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Louis, can you describe your stock picking
process for us?
One of the easiest ways to see what we do is to get on our online database,
PortfolioGrader.com, and see how the stocks rank. We have an A-B-C-D-F
scoring system. We have our quantitative criteria, which is reward-risk
criteria, and then we our multiple fundamental criteria like return on
equity, sales, profit-margin expansion, earnings quality, momentum, analyst
upgrades and earnings surprises.
What are the most important of these criteria?
One is profit-margin expansion. We are absolutely utterly obsessed with
profit-margin expansion. Let's say a company's operating margins
peaked at 8%, and next quarter they're going to be 7.9%. I don't
want to own them, because a lot of my earnings growth comes from profit-margin
expansion. When the margins are expanding, earnings always grow faster
than sales. You'll find our average stock only has about 12% revenue
growth but earnings are a little more 30% because operating margins are
expanding.
So you score these companies on each of these
criteria?
Yes. It's just like scoring an athlete. If I was looking at a basketball
player, I'd score them on their assists, rebounds, block shots, free
throw percentage, field goal percentage, three-point percentage. If I
had a salary cap, I'd figure out the bang for the buck. I'd
do a drug test on them. That's all we're doing. We're ranking
stocks like you rank an athlete or a kid at school.
The main difference is the rules sometimes change. Some years like '91,
'95, '99, will be an earnings momentum type market, other years
we're going to be in a much more selective market environment.
Even though you're a growth fund, you're
not looking at earnings momentum?
Earnings momentum is one of the factors, but earnings stability is more
important today than earnings momentum. Wall Street is obsessed with companies
that have had good earnings in the past and going forward. That's
the environment we're in. At times you're in what we call an
"earnings at any price market" like in '99. Then it flames
out as momentum doesn't work any more, and usually the market goes
into what we call a GART mode: paving growth at a reasonable price. Today,
a company that has real steady earnings growth is much more important
than one that has explosive growth one quarter and no growth the next.
Any examples of steady growers?
In the large-cap arena, a growth company with very good earnings stability
would be a Wal-Mart (WMT) or a Lowes (LOW). In the small- and micro-cap
area, it would be someone like Chattem, Inc. (CHTT), a pharmaceutical
company that makes Selsun Blue Shampoo. Wall Street is eager for simple
stories, very successful companies that have grown from within, and very
smooth steady growth.
In the small-cap arena, growth hasn't
been as much in favor as value in recent years. Is that changing?
I expect it will. Value does well when interest rates are falling. I'm
an ex-banking analyst. Banks tend to borrow short and lend long, and as
that yield curve flattens there goes their profits. So you're seeing
some instability in value [as we saw] last quarter. Growth beat value
last quarter and will continue to do so as that yield curve tightens.
I'm not saying you shouldn't have value. We do value, too. All
I'm saying is you're going to know who the good value managers
are pretty quick. There are some problems with real estate investment
trusts --some are ok, some aren't--and the financials too are going
to require much more selectivity. There was a time a year ago where everybody
was making money. That's no longer the case.
(Interview continued below.)
Louis Navellier's "Portfolio Grader":
Proprietary Quantitative Grade: Louis Navellier invented this quantitative
measurement. It measures how strong a stock has been performing relative
to its adjusted risk.
Sales Growth Grade: Measures the difference in a company's revenues
versus the same quarter one year ago.
Operating Margin Growth Grade: Measures whether a company is able
to expand its operating profit margin (how much the company profits from
each dollar in sales).
Earnings Growth Grade: How rapidly a company has grown its profits
from the same quarter one year ago.
Earnings Revision Grade: Over the past month, have Wall Street
analysts been raising or lowering their earnings forecasts for the company?
Earnings Surprise Grade: Has the company been able to 'beat' Wall
Street analysts' earnings forecasts?
Earnings Momentum Grade: Not only are the company's earnings growing,
but is the rate of growth, growing?
Return on Equity Grade: Measures how much profit a company is generating
compared to the total value of the company. A good measure of how efficient
the company is.
Cash Flow Grade: Measures how much cash a company is generating
from its business. This can often be more accurate than earning when analyzing
a company's financial health.
The final grade is based on two parts: the Navellier Proprietary Quantitative
Grade and the Overall Fundamental Grade.
Any other stocks you'd
like to mention?
In addition to Chattem, I like Hanger Orthopedic Group (HGR), which is
in the healthcare industry. They're both super high in both our reward-risk
and fundamentals. A small home builder called Hovnanian Enterprises (HOV)
is another. I've got a lot of home builders. There's also a
leasing company called New Century Financial (NCEN). I've got CACI
International (CAI), which does a lot of defense/government programming.
I've got FTI Consulting (FCN), which does a lot of pre-paid legal
work. They've had record profits. One of the fun ones would be PF
Chang's (PFCB), which is the Chinese restaurant chain. Believe it
or not, in some areas, like the South, there's a shortage of Chinese
restaurants. They're springing up all over the place.
