Playing the Field:
How Buzz Heidtke Courts Winners

By Richard Hefter, Editor, Small Cap Manager

Buzz Heidtke views picking stocks a lot like choosing someone to date: He knows what he's looking for ahead of time and isn't afraid to go out with a number of them, to play a wide field. The result has been eight winning years out of nine for Heidtke's widely diversified MidSouth Investor Fund, an Atlanta-based hedge fund focusing on micro-cap value. The $26 million fund, which pays itself performance fees only after returns of +6%, is up 15.1% annualized since starting in 1993 (compared to 6% for the Russell 2000), with returns ranging from just -1.3% (last year, his only losing year) to +36%. "I work real hard on my standard deviation, on not losing money, and I'm also the largest investor in the fund," Heidtke says.
Buzz Heidtke
Buzz Heidtke


Tell us about your strategy.

My investment style is primarily based on probabilities, starting with the fact that small caps do better than large. The smaller they are the better they do. Micro caps, which for me are stocks with market caps of less than $200 million, do better than the large ones.

I'm in value -- you can go back historically and see that value stocks do better than growth stocks. Mine are kind of a hybrid, though. They're actually growth stocks because they have to have earnings up 20%, which could be for the last quarter, and revenues up 10%. But they have to have a value characteristic such as a low P/E (preferably under 10) and/or selling under 5x cash flow and/or less than 25 percent of sales per share. Or selling less than book value. Studies have shown that if you pick a stock with any of those characteristics it will outperform the general market. There also has to be some catalyst which causes it to go up.

How do you determine the catalyst?

I'm big into trend analysis. I read about 45 publications -- about 10 newspapers business sections every day -- to get my mind on what areas are hot and what are not. I can kind of instinctively know which areas are good. I look at a stock and rate it between 1 and 10. It's like a beauty contest. What do I think people are going to like in the future? Is this company in the right area to be in?

I look at about 8,000 companies a quarter. I don't spend much time on looking at them, on doing a lot of in-depth analysis. My approach is like you're 25 years old, you're single, you like a gal, she's attractive, you have similar things in common. You don't have to wait a month to decide whether she's the one. You go out with them. It doesn't take me five minutes to decide whether I want to buy a company I've never seen before. I make a quick decision because I know what a good one looks like and I can't wait two or three or four weeks to get information and do a lot of studies. I just buy them.

How can you make an investment decision in such a short amount of time?

I do speed-reading of financial statements. I look to see, for example, how much the earnings are up, what kind of industry they're in. I look at what the management's paying themselves. I have a formula, and if the top three guys are paying themselves too much, I feel like they're greedy and I need to watch out. If they have relatives that work for the company, it usually means they're going to be an under-performer. I look on message boards for any real negative comments about it. If it just really feels good after quickly doing that, I go ahead and buy it. Unlike other people I'm not afraid to be wrong because I put less than 1 percent into a company when I buy it. So if it goes to 0 it hardly affects my return at all.

How many issues do you own?

120.

Are there particularly industries and trends you like currently?

I like some of the Internet companies right now. Probably 95-98 percent of the ones that went public are out of business today. But there are a few that are still around and starting to do pretty well. When a company utilizes the Internet, you hardly have any margins at all in terms of expenses for excess business. These, I think, can be very big winners.

Another area I like is junk bonds. With some of these micro cap stocks, their junk bonds and preferreds are really overlooked. Some of them give you a returns of 15-30 percent. These are situations where I like the company anyway, but maybe I've elected to buy the bonds or preferreds in lieu of buying the stocks.

Isn't that risky, especially in a segment of the market - micro caps - already fraught with risk?

There's actually less risk investing in the junk bonds than investing in the common stock. There's a company called Spacehab (SPAB). They were involved with the Space Shuttle Columbia. The stock was around 80 cents. I was looking at buying it because they had a book value of $6 a share. I found they had some bonds that were yielding 30 percent and maturing in 4 1/2 years, and I saw they were going to get insurance of $17 million to cover them on the space capsule. They were also going to get some money back from NASA. So I bought the bonds, which I'm better off owning than the stock because I'd be happy with a 30 percent return.

What other areas do you like?

I like are companies that are getting royalties by branding their name. For a lot of companies it's cheaper to pay someone and use their name rather than go out and pay an ad agency to develop your own brand name. If you're doing that, a good bit of the incremental revenues goes right to the bottom line.

One I've done really well on, which I've had for about nearly three years, is Emerson Radio (MSN). I bought it at 75 cents a share. It's at $7 right now and about 11x earnings. They've said their revenues will probably be up 15% this year, which means their earnings could be up 25-30% for the year. They do a lot of business with Wal-Mart, which likes them because, for example, a Japanese TV manufacturer that's not known over here could put the Emerson name on it, which is very recognizable. Wal-Mart likes it because they have a brand name product. So everybody does very well.

You mentioned the Internet earlier. Is there a company you want to mention?

