Hot On The Case

For Ariel's McKissack, value stocks are still to be found -- with a little extra effort

If there’s anything remotely close to a thankless investing job in a year when the market has rocketed into orbit, it’d be that of a value portfolio manager. Imagine having to look for undervalued stocks late this summer, when the S&P 500 ballooned to historic highs.

It’s a year when the pickings have slimmed, says Eric McKissack, portfolio manager of the Ariel Growth fund. “It’s not easy right now,” McKissack says, “and to be truthful, we’ve got to be that much more diligent when examining new ideas because often enough you’ll find that the rally has bypassed either really bad companies or ones that have worn out investors’ patience.”

As a value manager, McKissack is among the sleuths on the lookout for cheap stocks with a twist that most everyone has overlooked — provided they have all the makings of a good three- to five-year holding. Add another wrinkle to his strategy: McKissack focuses on mid- cap stocks, concentrating most of his hunting on companies with a capitalization of $200 million to $5 billion. Studies by experts at Prudential Securities, among others, have shown that mid-cap stocks as a group seem to combine the steady, low volatility price movement of the market’s better-known large-cap or blue-chip corporations with the price gains of peppy small company stocks.

So far, those studies have, by and large, held up. While the S&P 500 had soared 25% by early August, McKissack’s fund was up 18% — a full two percentage points above the S&P midcap 40O, which managers who share the same investment style reference as a benchmark. The credo at Ariel has been to keep expenses low — Ariel Growth for instance has a 1.3% expense ratio, a tally of the percentage of overall assets eaten up by the costs of doing business. That’s compared with around 1.5% for the average fund. One way to cap costs, McKissack says, is to keep turnover (or selling one company and buying another) down to a minimum. Ariel Growth switches out of 20%-30% of its portfolio annually, compared with 60% for the average- small- or mid-cap fund.

Whether or not the market is overvalued, McKissack has stuck to basic criteria when looking for stocks. First, he’s keen that his investments sell at a discount to the overall stock market P/E ratio. Another way he gets an edge on the competition is to look for shares that aren’t widely followed by the big Wall Street brokerages. Equity analysts are gossips; once one finds out something juicy about a company, the news is soon all over the stock market.

McKissack is careful in choosing new investments now because of what he sees ahead for the market. “We’d have to say we’re cautious in the current environment,” he says. “I think we’re in for a slowdown in earnings growth, and we could see a correction.” There are mitigating factors, however. McKissack says baby boomer retirement funds and money that foreign investors are channeling into the stock market could well keep any downturn brief.

That said, McKissack feels

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