Pick Stocks from the Bottom Up

08/07/2012 11:30 am EST

Focus: STOCKS

Craig Hodges

Co-Manager, The Hodges Fund

By using stringent fundamental analysis on individual company stocks instead of broad industry and economic data, portfolio manager Craig Hodges selects attractive value stock buys.

My guest today is Craig Hodges, and we're talking about a bottom-up approach to finding good stocks in the market.  So Craig, first of all, what is a bottom-up approach to the markets? 

Bottoms up is, instead of looking at the industry that they're in, you look at the actual company from the bottoms up. You don't necessarily—like if you're looking at the railroads—we got in on the railroads in 2003, and it was because of one idea in particular. 

We had met some individuals at Burlington Northern who had told us of things going on there, which caused us to look at the company. We took a bottoms-up approach and bought a lot of the stock, which at the end of the day, we ended up buying all of the railroads. And of course, they all did real well through 2005, 2006, 2007, and 2008. 

So that's what we do.  We do all of our own fundamental research, and really what we're focused on are the companies, and not really worried about the economy and the outside forces. 

What kind of things are you looking for?  Is it a news release or an article in the paper that catches your attention?  How do you find that? 

It can be just about anything.  You'd be surprised where we get our ideas.  We read every publication we can get our hands on, but one good source of ideas is when you talk to companies and you ask who is your strongest competitor, or who is your weakest competitor.

Or, a lot of times, our customers even say hey, I know a guy who knows about this company that's doing great, and we will check it.  Now, if you hear 100 of those, it might be five or six of them that are actually valid. 

But when you're like us, and you're small in nature, you're looking for an advantage. Since we're in that area of the smaller companies and the mid-sized companies, we can, I think, add value and add an advantage. Where if I'm covering General Motors or Home Depot, I'm not really going to add a big advantage from the research part of that puzzle.

So is it something where you are looking at a pure numbers game, and saying this stock is undervalued based on what we see in terms of revenue and profits and that sort of thing?

Yeah, there are a lot of different things that make sense.  You know, earnings is a big deal, but we look at every type of—we build models for every company that we track—and try to figure out what they're going to earn, and figure out what the intrinsic value of the company is. 

So there is kind of a moving target, and in some markets you look at value as your main ingredient.  What's this company worth at the end of the day?  And then in other markets, you know, you are looking for companies that can grow the bottom line and grow the profits. 

So it's kind of—like I said—a moving target, but I've been doing it 25 years and my dad's been doing it 50 years, and so after a while you get a feel for what in the market makes it move and that sort of thing.

And do you concern yourself at all with diversity?  For instance, with the railroads, will you then go out and try to diversify that or hedge that with other things? Or is it strictly about the company, and if that means you're in just a couple of sectors that's ok?

Yeah, we will overweight some sectors when we realize they're extremely undervalued.  I wouldn't say that we asset allocate across all of the different areas where we are totally diversified.  We do like a pretty focused approach, and pick out—like for example, in our Hodges Small Cap Fund—we have 50 stocks, you know, 50-60 stocks. 

So most funds that would be pretty focused funds, but as big as our universe is, we feel like with that number of stocks we can really focus on the areas we need to be, and that's a pretty diverse holdings when you look at it from that standpoint.

Alright, and then finally, holding periods.  How long are you typically holding something? 

Typically, you know, we're not daytraders who are trying to find any kind of short-term catalyst, and get in and get out.  I know there are people that are successful at that.  We've never been successful at that, but we look at more of an eighteen-month time horizon—a year to eighteen months—and if we see some sort of an event in the next year to eighteen months to increase significant value in the price of the shares, then that's kind of what we're looking for.

Craig, thanks for your time.

Yeah, my pleasure.