Value Investing: Two Sectors You Must Know
And where those two sectors intersect are the best values of all.
Brian Frank: Correct. The fund started in 2004, and for the first six years or so we were about 60% to 70% small- and mid cap 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 mega caps. 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 (NYSE:PFE), Berkshire Hathaway (NYSE: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 (NASDAQ: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.
When you install a software system, you have to pay maintenance fees on it, so it is very hard to switch once you have a large electronic health-records system in your hospital. The maintenance fees go on, almost forever. That is the great consistent cash flow from this company. And like I said, the valuation makes a lot of sense at this price.
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