3 Smaller-Cap Names You Haven’t Heard

12/16/2011 7:00 am EST


Investors typically hear a lot about large-cap S&P 500 stocks, hot growth plays, and high-profile IPOs. However, investment manager Tim Holland ferrets out companies that are not household names, but which have strong management teams driving fundamental growth. Today, he shares three of those ideas with MoneyShow.com.

Kate Stalter: Today’s Daily Guru guest is Tim Holland of advisory firm TAMRO Capital Partners.

Tim, your firm issued a report in October discussing why you are remaining constructive on US equities. So, tell us a little bit about that. Why is that?

Tim Holland: You know, it’s obviously been a very volatile year and a very volatile back half of the year. But the reasons we were constructive a few months ago are the reasons—volatility today not withstanding—that we are still constructive.

Which is, the private sector here in the US is in fantastic shape in terms of balance sheets and also levels of operating profitability. There was a tremendous amount of fat taken out of corporate America in 2008 and 2009.

Beyond that, the financial-services sector, which is much maligned and has not done well from a stock-picking perspective this year, is also very well capitalized relative to, say, Western European counterparts. So, even though those stocks haven’t done well, the balance sheets are strong and capital was raised.

So, you’ve got a strong corporate sector, you’ve got a recapitalized financial-services sector, you’ve got sentiment towards the asset class that I think that borders on despondent. And this volatility, obviously, adds to that. No one has made money in US equities in a very, very long time, and I’d argue they’re an underowned asset class as a result.

Then, finally, there’s valuation. If you look at the S&P 500, it’s trading at 11 times earnings, and again profitability for the third quarter was very strong. There are a few concerns about the fourth quarter and next year, but we also just think, beyond all those other points, it’s an asset class that on balance is attractively priced.

Kate Stalter: Let’s talk a little bit about your investment strategy. You use both a small-cap core and diversified equity, which I understand is large-cap. Tell us about some of the objectives there, and how this benefits retail investors.

Tim Holland: Sure, in both portfolios, small-cap core and diversified equity—which to your point Kate, is a large-cap, core-oriented strategy—are both long-only portfolios with 50 to 70 stocks…diversified, but high confidence.

The goal is to outperform the respective benchmarks over a full market cycle, which is something that we’ve been able to do for a very long time in both small-cap and diversified equity.

They are long-only, so if the markets are off, the portfolios will likely be off, and you’ll have to live with some of the volatility of being in the market. But we’ve also found that there are very few people in our profession who can accurately time the market, know when to get in and know when to get out.

Beyond all that, we’re also significant investors here at TAMRO Capital in both portfolios, small cap and diversified equity, in addition to owning the majority of the firm.

Kate Stalter: What are some of the specific holdings within the funds that you can tell us about today?

Tim Holland: Sure, there are a couple or three stocks I can talk about. One we own in both portfolios, a small-cap health-care concern. One we own only in small-cap, and then one we own only in diversified equity.

The small-cap health-care concern is a company by the name of The Advisory Board (ABCO). What The Advisory Board does is essentially the best practices within the health-care industry, focused on hospitals, but they also provide data and solutions to other participants within health care.

It’s a research-driven business. They’ve been in business for decades. They have collected a tremendous amount of information around what works and what doesn’t work within the health-care space. They also have technology solutions that they make available to the health-care clients—again, with an emphasis on the hospitals.

If you think about health care, it’s a huge part of our economy. Prices continue to grow at a multiple of inflation, and now you’ve got the baby boomers aging.

If that industry is ever going to get its hands around the demographic challenges and the cost challenges facing it, it’s got to be through better use of technology and better use of data and best practices, and that’s what The Advisory Board does. And there’s really no one else that does it with such a focus on health care, like The Advisory Board.


Kate Stalter: That sounds like a very interesting company. Tell us about some of the others.

Tim Holland: Sure, the other one that we own exclusively in small-cap is a small-cap bank called Bank of the Ozarks (OZRK), which in 2011, as of this afternoon, is actually up 28% year-to-date.

