A Small Ambition

L.A. Times Archives

March 4, 1997 12 AM PT

Mary Lisanti hasn’t been at the Strong Funds long enough to show her Midas touch for picking small stocks, but she certainly has had one.

Before joining Strong in October 1996, she guided Bankers Trust Small Cap Fund to returns of 19.3% in 1994, 58.6% in 1995 and 18.2% through September 1996.

By the time she left for Milwaukee-based Strong to manage its Small Cap Fund, she led an investment team that managed $2 billion for Bankers Trust. She has since reassembled that team at Strong. In January, Lisanti took over stewardship of the Strong Mid Cap Stock Fund as well.

Lisanti invests in small and medium-sized companies whose sales and earnings growth rates exceed their stock price-to-earnings multiples. She combines scrutiny of individual companies with a belief that broad societal and economic trends will provide a tail wind for certain industries.

Lisanti, 40, got her first taste of the stock market growing up in New York, where as a preteen she earned pocket money typing up her father’s personal investment holdings on index cards. Her serious education began at E.F. Hutton, then continued at the Evergreen Funds and at Bankers Trust.

Lisanti was interviewed by Russ Wiles, a mutual funds columnist for The Times.

Times: You have been on the job at Strong for only a few months, yet your performance over this short span seems to be suffering. What’s happening?

Lisanti: Basically, it’s just a style thing. If you compare us to other [small-stock] growth funds, we don’t look that bad. The underperformance came mostly from our technology holdings, many of which fell late last year over general uncertainty about the economic climate. Our style has been a bit out of favor because we own the higher-growth stocks. But we haven’t changed our strategy.

Times: Your approach mixes top-down with bottom-up investing--that is, you look at broad investment themes and combine that with careful analysis of individual companies. Can you elaborate?

Lisanti: From a bottom-up point of view, we screen companies to catch stocks that are inefficiently priced. We try to identify two types of firms: The first are good companies growing at least 15% a year in terms of profits and revenue, yet selling at a discount to their growth rate. By this I mean situations where the price-earnings ratio of the stock is below the company’s projected growth rate over the next 12 months.

The second situation involves great companies that for some reason are not great stocks. When a company has a good track record yet there’s a disconnect, usually it’s because investors are worried that the firm’s future won’t be as good as the past. Sometimes those fears are justified. Sometimes they’re not.

Times: Can you give an example of the latter type of company [in which the fears aren’t justified] that you own in the fund?

Lisanti: Certain companies that provide information systems have reported disappointing earnings, which has prompted investors to sell. An example is HCIA, which has been growing around 35% a year. It trades at a P/E of 33 based on [estimated] 1997 earnings of around $1.30 a share, and 24 based on next year’s projected earnings of $1.70 a share. So you get a little discount on its 1997 growth rate and a huge discount on its projected 1998 earnings.

HCIA provides integrated clinical and financial information systems for the health-care industry. By combining clinical and financial, medical providers can examine both the quality of care and its cost. Automation in the medical area will continue, because all parties want more value for their dollar. You need better information systems to deliver it.

Times: Are all of your favorite holdings in the tech area?

Lisanti: No. Another company, Blyth Industries, is the dominant maker of candles. This company has grown by better than 50% annually over the past five years. There are big short-sale positions [bets that the price will decline] in the stock. Investors are worried about new competitors entering the business.

But the candle business is huge. Even if you get a little more competition, it won’t bother Blyth. For the fiscal year that just ended in January, I estimate the company earned about $1.25 a share. The stock trades at 27 times earnings. For the current year, estimates suggest the company will make $1.60 a share. Blyth is managed by an exceptionally strong group of people. The guy who heads the firm was a venture capitalist who helped to finance the company, then joined it.

Investors now are paying about 20 times next year’s earnings for a company that probably can continue to grow 30% or more for many years. The candle industry is not expanding much, but the market is vast and Blyth is winning market share. The short sellers are betting that the company won’t meet its profit targets and that competition will intensify. But the stock, which traded at $46 in December, now sells at $32. So you’ve had a huge price decline that I think was unwarranted.

Times: Any other examples of good companies growing at 15% or more a year that trade at lower P/E multiples?

Lisanti: Most of what we own fits that description. One example is Sitel, a telephone-outsourcing company [for the credit card and insurance industries]. It handles customer service programs, takes orders and more. The stock sells at about 23 times earnings, yet the company is growing better than 40% a year.