There is a company called E-Loan (EELN), which I'm in. This company was at $73 a share and is now around the $2 area. They're putting out some pretty big numbers right now. Their revenues were up about 50% last quarter, from $19 million to $33 million. There's a lot of people that don't know of lenders, and E-Loan deals with a lot of smaller people like that. They've reported some pretty good earnings. I think they earned 18 cents untaxed last year versus a loss of 73 cents. They're projecting earnings this year of 22 cents fully taxed, so it's selling at 10x estimated earnings, and that's assuming the mortgage industry business is down about 45% for 2003.

Another one I like, which isn't an Internet company, is Everlast Worldwide (EVST), a 100-year-old company in the boxing business. They're selling at less than 10x annualized earnings, and also have a big preferred stock out there. They're talking to the people that own the preferred about converting that over into a bond, and if they do that, the earnings would really go up.

There's also a little interesting company that I think is going to do pretty well called Varsity Brands (VBR), out of Memphis. It used to be called Varsity Spirit, and a few years ago Riddell Sports took them over. They make football helmets, which are used in the pros, and the Riddell part didn't do that well so they spun that off and named the company Varsity Brands. This company handles most of the cheerleading camps for high schools and colleges in the U.S. and also in Europe. They project they're going to earn 70 cents a share untaxed for 2002. The stock only sells for $4 a share. The company sold out at about $9 a share to Riddell a few years ago. What I like about this is if your daughter makes the cheerleading team and she wants to go to camp for a week but you don't have the money, I can assure you you'll find money to get her to the camp. You may do without something else, but your baby is going to go to camp. That's an area I think will be recession-proof. Here's a company nobody's even heard of because they've been around as that name for less than a year.

Is that what you mean by the catalyst?

That's right. The catalyst is it's not going to be affected by the economy and it's only selling at less than 6 times earnings. It's got a book value of 3.20 and it could easily be a $12 stock. When it was trading as Varsity Spirit, it always had a very high multiple to it. This is the kind of stock that could sell at 15-20 times earnings.

There certainly must be a lot of value stocks like these to choose from right now.

Yes, there are. But in addition to finding the right ones, another trick on these is to learn how to buy and sell them. A lot of people don't know understand that part of it. You don't just go out there and show what you've got. As Jesse Livermore used to say: You throw a line out. You put a little bit in there and see what happens. It sometimes takes me five to six months to get in a stock and five to six months to get out of one. Right now I've got orders in to buy about 25 companies below the market, and with all this uncertainty I'm picking up some of these at very good prices. Picking them up at the right price is half the battle.

What's your exit strategy?

Usually, if it sells at 30x earnings I'll get out of it. And I automatically make myself sell if anything gets over 10 percent of my portfolio. Emerson Radio, for example, which we started buying at 75 cents and is now at $7, is close to being 10 percent of my portfolio. I work very hard on my standard deviation. The best I've ever been up is 36% in a year and the worst is down 1%. There are not many funds that have had that kind of range.

© 2003 Small Cap Manager, a publication of AdviceTrade, Inc., and sponsored by JM Dutton & Associates (www.jmdutton.com).
9 Micro-Caps Worth Watching

A Message From Our Sponsor:
By John Dutton, President, JM Dutton & Associates, LLC

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 quality 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.

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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:

Teton Raised To Strong Speculative Buy Rating In Update
February 18, 2003. Teton Petroleum (TTPT) is one of the more unique and exciting small cap companies. Based on greater production volumes, newly found enthusiasm for Russian oil investment by major oil companies, and higher world oil prices ($36.39 per barrel), we believe our 12-month price target of $0.74-0.80 per share for Teton shares is realistic if not conservative. We anticipate that our appraised value per share of Teton's reserves will be significantly higher than the current $0.55 per barrel once engineering reports for 12-31-02 are available. Teton is the only publicly traded U.S. Company with all of its oil production coming from Russia, producing and exporting oil from Russia since 1997. If Russian oil were valued at Colombian or Venezuelan levels, our appraised value of Teton's reserves would likely be in the $126 million range or $2.15 per share. There is expectation of an AMEX listing.

GREKA Energy Speculative Buy Rating In Update Report
February 14, 2003. GREKA has a unique and attractive business model. Our investment case is that GREKA shares are significantly underpriced relative to the Company's potential "intrinsic" value. There was a lot to like in GREKA's Q3 results: better than anticipated earnings, significantly lower operating costs and the first signs of the potential from expanding gross margins were some of the highlights. To us the most important element in Q3's results was that average throughput at GREKA's refinery increased 44% to 3,417 bpd from 2,369 at September 30, 2001. The asphalt business in California tends to be supply constrained versus demand driven, but in view of massive state budget deficits this year and next, we believe the West Coast (California in particular) is susceptible to Draconian measures to balance the state budget. Due mostly to uncertainties surrounding state spending in an unparalleled fiscal crisis, we are lowering our rating to Speculative Buy.

