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Tickers in this Article: ALG, BRS, CNK, HDPSX, HIBB, KOG
The overall picture for the small-cap universe, growth and value alike, suggests there’s room to run, says fund manager Eric Marshall. Today, he discusses five of his top picks, and tells MoneyShow.com why it’s a great time for retail investors to get back into the market.

Kate Stalter: Today’s guest on the Daily Guru is Eric Marshall. He’s the director of research for the Hodges Fund.

Eric, you also co-manage the Hodges Small Cap Fund (HDPSX) in particular. Given your vantage point of looking at the overall market, let’s just start with your take on what individual investors should be watching for at this time.

Eric Marshall: Well, I think right now there’s been a lot of concern and fear over the debt situation here in this country, as well as the problems over in Europe.

But underlying that, if you step back and really focus on what’s going on with the individual companies and focus on earnings, which we believe is the most important determinant of what future stock prices are going to do, there’s some attractive opportunities out there.

Valuations for the S&P 500 right now are about 12 times forward earnings. If you take the inverse of that 12 times earnings, that’s like an 8% earnings yield on stocks, and you compare that to a 2% ten-year Treasury, that premium between equities and the risk-free rate is really the widest that it’s been in some time. We think that’s going to create a very attractive risk/reward for investors to own stocks going into 2012.

Kate Stalter: That’s good to know. Let’s drill down a little bit and talk specifically about the small-cap fund. Do you have more of a growth or a value orientation in that fund, Eric?

Eric Marshall: Well, right now we probably have a little bit of gravitation towards growth, but we can go wherever we see the best relative valuations in the market.

Right now we see the rewards for owning growth as very attractive. For the type of slow-growth economy that we’re probably going to be facing here for the next year or so, the small caps offer a space where you can find pockets of opportunity, where you can find companies that are doing well, that are growing their business, and that are accelerating earnings despite what’s going on with Spanish bond yields.

Kate Stalter: Let’s talk then a little about some of the particular holdings within the fund at this time.

Eric Marshall: Sure. We have a pretty eclectic representation in the fund right now. We have several, kind of niche consumer discretionary names.

For instance, we own Cinemark Holdings (CNK), a movie theater company that pays a nice dividend yield.

We own Hibbett Sporting Goods (HIBB), which is an operator of sporting-goods stores in small markets where they don’t have a lot of competition. The company has been doing very well, putting up nice same-store sales on top of very difficult comparisons a year ago. It’s one that’s relatively unique.

We also own some companies like Alamo Group (ALG), which is a manufacturer of agriculture implements, as well as maintenance-related industrial equipment that’s used for things like street sweepers, snow removal, large mowing equipment for airports and county right-of-ways, and stuff like that. That company surprisingly is doing very well.

There’s a perception out that county and city governments aren’t spending money on that type of thing; however, because there’s been so much of a deferral of that type of spending over the last three years, and there is so much of a maintenance component to it, that there is some pent-up spending right now in those areas, as well as a benefit from the bonus depreciation for a lot of people within the ag community as well as contractors to go out and buy equipment between now and the end of the year.

That’s a stock that, like I said, they grew 15% last year, and it’s trading at less than ten times earnings.

Kate Stalter: You mentioned quite a few different sectors in the stocks you just named there. Any particular areas, looking ahead, that you believe are showing extraordinary strength or the potential, at least, that investors should do some research into?

Eric Marshall: Well, we like the energy space. We think that that is an area that’s really being underappreciated by investors, and we own companies like Kodiak Oil & Gas (KOG), which is a play on some of the shale formations, as well as some service companies like Bristow Group (BRS), where they provide helicopter services to offshore oil rigs. That’s an area.

Within the consumer discretionary, I think you have to really go in and look at the individual business and see what’s going on in the underlying businesses, because in this environment you’re going to see some companies do very well. And some of those companies will be doing very well at the expense of others that are not doing so well.

Kate Stalter: Are there any areas where perhaps the fund has pared some of its holdings lately? Areas where you deemed that it was appropriate to begin selling?

Eric Marshall: You know, there have been some cases where valuations just probably got way ahead of themselves, and we’ve taken a little bit off the table, but by and large we haven’t made any real dramatic changes to the portfolio in the last six months.

Kate Stalter: Eric, just to kind of wrap up today: What do you believe would be the best course of action for individual investors who are managing their own portfolios at this time?

Eric Marshall: Well, you know, I think they should realize that with the long-term threat of inflation on the horizon, that stocks preserve purchasing power better than bonds and cash.

By and large, individual investors have somewhat abandoned equities. We’ve had three years in a row where individual investors have left equity mutual funds, and stocks are really underowned right now because of that.

I think looking out, going forward, long-only equities could become the new alternative investment for a lot of investors out there that have just kind of given up on stocks.

I would just point out that owning equities, owning companies that are able to generate earnings and increase those earnings and increase their dividends and buy back stock, and reinvest in their business every year, that there’s a compounding effect to that, and you’re going to grow your capital much faster, and you’re going to preserve your purchasing power much better than owning bonds or cash, especially in this low-interest-rate environment.

Kate Stalter: So, would it be correct to gather from what you just said then, even though people are maybe frightened and frustrated in these volatile market conditions, now might be a good time to start making some investments in the right equities?

Eric Marshall: Absolutely. I think one of the keys, though, is to look at your time horizon, and if you truly do have a three- or a five-year, or a ten-year time horizon in your investment approach, then you shouldn’t be too worried about what the market does over any 30- or 60-day period.

Or just kind of read through some of the volatility out there in the market, which I think is just a lot of noise. If you focus on what’s going on with the underlying earnings of companies and focus on valuations, a lot of that volatility that we’re seeing in the market is just simply noise.

As you look out over a multiyear period, you’ll forget about that volatility and the compounding of earnings and fundamentals will prevail.

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