Value investors are finding some great buys these days, especially in IT and health care—and where those two sectors intersect are the best values of all, observes Brian Frank of Frank Capital Partners.
Gregg Early: I’m here with Brian Frank, portfolio manager of the Frank Value Fund (FRNKX). Brian, it has been such a long time since value has really been at the forefront of investors' thoughts. Could you tell us where we are in the cycle, where you are looking for value, and where you are finding value?
Brian Frank: Absolutely. I think the fact that we have been so far from investors' thoughts—the savvy investors—usually means we are at the bottom of the value cycle. It is a fantastic time to start looking at fundamentals.
Most of the value gurus I follow are trailing the market this year, including ourselves, and a lot of growth and momentum stocks are clearly in favor. Just by focusing on the numbers and running a strategy based on valuation, we are finding a lot of compelling ideas, a lot of things that haven’t moved in the bull market, and a lot of smaller stocks especially, that have gotten left behind.
The fundamentals look great, the business line and the stock prices look great, and I think a lot of these small stocks are ripe for buyouts too.
Gregg Early: You’re fairly secular in what you’re looking for. I mean you don’t care whether it’s large-cap value or small-cap value or midcap for that matter. Is that correct?
Brian Frank: Correct. We run an all-cap strategy just for the simple idea of if you’re running your own money, why would you limit yourself into one space?
If all large-cap stocks are expensive and you’re a large-cap manager, you have to buy those stocks. That just never even made sense to me because we started with family money, even before we had the fund, and the idea was "make money in the stock market." It wasn’t built to fit a style box.
So by having an all-cap fund, our universe is about 3,500 stocks, which is larger than the universe of almost every major fund company out there. We are looking for the best 25 to 40 stocks that are extremely low in valuation, but have extremely high returns on capital.
Of course, we do a bunch of qualitative metrics that we check on from there as well. We are trying to build a concentrative portfolio that can outperform the S&P, because I think in order to beat an index, you can’t look like one and own hundreds of stocks like many other funds do.
Gregg Early: You said you’re finding more value in small-caps at this point?
Brian Frank: Correct. The fund started in 2004, and for the first six years or so we were about 60% to 70% small- and midcap stocks, which was a nice balance for us. Then, after the recovery from the financial crisis in 2009, small stocks really led the way and kind of took off in valuation.
We never want to overpay for anything, so we started going up the cap curve toward large- and megacaps. Large and mega really got ignored in 2010, and in 2011 the fund outperformed the S&P by about 600 basis points. I think the reason is we were very large. We had Pfizer (PFE), Berkshire Hathaway (BRK.A) and a lot of the giants in the fund, which wasn’t the norm for us. We were about 60% to 70% large cap at that point, and it ended up doing very well for us.
Now in 2012, a lot of these big-cap companies are getting bought up. A lot of people are chasing the dividends on them and the P/Es are going up, so we are moving away again. We’re finding where the P/Es are low and there are definitely some Russell 2000—some small-cap stocks that have really come down this year. The valuation looks better in small right now.
Gregg Early: Are there any examples in particular, or are there any sectors specifically that seem to be a well of value?
Brian Frank: Absolutely. I would say all IT companies, most technology companies, are cheap right now, and in the small-cap technology space we have a position in Quality Systems (QSII). This is a smallish company that does electronic health records for hospitals and physicians.
It is a growth company, but in about the second quarter they disappointed the growth investors by not growing as fast as everyone thought they were. There was indiscriminate selling in this stock.
Then, over the summer, one of its directors who held all of his shares in a margin account—this is not something you should ever think of doing, because if the stock declines you have margin calls—the stock just went off a cliff in July.
After exhaustive research on this company, we found out that it is actually very well positioned. The cash flows are very consistent, which is one of the most important things that we look at. Not only do we want to buy cheap, but we want to make sure those metrics are going to continue in the future.