Isolagen Initial Report Lays Out Impressive Potential For Facial Rejuvenation and Dental Markets
February 10, 2003. Isolagen (ILE), an emerging biotechnology company, was founded to develop and commercialize a patented autologous cellular therapy, initially for cosmetic purposes to treat the chronic effects of aging. Isolagen uses a few of the patient's own (autologous) skin cells extracted from behind the patient's ear, and after being sent to Isolagen where millions of new autologous fibroblast living cells are propagated, the larger quantity is returned to the physician, who injects them back into the patient in order to stimulate the natural production of collagen and accomplish facial rejuvenation. Late in 2002, the Company began selling product in the United Kingdom with sales to the Australian and Korean markets anticipated by August. US sales are being deferred by FDA required clinical studies. This technique is expected to have major application in the dental market related to gum and bone regeneration. The potential for Isolagen is impressive--our current forecast is for 2003 revenues of $7.2 million rising to $37.8 million in 2004, with no US revenue assumed until 2005. We will update our forecasts based on the Company's execution of its business plan. We rate the stock a Speculative Buy.

Riviera Tool Speculative Buy Rating In Update Report
February 10, 2003. This leading tooling company for the automotive industry recently secured replacement long-term bank financing from Comerica bank, thereby removing the basis for their auditor's "going concern" qualification of their financial statements. The industry is emerging from a very difficult unique period, and is consolidating. Near term profitability is improving and appears very likely to continue to improve although the level of future profitability is difficult to predict. Company's most recent results exceeded our estimates. Earnings clearly appear to be on a rebounding upward trend. We are raising our EPS estimates to $0.22 for fiscal 2003 and $0.62 for fiscal 2004. We are raising our 12-month price target to $3.20 per share, after recently lowering it.

K2 and Rawlings Move Towards The Merger In The Early Spring
February 23, 2003. K2 Inc. (KTO) and Rawlings (RAWL) have announced the scheduling of shareholder meetings for March 26th. With its price off, K2 is obligated to increase the designated number of shares so as to maintain the $9.00 level. While a K2 "walk-away" provision introduces some element of risk and while arbitrage activity may create some pressure on KTO shares, to our knowledge there are no negative developments at either company to suggest sustained weakness in KTO shares. We believe KTO's long-term industry roll-up strategy could make this an attractive investment over time.

First Cash Financial Guidance For Q1 Results And FY 2003 Confirms Our Projections
February 20, 2003. First Cash (FCFS) provided guidance for Q1 of 2003 of diluted EPS of $0.34 to $0.35 and confirmed its previous guidance for fully diluted EPS, of $1.28 to $1.31 for F2003. Management also addressed the current risks associated with short-term loans, or "payday advances," and the current regulatory activity. First Cash's common stock has been relatively firm since the first of the year 2003, and we discuss the associated effects of the possible regulatory changes. We reiterate our rating of STRONG BUY of First Cash common stock

Comments On Structure Of Vita's Acquisition of Halifax; Reiterate Strong Buy Rating
February 18, 2003. A review of the Company's 8Ka filing regarding the November 1, 2002 acquisition of The Halifax Group revealed that a number of steps were taken prior to the merger that protected Vita from any future write-downs or negative surprises. We review these steps in our Research Note. We are in the process of developing our 2003 earnings estimates by quarter. In general, there are a number of positive factors that could in the aggregate result in a strong operating performance for 2003. We continue to rate the common stock of Vita Food Products as a Strong Buy.

Warrantech Q3 And Nine Months Net Income Up 108% And 124%
February 14, 2003. The results of the third quarter and nine month period continued the strong growth, but the results were slightly below our estimates. The biggest change in the reported results and our estimates is the revenues. Our FY 2003 (March) estimate is basic and diluted EPS for Q4 at $0.08 with basic and diluted EPS for full year at $0.26. Estimates for the 3/04 year remain the same. Given the cautious state of the general stock market, on a relative and absolute basis Warrantech continues to afford investors excellent opportunity for long term capital growth and we retain our Strong Buy rating.

Trinity Biotech Strong Buy Rating Issued
Trinity (TRIB) develops, acquires, manufactures, and markets diagnostic products for the point-of-care (POC) and clinical laboratory segments of the diagnostic market. Its test kits are mostly used to detect infectious diseases, sexually transmitted diseases, blood coagulation disorders, and autoimmune diseases. Trinity itself accounts for a very small share of the $20 billion worldwide market for diagnostic reagents, consumables and instrumentation. Their small market share represents less of a vulnerability than an opportunity to grow rapidly from a small base. Trinity's earnings are likely to rise sharply in 2003 because of the five factors noted in the report. Assuming a favorable overall market environment, we believe that the stock has the potential to nearly double over the coming year, to $2.50 per share, and, it would appear, still be undervalued. Revenues and EPS in 2003 are estimated at $69 million and $.175, rising to $75 million and $.22 respectively, in 2004.


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