Fund manager sees growth in small-cap stocks

Investment strategists have been touting blue chips as a bargain for the last several months because of their dividends and value. But there’s still room for growth in small-company stocks, said Craig Hodges, co-manager of the Hodges Small Cap Fund since its inception in 2007.

The Dallas-based fund outperformed 95% of its peers in 2011 and gained 15% in the first quarter of 2012, beating the Russell 2000 small-cap index, the Dow Jones industrial average and the Standard & Poor’s 500 index. Hodges said it’s easier to find bargains in small caps than blue chips because many small companies are not tracked by Wall Street analysts.

Hodges also said he believes that stocks remain good investments despite two consecutive quarters of explosive growth because many private investors have stayed on the sidelines, still shellshocked from the market’s 2008 meltdown.

The Hodges Small Cap Fund has $145 million in assets and is one of five funds handled by the boutique money manager. The company was founded by Hodges and his father in 1989, and employs six researchers and four managers.

Question: Your fund has been one of the best-performing small-cap funds for more than one year. To what do you attribute the success?

Answer: We look for ideas everywhere and anywhere. We come across companies all the time that may have two, or even zero, analysts covering them. We try to get as much information as we possibly can about a company. You have to talk to their competitors, talk to people shorting their stock. The key for our analysts is objectivity; you want to know the good and the bad. You don’t want an analyst to be a cheerleader for a stock.

Question: Small-cap stocks have been beating the broad market for the last decade, but many on Wall Street are advocating blue-chip, dividend-paying stocks. Do you think small caps can retain their edge?

Answer: I do believe the large caps are undervalued from a historical basis. But I believe there are always opportunities for small caps, just because they’re so entrepreneurial and there’s always something going on that people have come across. With blue chips, there’s a limited number [of companies] and there’s not a lot of new things. There’s also opportunities because the blue chips are going to be acquiring small companies for additional revenues.

Question: Wall Street is worried about a slowdown in earnings growth for S&P 500 companies. Do you see this as a problem for small caps too?

Answer: I don’t. It’s so much easier for a company doing $100 million [in sales] to take that to a 20% growth rate and add $20 million than it is for a company doing $200 billion to take that up a similar percentage. It’s just easier for small companies to grow than it is for large companies. There are always opportunities in the small caps. And a lot of them aren’t hostage to what’s going on in the economy or in the world. A lot of them aren’t hostage to what’s going on in Europe. There are a lot less things that could go wrong.

Question: The last two quarters have seen explosive growth for stocks. Can we expect a correction in the near future?

Answer: I do know a correction will happen, 5% on the small side, 10% on the large. But I do not look for it to be drastic. You had four years of people selling stocks after what happened in ’08. People have been buying money markets, bond funds, shedding stocks. At some point greed will return and people will not be satisfied making 2% in a bond fund.

You’re going to see big pools of money coming back into the stock market in the next three, four years. A lot of people have missed the latest run. People are underestimating the large pools of money that have to be invested. As soon as money starts coming back from the public, you’re going to see the pendulum swing the other way. We will see a correction, some setbacks, but stocks are so under-owned right now.

Question: You have a large stake in consumer-cyclical stocks, which suggests optimism about continuing economic growth. What’s the appeal of the sector and what are some of your major holdings?

Answer: As bad as the economy has been, there are a few pockets that have not shown any weakness. The shoe business is one of them, particularly women’s shoes. They’ll hold off buying blouses and dresses, but they’ll spend money on denim and they’ll spend money on shoes. In the shoe business, we like Steve Madden, and the old favorite, Crocs, has had a real resurgence. They’ve right-sized that company and have taken a lot of their sales overseas.

There are some real niche companies that are doing extremely well. Cinemark, the movie theater company, has been a poor performer but just recently it’s started to show some results. This company is growing in Latin America. That’s an area that looks pretty good to us.

Question: Is your fund focused more toward growth or value?

Answer: We’re actually categorized as a core [fund], meaning we can do value and growth. That’s one of the flexibilities we have. Right now we’re more slanted toward growth just because we see more opportunity in that area. There are a lot of smaller companies that do have some pretty good growth characteristics.

Question: You seem to be underweight on technology. Why is that?

Answer: We have a real concerted effort right now to at least get market weight, if not overweight. There are a lot of opportunities with the smaller companies. Smartphones, between now and 2015, there’s going to be half a billion sold. One company we like is Omnivision, which makes optical sensors for smartphone cameras. There are so many different applications with smartphones. We’ve identified a lot of companies that aren’t really making money now but have extreme promise.

stuart.pfeifer@latimes.com