How many positions do you own?
We've been pretty concentrated, but are over 30 right now, which
is pretty diversified for us.
What's your typical hold time?
In micro the turnover's not too bad. We hold positions for several
months, but we can push up to 200% a year turnover. We update our online
database weekly. So, for example, if a stock falls from a B to a C, we
sell it. I own all the A's and also a lot of B's, as I have
a hard time finding A's in this narrow market.
What are your thoughts about micro/small caps
vis-à-vis the general market?
Micro and small caps did exceptionally well early in the year because
the asset class was an oasis. When the liquidity of the market broke down,
a number of small-cap stocks got hit, whether they were growth or value.
The nice thing about both the small- and micro-cap growth arena now is
the P/Es are at extremely low levels. We have a lot of stocks trading
at 12-13 times this year's estimated earnings, yet they have more
than 30% growth. I'll never see these growth-to-P/E ratios again
in my life. Most of that growth is coming from profit-margin expansion.
So we're very comfortable right now with the small-cap arena.
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New & Updated Research Micro Caps Worth Watching
By
John Dutton, Director of Research, JM Dutton & Associates, LLC
www.jmdutton.com
As one of the largest independent equity research firms in the U.S., Dutton
& Associates is helping investors gain high-quality fundamental research
on good companies. Many of these companies had little or no research coverage
prior to us, and as a result have been under Wall Street's proverbial
"radar screen" and trading at prices well below intrinsic value.
Our program of independent research minus any investment banking or brokerage
constraints involves a full year of coverage, with an initial report,
three quarterly reports, and research notes in between the quarters.
The following are companies we've reported on within the last several
weeks, whose reports on our site at www.jmdutton.com may be of interest
to you:
HPSC Inc. (HDR) Announces Completion Of $85 Million In New Financing
October 22, 2002. HPSC announced the completion of its Receivables Interest
Purchase Agreement with ING Capital up to a maximum amount of $20 million
and by $65 million with MBIA under its HPSC Bravo Funding LLC loan. We
estimate Q3 fully diluted EPS of $.24 and $.98 for the 12/31 year. We
maintain our strong buy rating with a 12 month $15 price target.
Friedman's (FRDM) Buy Rating Issued In Initial Report
October 15, 2002. Friedman's is the third largest retailer of fine jewelry
in the United States, operating 650 stores in 20 states in the Southeast.
We believe favorable demographic trends argue for a continuation of superior
relative performance for the jewelry industry through the remainder of
the decade. Friedman's has shifted its focus from rapid store expansion
to the improvement of profitability. Friedman's target market of 18- to
45-year-old low-to-middle income consumers is a large and growing underserved
market. Friedman's shares currently trade at only 4.6x our fiscal 2003
earnings projection of $1.45 on estimated revenues of $462 million, versus
P/Es of 9.5x and 11.8x for the two larger specialty jewelry retailers.
CytoGenix (CYGX) Speculative Buy Rating Reiterated In Update Report
October 14, 2002. CytoGenix has patented core technology exploiting the
manipulation of RNA to produce gene-based therapeutics based on gene silencing
(blocking), RNA (ribonucleic acid) interference, and other gene modification
applications. Recently, CytoGenix has begun preclinical toxicology and
efficacy studies for the first of its DNA enzymatic therapeutic products.
CytoGenix has launched target validation services using its proprietary
technology to down-regulate a client's gene of interest. CytoGenix's novel
single-stranded DNA expression vector system is beginning to garner increased
visibility in the academic research community, with two articles describing
the system in the publication process. Twelve-month $1 price target reiterated.
Medix (MXR) Annual Meeting: WellPoint Health Networks Converts Note
& Update Business Plan Detailed
October 11, 2002. WellPoint Health Networks' $1 million promissory note's
principal and accrued interest had been converted into MXR common shares.
Darryl Cohen, new President and CEO,described the Company's initial business
plan as being outdated, and described a new multiple market national approach
that would utilize outsourcing strategies and multiple distribution channels.
He provided an outline of his expectations for the Company over the next
2-3 years. We believe the new management alignment of Darryl Cohen as
CEO and Patrick Jeffries as Chairman is a positive development for MXR
and that the outline of the new business plan suggests continued substantial
potential for the Company. Pending a clearer picture of the new business
plan, tangible progress in fund-raising, and input as to the details of
the Georgia operation's early results, we will continue our Neutral rating
on the stock.
The Leather Factory (TLF): Craft Industry Sales Remain Bright Spot
of Retailing
October 11, 2002. Although the overall retail sales picture appears to
remain downbeat, Crafts Retailers continue to report solid sales increases.
The strength of this segment clearly supports our positive view of The
Leather Factory. Michaels Stores, Inc. (NYSE:MIK) reported that same-store
sales for the month of September increased 10%, while A.C. Moore Arts
& Crafts, Inc. (Nasdaq:ACMR) reported an 18% increase in sales for
the third quarter. Jo-Ann Stores (NYSE:JAS.A) reported that September
same-store sales increased 5.0%, versus a 4.0% same-store sales increase
last year.
