Q: What is your investment philosophy for running the fund?
A: We share the same philosophy and process in mid-cap sector as with the other Bjurman Barry Growth Funds. The Fund seeks to identify undervalued companies with superior growth characteristics. We identify companies with conservative earnings per share estimates that experience accelerated growth.
The selection process typically screens a universe of 1,300 mid-cap companies, with market capitalizations generally between $1 and $10 billion. The screens include metrics on both growth and value. We screen for earnings surprise, earnings strength, and earnings growth, as well as price/earnings to growth and cash flow to price.
Q: How does that philosophy translate into an investment strategy and process?
A: After we identify the highest ranked companies through those five models, our next step is a top-down economic analysis designed to identify the most promising industries over the next 12 to 18 months. We identify approximately 130 stocks that have the best growth prospects and are selling at attractive prices. The highest-ranking stocks in that group are then subjected to additional fundamental and technical research to ensure that we have a well-diversified portfolio.
Q: Would you explain the five elements of your selection in more detail?
A: The model was developed by Tom Barry. Through research and back testing he discovered that those five attributes were excellent for identifying undervalued growth stocks.
The price/earnings to growth metric represents a Growth At Reasonable Price approach but we don’t set specific limits. Often some of the best growth stocks have high multiples so we wouldn’t necessarily avoid a stock just because it had a high P/E multiple. For example, Hologic Inc. is one such name that we really like and we hold.
The earnings surprise screen attempts to identify stocks that have a high probability of beating the Street estimates. The model doesn’t necessarily look at the company’s guidance as a benchmark, it focuses more on consensus estimates. However, if the company is guiding lower, then the stock should be on our watch list as a prospective sale. On the other hand, if the management is raising guidance above consensus, it means that consensus estimates are too conservative and will be going higher.
The EPS strength metric identifies companies with consistently strong earnings and lower volatility because lower volatility means fewer surprises. Cash flow to price just ranks the companies according to the cash flow.
Q: Do you pay more attention to historic growth or to expected growth?
A: It is definitely a forward-looking model. We try to identify undervalued companies that display the growth characteristics necessary for successful stock selection. Obviously, the historic view helps to identify companies that have consistently delivered earnings in the past but it is the forwardlooking view that drives stocks higher.
Q: Can you give us some examples of stocks that you have been able to identify and capitalize on?
A: The energy sector started hitting our screens in early 2004 and that’s when we began to build positions in those names. We were overweight in energy up until this summer but now the rankings are slipping so we’ve been selling those names. We went from an overweight to being slightly underweight against our benchmark - at the peak we were as high as 15% and now we’re down closer to 5.7%.
The overweight position was because the model was identifying the stocks in that sector as having attractive growth characteristics. The trend continued for about two and half years and then those rankings started to fall. Some of the better examples in the energy sector would be Weatherford and Nobel Drilling.
Right now technology stocks are highly ranked. It seems that after the tech sector has been out of favor for so long, we’re seeing a rotation out of energy, industrials, and basic materials into technology.
Q: How did you reduce your energy exposure? Overall, what is your sell discipline?
A: We have a weekly watch list, which shows us the stocks with the lowest rankings and the ones that are 15% off the most recent high, and/or the stocks that are 15% off of our cost. These stocks are monitored and evaluated both technically and fundamentally for any changes in the earnings and revenue expectations. If a company is lowering its guidance, then it will show up on our watch list as a sell. We thoroughly review the list for sale candidates. Weaker names are sold to make room for higher-ranked stocks with better prospects going forward. If we have a high-ranking stock that looks really attractive, we would replace the stock with falling rankings.
Q: How do you select the sectors that you invest in?
A: The model does not rank industries or sectors but we do look for the industries with the highest number of highly ranked stocks based on the criteria that we talked about. We then group the highest- ranked stocks within each industry and the industries that have the greatest number of highly ranked stocks will be on our Hot Industry Report.
Q: What would you do if the bestranking stocks in your system do not meet your criteria on the fundamental level?
A: We try not to invest in companies that have too much debt burden. An example would be airline stocks. A lot of airline stocks have been ranked well lately. The majority of them have high fixed costs; high debt levels and high energy prices definitely weigh on them. In addition, the threat of terrorist acts could really cripple the airline industry. With the high levels of consumer debt and a slowing economy, people will be traveling less. There are just too many economic variables that can devastate that industry, so I avoid it regardless of the rankings.
Q: Do you look for certain levels of debt to equity?
A: Yes, we try to avoid excessive debt but some debt is fine. Presently, our long-term debt to equity ratio is 51% and that’s right about the top of the range that we like.
Q: Would you explain your portfolio construction principles?