Five Small-Caps The Pros Own

By James Brumley | October 11, 2009 AAA

A new leading group has emerged, a group I liked in theory a few weeks back, but am starting to actionably love now. The group is small-cap value stocks. According to Morningstar, the mutual funds that specialize in this category are the top performers out of all style/cap groups over the last three months as well as the last 30 days - which is much better than the group's mediocre results in longer-term timeframes.

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While many folks would just tap into the emerging strength with the iShares S&p Small Cap Value ETF (NYSE:IJS) - which isn't entirely bad idea - I think there's a much bigger opportunity here with individual stocks. I've named five of the pro's favorite small caps below.

Method to the Madness
Just as I selected five of the top mid-cap value opportunities in mid-September, I'll be exploring the top-performing small-cap value funds today, and poaching the picks of the litter. The theory is that if leading fund managers like - or at least liked these stocks at one point recently - then there must be something to them.

I'm not necessarily looking for the most widely held small-cap value stocks among all fund managers of that ilk, since most small-cap value fund managers have actually underperformed the group. I'm just trying to latch onto the coat-tails of the leading fund managers by stepping into their quality holdings.

Here are the best of the best. (Read about the success of those who helped individual investors achieve high returns, check out Top Five All-Time Mutual Fund Managers.)

Schneider
Though the Schneider Small Cap Value (SCMVX) top-ten holdings list isn't exactly for the faint of heart, the fund has indeed led rather than lagged in most timeframes. Of its top holdings, I found two to be rather interesting: Massey Energy Co. (NYSE:MEE) and AAR Corp. (NYSE:AIR).

Massey Energy is one of the coal plays I discussed earlier this week in a bigger-picture bullish call on coal, so I'll just refer you here for more on Massey: Can Coal Stocks Continue To Rally?

As for aerospace/defense contractor AAR Corp., I didn't specifically mention it when I pinpointed some defense-oriented value ideas a couple of weeks ago, but I certainly could have put it in with that group.

Artisan
The Artisan Small Cap Value (ARTVX) fund has consistently outperformed its peers, and if it was possible, I would say it deserves better than the four-star rating that Morningstar gives it.

ARTVX's most promising hold is Acuity Brands Inc. (NYSE:AYI), which was the only name that stuck out as a value stock that still has actual value left to tap.

Shares of the light fixture maker went deep in the red two weeks ago in front of news of a 31% dip in quarterly earnings. However, with a trailing P/E of 17 and a plausible forward-looking P/E of 14, the worst may have been priced into the stock already. In fact, the stock rebounded after that bad news was made official. (If these numbers have you in the dark, these easy calculations should help light the way How To Find P/E And PEG Ratios.)

Adirondack
And finally, while the Adirondack Small Cap Fund (ADKSX) has decent long-term performance numbers, the fund's picks have been firing on all cylinders this year and are definitely worth a closer look. I found two gems in here as well: Fresh Del Monte Produce Inc. (NYSE:FDP) and Knight Capital Group Inc. (Nasdaq:NITE).

I know, Del Monte is a boring fruit company, and I'll be the first to acknowledge that even this fruit company saw earnings take a hit when things got ugly last year. However, profits were up in the last reported quarter ended June 26, 2009, and well above expectations. I have to wonder if the market built an overly-pessimistic outlook into FDP's price. The forward-looking P/E is attractive 9. Earnings are set to come out October 27, after market close.

As for Knight Capital Group, despite the 68% runup from early Aprils low, the past and forward-looking price/earnings ratios are both under 13, while net margins have been running around 13.3%. Knight staved off any quarterly losses last year as well, which is more than most of its peers can say.

Not Perfect, But Pretty Darn Good
The same caveats that applied in September apply now; these funds might now own these stocks any longer, or these funds may sell these stocks at any point in time and you won't know about it until the next quarterly update. Still, it's easier to use someone else's proven research rather than try and do the digging on your own.

As well, sometimes it's easier just to buy the fund if you're not interested in dealing with a handful of off-the-radar stocks. In any case, there should be at least a couple of attractive ideas in the bunch now that small-cap value is heating up again.

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