3 Picks from a Quantitative Fund Manager

02/08/2012 6:30 am EST


Fundamentals are the preferred way Mark Coffelt determines investments for his top-performing fund. He shares three of those ideas with MoneyShow, and describes why they caught his attention.

Kate Stalter: Today’s guest is Mark Coffelt, who runs the Empiric Core Equity Fund (EMCAX).

Mark, you use a quantitative strategy, and I see that you have outperformed the S&P 500 by a significant margin over the past ten years. Give us just a little bit of background on what your strategy is.

Mark Coffelt: Well, what we try to do, Kate, is to look through companies and find the aspects of their DNA that really indicates that they will perform well. So, essentially we’re looking for characteristics or factors, as they’re sometimes called, that really point toward companies that should do well.

Kate Stalter: And what would some of those factors be that you’re measuring for?

Mark Coffelt: Well, we look for things like free cash flow, we look at cash flow, return on invested capital. It really varies depending upon the timeframe that you examine.

So, for instance, in today’s market, the factors that are being rewarded are companies that have really good balance sheets that don’t need to go to the debt markets, and really are buying back stock.

Kate Stalter: Are they all fundamental metrics, or are there any technicals that you look for as well?

Mark Coffelt: We do look at technical, too, but probably 98% is really fundamental aspects. So, it’s how well the companies are run, what they’re doing for shareholders, like stock buybacks. It’s really based on the efficiencies of a company, the valuations of a company, and what they’re doing for shareholders.

Kate Stalter: Can you tell us about a few of the names that you’ve identified?

Mark Coffelt: Yeah, I’d be happy to. I think in line with this quality company, and probably a company that you don’t have to worry about in Europe, is a company called Bed Bath & Beyond (BBBY).

It really has some of the quantitative characteristics that I discussed. For instance, they produce a lot of free cash flow, and one of the aspects that we look at specifically is the free cash flow stability. Bed Bath & Beyond has that.

We also are looking for companies that are buying back stock, and that really is an indication of quality, because it tells you that they’re producing lots of cash flow, No. 1, so that they don’t have to go out and issue stock. And No. 2, that they’re acting favorably toward the shareholder. Again, Bed Bath & Beyond has been reducing shares over the last year.

Kate Stalter: Are there any particular market caps that you focus on?

Mark Coffelt: We really don’t. Most of the anomalies, as they’re called in the marketplace, really occur in the small- and mid-cap space, but Bed Bath & Beyond is probably somewhere between a mid cap and a large cap.

So, we can get large caps. It’s just typically, most of the securities we find that have factor profiles that indicate our performance. You’re going to be in the mid and small cap areas.

Kate Stalter: Any of those names you could tell us about today?

Mark Coffelt: A company called Dolby Laboratories (DLB). Of course, everyone knows that they’re the ones that originally produced the anti-white noise for radios and so forth. But they’re now starting to put their products on cell phones and smartphones.

So again, it has the characteristics that we look for: No debt, it’s reducing shares, it’s got great operating cash flow to assets. It’s a well-run company, it’s producing a lot of cash, and that would certainly qualify in the smaller-cap area.

Kate Stalter: You have another larger company that you were also prepared to talk about?

Mark Coffelt: Well, I do, and the stock is MasterCard (MA). MasterCard and Visa (V) almost have a duopoly.

Now, they’re not taking credit risk. MasterCard, interestingly, is not in the financial area, but it’s in the information technology area. So, essentially, MasterCard and Visa are processors of transactions.

I don’t know about your behavior, but I charge everything. I mean, I hardly ever write a check—it’s hard to do—so MasterCard benefits from that trend. And again, you see they’re reducing shares, you see the free cash flow stability…and kind of an added bonus, it comes up on our screens, but also it’s a holding of Warren Buffett.

Kate Stalter: When you were just mentioning a moment ago some of the consumer behavior and going to plastic instead of checks. Is there any form of sort of qualitative research that goes into your model?

Mark Coffelt: We do. Certainly one of the aspects that we have is we want to make sure that there’s no accounting issues with the companies in question. So, if there’s rumors that they have bad accounting, and we test for the accounting, but sometimes if companies fake it, we don’t want to be anywhere near that stock.

So, if there’s any questions whatsoever about the quality of accounting, even it if doesn’t show up in our numbers, then we won’t touch the stock.

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