TASA Division Signs $2 Million Contract with State of Michigan
October 11, 2002. Touchstone Applied Science Associates, Inc. (TASA) announced
that its BETA division has been awarded a $2 million contract to develop
custom language arts and math assessment tests for the state of Michigan
during fiscal 2003-2004. This new contract is the result of the federal
"No Child Left Behind Act." This contract will begin generating
additional revenues for the Company during the 2003 and 2004 calendar
years. We maintain our Buy rating.
Advant-e (AVEE) Upgraded To Strong Speculative Buy
October 10, 2002. The Company announced it processed $1.5 billion of orders
through its GroceryEC.com during the first 9 months of 2002, representing
a 100% increase over its entire 2001 volume. It noted that the number
of supplier subscribers increased 29% to 2,295, and the number of trading
relationships increased 61% to 5,615. Its EnterpriseEC became operational
during this past quarter. There is not significant liquidity, however,
with its $5 million market cap.
Warrantech (WTEC) Annual Meeting Upbeat On Continued Increasing Revenues
And Earnings
October 09, 2002. Warrantech's results in the past year and last quarter
have continued the profitable trend that began nine quarters ago and continued
in the first quarter of FY3/03. Earnings increased 441% over the prior
year's first quarter. A key to growth is client (retailer) education because
of the importance of their service contracts and extended warranty programs,
which in most cases are the single largest profit center with the highest
margins for many retailers. In these uncertain times, consumers seem to
be turning to the certainty of Warrantech's contracts and warranty programs.
Evidence of this trend is the strong growth in the automotive income from
operations before taxes that increased 45% in FY3/31/03 and 48% in the
first quarter of 3/31/03.
HTTP Rating Upgraded To Buy
October 09, 2002. HTTP Technology (HTTP) has announced a name change and
a definitive Medicsight "Launch" date. These events prompt our
rating upgrade to Buy from Neutral. Its Board approved changing the name
to Medicsight, Inc., effective October 28, 2002. Medicsight will focus
entirely on the healthcare sector, with the first center to be opened
at the end of October within the highly respected Hammersmith Hospitals
NHS Trust in West London. Two other centers are expected to be opened
in Central London during the first quarter of 2003. Medicsight will be
officially launched at the prestigious Radiological Society of North America
annual meeting in Chicago in December 2002, which attracts over 35,000
radiologists from around the world. The Medicsight system is aimed at
interpreting data in high-risk individuals which may indicate very early
stage disease, thus enabling early intervention. The name change will
coincide with a symbol change.
Buy Rating Issued For Integrated Asphalt Producer
October 07, 2002. GREKA Energy (NasdaqNM: GRKA $5.04) has ownership of
1,100 oil wells and an asphalt plant in the Santa Maria area of CA. It
is the operator of the only fully integrated independent asphalt plant
in the State. GREKA's oil fields produce Santa Maria heavy crude that
is ideally suited to the production of asphalt. GREKA's refinery currently
operates at only 34% of its 10,000 bbl1/day rated capacity. With restructuring
now behind, Q3 should see major improvements in operating performance.
Asphalt products are sold at historically stable open market prices. GREKA
is invulnerable to commodity oil price swings and can sustain a relatively
secure and high profit margin. FY2002 revenues are forecast $31.3 million,
rising to $50.1 million for 2004. EPS in 2002 is forecast at a loss of
$(.45) rising to $2.47 in 2004. Our investment case is that GREKA shares
are significantly underpriced, and this is supported by a low single-digit
P/E ratio, its current book value of $7.22 per share, an SEC value of
$12.06 and our estimated appraised value of the Company's assets of $25.38
per share. Our 12 month price target is $10.50.
Neurobiological Technologies (NTII) Rating of Strong Buy Maintained
In Quarterly Update
October 02, 2002. This week's decline in Neurobiological stock, on the
news that U.S. commercialization partner Forest Laboratories is voluntarily
withdrawing the NDA filed on July 31, provides an excellent buying opportunity.
Forest's rationale is sound and investors failed to grasp the strategic
move on Forest's part. By updating the filing with the inclusion of the
donepezil combination pivotal study data, Forest improves the likelihood
of a favorable FDA ruling, and with the combination data conveying strong
results, Memantine potentially could be approved for more than the single
indication of the intitial filing. This would expand the market, and perhaps
set the stage for follow-on approval in mild-to-moderate Alzheimer's disease.
The FDA has granted NTI Orphan Drug Status for Xerecept for peritumoral
brain swelling. We are now initiating a preliminary estimate for FY2004
of $5.8 milliom revenue and EPS of $0.09 versus revenue of $3.4 million
and EPS of $(.03) forecast for FY 6/03.
We invite you to read all of our reports at www.jmdutton.com
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