2004, but earnings have rebounded.
Service Corp. International SCI, a top holding, is up 35%. On May 10 it gapped up nearly 8% on its way to a new eight-year high. The cemetery and funeral services provider reported a 70% jump in first-quarter profit. Sales gained 37%.
For 18 months, the stock had tumbled from a 1998 peak of 47.13. That was due to difficulty digesting a string of acquisitions in the 1990s, McCallister says. The firm has fixed those problems, he says, and now it's benefiting from a highly consolidated industry.
"They're the largest in their industry," he said. "Their rate of return on capital is up. And they're in a sweet spot demographically."
Thermo Fisher Scientific TMO, another top holding, is up 19%. The firm sells lab equipment used by health care researchers. Last year Thermo Electron merged with Fisher Scientific.
"It's getting lots of synergies from that merger," McCallister said. "Fisher was already a leader in the research supply space."
Ansys ANSS is up 28% this year. The company makes simulation software used by engineers and product designers. On Monday its board approved a 2-for-1 stock split in the form of a dividend.
"They have huge market share," McCallister said. "Gross operating margins are really high. That tells you they have dominance."
Automakers, for instance, can use Ansys software to test what-if scenarios in engineering a vehicle. "Instead of crashing costly cars, you simulate it," McCallister said.