If you tell anyone that their bank stocks are up 25%, 28% year-to-date, they’d look at you like you have two heads, Kate, because it’s a maligned industry. But Bank of the Ozarks is a stock we’ve owned for about three years now.

We’re really excited about small-cap banks, because as a country we’re over-banked—we have too many thrifts, too many banks. We had too many weak banks post-credit crisis, and we think the better capitalized banks—the banks that were judicious with credit during the bubble years—are in a really good position to acquire their peers at very attractive prices. That’s a great way to get loan growth in a low-loan growth environment and expand your physical footprint on very attractive economic terms.

So, Ozarks has all the characteristics we look for in a company. It’s led by a very tenured group of people. The chairman essentially founded the company 30 years ago, and still has a significant ownership stake.

It’s got a great core business on the banking side in Arkansas and in east Texas, and the financials are very robust. They did such a good job during the bubble years and then through the downturn, they’ve now been able to do seven FDIC-assisted bank acquisitions over the last year, year-and-a-half. Those deals have proven to be very accretive to book, very profitable, and it’s one of the reasons why the stock has resonated.

We think this consolidation cycle is going on for some time, and hopefully Bank of the Ozarks will continue to participate.

Kate Stalter: It seems that some of these regional banks did get unfairly lumped in with some of the money-center banks throughout the financial crisis.

Tim Holland: Yes, that’s a good way to think about it, and they sort of threw the baby out with the bath water.

You go down the cap structure, to your point Kate, you’ve got parts of the country that are doing OK economically. You have smaller banks that aren’t impacted by as many of the regulations, and banking at its core is a local, high-touch business. And these small banks tend to do a better job than the big banks at attracting and retaining customers.

The great thing about Bank of the Ozarks: It never cut its dividend through the downturn. It’s actually raised it of late. It’s very well capitalized, and there are any number of small banks that fit that profile across the United States.

Kate Stalter: Tim, I think you have one more stock you can tell us about today?

Tim Holland: One more stock that we own in the diversified equity portfolio is a cyclical company, an agricultural equipment manufacturer by the name of AGCO (AGCO). This is a company in Duluth, Georgia. The market cap is approximately $4 billion, and they make tractors of different sizes and combines, along with some other equipment.

The reason we like AGCO—and it’s a larger position within our diversified equity fund—is that it’s got everything we look for in a company, in terms of management, financial flexibility, and a good core business.

But it’s also a turnaround candidate, in that it used to be a growth-through-acquisition story, and the prior leadership that built the business never really successfully integrated everything that was purchased.

So, the board went out and got a great operator with significant industrial experience. He and his group have put together and put in place a very straightforward turnaround plan focused on driving operating profitability higher, much higher than it’s been in the past. So, there’s potential to drive margins up, even though the world is very volatile and could be a spooky place.

The economics within the farm space still remain very good in terms of farmer income and demand for crops, and with AGCO, most of their revenues—approximately 70%—actually come from outside the US.

So, he even though they’re based in Duluth, Georgia, they’ve got a big footprint in Brazil, a big footprint in Germany—which is a point of concern for some people—but so far it’s held up very well. So, it’s a nice play on international growth, including those emerging markets that are mechanizing their farming the way we did as a country many decades ago.

Kate Stalter: Well, those are three names that I’m sure many listeners may not be fully aware of. So, thanks for telling us about those today.

One last thing, just to quickly wrap up here: You started out today by talking about the challenges in the market, the volatility. How can retail investors navigate their way through this? What’s the best approach?

Tim Holland: That’s a really good question, and as a stock picker and not an investment advisor, I may not be the right person, but I think ultimately what I’ve always read, what I’ve always preached, what I’ve always been told is: Have an investment plan, have a set of goals in mind, allocate your assets around that and rebalance accordingly, and just try not to get shaken out.

Because when things get scary and the volatility picks up, the emotions take over and people tend to make very poor, poor decisions. You go back to a couple months ago and the market was at death’s door, and then you had a massive rally in October when a lot of people just finally gave up on equities, and then even November was flat.

December is down, but considering where we were a couple, three months ago, we’re still up nicely. So, I think it’s have a plan, understand what assets you need to get to that plan, and try and stick with it as best as you can.

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