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John Osterweis Finds Value Stocks With Growth

By    |   Tuesday, 17 February 2009 12:19 PM

John Osterweis manages an eponymous mutual fund, The Osterweis Fund, which has delivered enviable returns to small investors. Over the 10-year period ending in December 2008, this fund provided an average gain of 7.27 percent. Over that same timeframe, the S&P 500 showed an average loss of 1.38 percent a year.

In a bear market, the best thing investors can do is follow Warren Buffett's top two investment rules as closely as possible: "Rule No.1 is never lose money. Rule No.2 is never forget Rule No. 1." Sometimes losses are inevitable and limiting losses becomes a sign of success. Although Osterweis lost money in the bear market of 2008, he managed to lose less than the market.

His fund lost only 29 percent in the long bear market that marked last year. This made The Osterweis Fund the seventh best performing out of 508 mid-cap equity funds, according to Morningstar.

In a recent interview with Steve Forbes, Osterweis provided some insights into how he manages more than $3 billion through his firm. He looks at any type of stock, telling Forbes, "We try not to be constrained by either size of company or the traditional value-versus-growth paradigm."

Instead, he tries to find stocks trading as beaten-down value stocks that are at an inflection point and about to begin trading as growth stocks. In his own words, "And so, we were buying value cheap. And then, hopefully, the company turns the corner, turns back into a growth stock, and then the value goes up as well."

This idea makes a lot of sense and is the basis of this week's screen:

  • Osterweis uses free cash flow as his most important valuation metric. This is because cash is real and not numbers that are "rather elastic and negotiable" as earnings can be. The screen starts by identifying stocks with positive free cash flow that have a price-to-free-cash-flow ratio below the level they had last year and below their industry average.

  • To avoid highly leveraged companies that use all of their available cash to pay interest on their debt, we restricted the search to only companies that are in the top 10 percent of the market with respect to the ratio of earnings to interest paid, meaning they pay a small percentage of their cash towards interest.

  • To find the inflection point Osterweis is looking for, we want to find stocks that have had positive earnings estimates revisions over the past three months and are followed by at least two analysts.

    The list contains eight stocks:

    AFLAC (AFL) has fallen nearly 50 percent since the start of 2009, giving it a dividend yield of 5.5 percent at the recent price of 20.51. The market is concerned about the insurer's exposure to European banks. The company says it is adequately diversified and these securities don't represent a problem. In today's market, many investors are selling first and asking questions later, creating potential gains for AFL if management is correct about the balance sheet.

    Amerisafe (AMSF) provides worker's compensation and general liability insurance for logging contractors in the southeastern United States. The stock has actually shown a gain of almost 20 percent over the past year, much better than the market or most other insurers. The company has grown earnings by an average of more than 30 percent a year for the past five years and trades at a P/E ratio of only 7 at the recent price of 17.43.

    Biogen Idec (BIIB) is a drug company with more than $4 billion in annual sales. Pharmaceticul giant Sanofi-Aventis is rumored to be interested in buying BIIB. Carl Icahn, who has made billions in takeovers, owns nearly 5 percent of BIIB. Recently trading at 52.42.

    EMCOR Group (EME is a construction contractor that handles installation and maintenance of several building systems, including electrical, HVAC, plumbing, and communications for major construction projects. EME is poised to profit from the economic stimulus bill since shovel-ready projects will often require the company's services. At the recent price of 21.02, EME trades at eight times earnings.

    Orbital Sciences (ORB) develops and manufactures small rockets and space systems for commercial, military, and civil government customers, including the U.S. Department of Defense and NASA. Sales at the billion-dollar company grew by 35 percent last year and earnings per share increased by 60 percent. ORB reports that is has orders totaling more than $4 billion, with over $2 billion in orders scheduled for delivery in the next three years. Recent price: 16.93.

    Steiner Leisure (STNR) provides spa services on 131 cruise ships, at 50 resort spas, and in two luxury day spas. Customers include Carnival Cruise Lines, Hilton Hotels, Planet Hollywood, and Royal Caribbean Cruises. Despite a tough economic environment, the company has grown sales and managed to maintain a steady level of income. At a recent price of 27.44, STNR has a return on equity of 25 percent, a level Buffett considers to be indicative of good management.

    Sterlite Industries India (SLT) is the leading copper mining company in that nation. The government expects economic growth of 7 to 7.5 percent in 2009, and recently passed a small stimulus package. SLT is trading near 5.50, about 75 percent below its high and at four times earnings. If the economy eventually recovers, SLT should recover along with it.

    Synaptics (SYNA), a maker of touch-screen technology, produces a $15 screen overlay device that RIM needs to make the BlackBerry Storm's screen function. With a proven product line, SYNA is ready to profit from touch screens becoming more popular on phones and laptop computers. Earnings grew by 35 percent in the most recent quarter and should increase by more than 50 percent this year. At a recent price of 26.01, this growth stock trades at 14 times next year's estimated earnings.

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    John Osterweis manages an eponymous mutual fund, The Osterweis Fund, which has delivered enviable returns to small investors. Over the 10-year period ending in December 2008, this fund provided an average gain of 7.27 percent. Over that same timeframe, the S&P 500 showed an...
    Tuesday, 17 February 2009 12:19 PM
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