Then there’s Pharmaceutical Product Development, a clinical research firm. Drug companies and biotech companies rely heavily on outsourcing as they desperately try to get their products to market. You have to go through many clinical trials for the Food and Drug Administration. The biotech companies don’t always have the resources to do it, and the drug companies don’t necessarily want to take on more full-time employees. So firms like PPD can help.

Investors became nervous about the company after it made an acquisition last year, as the acquired firm operates an environmental consulting business that hasn’t been doing well. But I think most of the environmental [firm’s] problems can be fixed. At any rate, PPD has been increasing earnings at better than 40% a year, yet the stock trades at 30 times earnings. It conducts some of the research that companies must do for FDA approval, including the clinical trials. There’s no question but that this is a growing business.

Times: So you screen stocks for profit growth, P/E ratios and the like--is that it?

Lisanti: No. We also spend a lot of time meeting with the management of every company we own. This is critical. Good management can take a bad company and make it brilliant, while bad management can take a great company and run it into the ground.

National Data is an example of a company where the guy who runs it came in and fixed what was essentially a broken firm. Management got rid of an unrelated struggling business so that National Data could focus on its main area, the processing of medical transactions. When patients go to the doctor’s office and pay for [the visit] with either a credit card or insurance card, National Data earns income on each transaction. It’s a software-intensive and highly profitable business.

Times: How about some of the broader themes that you follow?

Lisanti: One is managing the Information Age. Society has a huge investment in information technology. The key is maximizing what you can get out of it, because it’s such a huge expense. Companies that help others manage their information systems will continue to do well. Some of the companies I have mentioned would fit this.

Another area I like is biotechnology. It’s finally at the point where myth and reality are coming together. For years, we’ve had this promise of biotechnology, but investors have had to wait to see if the products will be profitable, because it takes 10 to 12 years to bring a drug to market in this country by the time you go through the FDA trials. We’re finally at the point where a number of biotech companies are 12 years old and their drugs are coming to market. They have real products and profitability.

The Holy Grail of biotechnology is that these products don’t just stop the progress of a disease but try to reverse it. If you can reverse it, you can save patients and the medical system a lot of money because you won’t have to spend a fortune on custodial care. That increases what you can charge for such a product.

One of my favorites is Biochem Pharma, which has a strong product pipeline, including a treatment for AIDS . . . it appears to be effective. The company also has a hepatitis drug that’s nearing final FDA approval or rejection. There are a lot of companies like Biochem. It’s just further along than most.

Times: How about your Strong Mid Cap Fund? What’s the slant there?

Lisanti: We define small stocks as having less than $1 billion in market capitalization [stock price times shares outstanding]. Mid-caps range up to about $5 billion. Mid-cap companies are more stable than small companies because they’re bigger, yet they still feature faster earnings growth compared to the large S&P; 500 firms. So you get more stability and good profit growth, but with less risk.

Times: What are some examples of mid-cap companies that you like?

Lisanti: Biochem Pharma is [one]. Another example is Medic Computer Systems. It also is an information provider for the health-care industry that has gained market share as it has gotten bigger. The company focuses on physician practice-management systems that schedule billings, process claims and so on. Many mid-cap stocks throw off a fair amount of cash that can be reinvested back in the business, accelerating growth. And that’s what’s happening with Medic.

Times: Do you buy initial public offerings?

Lisanti: It depends on whether we think the values of IPOs are good compared with companies that already are public. That’s not the case currently. A lot of these companies are coming out at very high [P/E] multiples. But some of our holdings were IPOs, including Steiner Leisure, Splash Technology and Mazel Stores.

Times: But in general, are you finding enough small companies that are attractively priced today?

Lisanti: More so than in a long time. Investor nervousness has pushed people away from small stocks. And the recent changes in Nasdaq [trading] regulations have resulted in some short-term dislocations. Because of these factors, small stocks are out of favor. But if you look at their earnings growth, you can find good values. When you compare it all with what the S&P; 500 has done and the growth prospects for companies in the index, there’s no question that small stocks are undervalued on a relative basis. This does not mean they will move higher right away. But as people become more confident again that we’re not facing either an inflation or recession problem, they might migrate back to smaller companies.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Strong Small Cap Fund

Strategy: Invests in fast-growing domestic small companies selling at reasonable valuations.

VITAL STATISTICS

Lisanti’s record at BT Investment Small Cap

Jan. 1, 1994, to Sept. 30, 1996: +124%

Avg. small-company fund: +53

Lisanti’s first months at Strong Small Cap

Oct. 1, 1996, to Jan. 31, 1997: +2%

Avg. small-company fund: +5

Strong Small Cap Fund’s five biggest holdings

as of Dec. 31: