Mining the Upper Midwest:
Perkins Discovery Fund's Dan Perkins

By Richard Hefter, Editor, Small Cap Manager

In the Land of a Thousand Lakes where Dan Perkins resides, there is an abundance of more than water. Perkins, who co-manages the Wayzata, MN-based Perkins Discovery Fund, says there's a bounty of good, small companies up his way. About half of the holdings in his $3.5 million micro-cap fund are, in fact, Upper Midwest regional firms. With the fund returning +11% so far in 2003, they've been good discoveries, indeed.


How do you account for the outperformance of the Discovery Fund this year?

Small-cap stocks have been doing well, which is really what we expected. That's typical coming out of recessions. We use a study prepared by Steve Leuthold, a market historian, that graphs the relative strength between small caps and large using the S&P 500 and Russell 2000. From 1994 to 2000, the line was trending down, indicating large caps were doing best. That changed in 2000 when the small caps started to outperform. That cycle typically lasts 7-10 years. On his graph he also puts shaded areas indicating recessions. It's typical that small caps do better coming out of recessions.

What area of the small caps are you in?

We don't necessarily fit into a distinction like growth or value. We're bottom-up stock pickers. We look for ideas one by one. We don't focus on industries necessarily. We combine fundamentals and technical analysis, fundamentally looking for stocks where we see some changes taking place that have potential to be big winners. Technically, we use chart patterns recognition, looking for bases and head-and-shoulders bottoms -- Edwards & Magee-type analysis. We can find ideas from either approach.

We also work with a lot of brokers that bring ideas to us. We follow most companies here in the upper Midwest, keep charts on them and follow them fundamentally. We may be looking through our charts and see where a company has traded in a price range for an extended period of time and is breaking out to the upside, and we say, "Well, something's going on there and let's go and find out what it is." We may become aware of a company fundamentally and look at its chart to indicate buy zones.

What's your background?

Perkins Capital Management is a family business. My father, brother and me. We opened in 1985. My dad [Richard Perkins] was an institutional broker at Piper Jaffrey. He started their institutional research department many years ago. Piper was a regional boutique at that time. They followed mainly upper Midwest companies and sold their investment ideas to institutions around the country and overseas. So his focus for years has been upper Midwest companies, and that's been a focus for us in our managed accounts and our funds. Probably somewhere around half of the companies in the fund are located in the upper Midwest. We don't have as strong a focus as we did some years ago, but it's still there.

The Discovery Fund, which focuses primarily on companies with market caps of less than $100 million, was started in April '98 and it's still very small. It has around $3.5 million in it. The Opportunity Fund started in 1993. Originally, the Opportunity Fund bought all sizes of stocks. It got larger back in the 1995-96 timeframe, and we just felt we needed a smaller fund. So we decided to open the Discovery Fund and cap it at $50 million, focusing on these really small stocks that you can't really effectively own in a bigger fund.

What's the benefit of sticking to this region?

For one thing it's easy to visit the companies and follow them through time. You're more aware of what's going on. It's easier to focus on companies in your area. That's really the primary benefit.

What's the benefit of combining technical and fundamental analysis?

I guess, two disciplines are better than one. Of course you need fundamentals. But just looking at a company fundamentally has the potential for being way early. A lot of times, the charts can help in picking buy and sell points. They're kind of a confirmation of what other investors see is going on in a company.

Which companies do you like?

One is Staar Surgical (STAA). They're a manufacturer of products for ophthalmologists and other eye care professionals. They have various products of intraoculary lenses and medical devices used in connection with cataract surgery. One of their products in clinicals is an implantable contact lens. There was a study published in the May issue of the Journal of Cornea and External diseases that showed patients with lens implants had better results than those that used Lasik surgery. These lenses are selling overseas now, but they're still in clinicals in the U.S. Approval in the US is expected as early as next year. That's a really big market, especially for people who have a strong correction that Lasik can't treat. These lenses could be a real breakthrough. The stock's been up very strongly recently.

Another holding that's doing well is First Cash Financial Services (FCFS). They operate pawnshops, more than a hundred of them, mostly throughout the South. This is more of a value stock. It's trading at 10x trailing earnings and is growing nicely. It has a big head-and-shoulder bottom on the charts, and is a company we feel could do as well in recessionary times as in good economic times.

Another company that's been dong well in the fund is a food processing company, Stake Technology (STKL). They're the largest processor of soy concentrate in the country. It has been growing well, and has been acquiring and consolidating businesses in their area. We like it a lot.

Do you think the market will cooperate?

Yes. Market-wise, we think October could well have been the bottom. There's another study we follow that shows the lapsed time for various so-called busted bubble tops. When you look at the time elapsed from the top of 2000, and compare that to similar periods from other busted bubbles, including Japan, and gold from the 1980s, and several others they compare it to, we think the market decline since 2000 could be over.
6 Micro-Caps Worth Watching

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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.

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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:

Initiating Coverage of K2, Inc.
May 19, 2003. K2 (KTO) is a branded consumer products company with a primary focus on sporting goods and other recreational products. It is executing a promising if yet untested long-term strategy for spearheading industry consolidation. K2 holds leading market share positions in fishing, baseball equipment, personal water sports and safety products, snowboards, alpine skis, and inline skates. Q1 revenues (excluding Rawlings Sporting Goods) increased 6.5% to $157.1 million from $147.5 million, with particular strength being exhibited by Stearns' water safety and recreational products and a recovering in-line skates business. Q1 EPS, before debt extinguishment costs of $0.24 per share, rose to $0.25 from $0.21 in prior year's Q1. We estimate FY 2003 EPS at $0.53 (including the $0.24 charge for the extinguishment of debt in Q1) and $0.93 for FY 2004. We are initially assigning a $13.95 price target, 40% above the current level, based on a 15x P/E on our 2004 estimate.

Alaris Medical Rating Maintained At Strong Buy In Update Report; Raise Estimates and Price Target
May 21, 2003. Alaris (AMI) reported an outstanding 2003 Q1, with sales up 16% and EPS at $0.04, ahead of guidance and the Street. The strong Q1 follows year-end 2002 results where Alaris achieved its first year of profitability since the 1996 merger. We have fine-tuned our EPS estimates upward for 2003 and 2004 to $0.24 and $0.40, respectively. We are raising our 12-month target price to $12 from $11. Alaris filed a mixed shelf registration statement covering the periodic sale of up to $550 million in debt and equity securities. We believe de-leveraging the Company will be one of the factors that will drive market valuation during the upcoming year. Alaris continues its aggressive rollout of medication safety compliant modules for its MEDLEY(TM) Medication Safety System. Alaris reported medication safety data, collected from a special study that included seven hospitals that use its point of-care MEDLEY Medication Safety System.

Vita Foods Strong Buy Rating Maintained In Update Report
May 20, 2003. The strategy of Vita Food's (VSF) management is to leverage the well-established Vita brand name and the Company's extensive distribution network by acquiring compatible products that can be introduced into national markets. The strategy was implemented with the acquisitions of Virginia Honey in July 2001 and The Halifax Group in November 2002. In the second half of 2003, Vita's sales and earnings performance should be exceptional. Net sales of salmon and salad dressing are growing at double-digit rates with favorable margins. Honey is in a recovery phase. By midyear, the entire Halifax product lines will be integrated into the Virginia Honey operation. We are estimating that earnings per share in the second half will be 40% above the comparable 2002 period. The market has not yet recognized that Vita has completed the transition from a turnaround situation to a growth company.

LESCO Speculative Buy Rating Maintained
May 13, 2003. LESCO (LSCO) is the largest supplier to the highly fragmented U.S. professional lawn care and golf course market, and is the industry's largest vertically integrated supplier. LSCO recently announced 2003 Q1 results, reflecting the disruptive element to the quarter of poor weather in its Northeast market. This significantly reduced sales growth to $94.5 million, a 1% gain over 2002 Q1. With the Northeast now in spring, Q2 sales and EPS should match or exceed our expectations of $180 million and $1.20 per share. Despite the weather-impacted Q1, LESCO can still reach our full year EPS projection of $0.72. We believe that the shares do not reflect the potential growth from current initiatives. We expect LESCO to achieve a 2004 gain of 43% in EPS and 20% EPS growth in the 2004-2008 period. Based on our unchanged projected 2004 EPS of $1.03 and our assumption of a 15 price/earnings multiple, we derive a one-year price target of $15.45, more than 40% above the current level.

SCB Computer Strong Speculative Buy Rating
May 09, 2003. After restructuring and acquisitions, we believe SCB is poised to grow significantly over the next several years. SCB Computer is in three sectors within the $102 billion IT industry: Professional staffing (51%), Consulting (15%), and (3) Outsourcing (34%). Its primary customers have been state and local governments. Its recent acquisition of Remtech Services added over $30 million of sales, primarily to the Federal government. SCB has completed its restructuring program by eliminating unprofitable businesses, reducing debt and SG&A expenses, and making strategic acquisitions. SCB intends to focus its competencies on becoming a pure play solutions company. SCB forecasts revenues, if a second acquisition is completed, to be approximately $115 million and $135 million in fiscal 2004 and fiscal 2005. We believe fiscal 2004 and 2005 EPS could reach $0.15 and $0.21, implying an unusually low multiple of 6.3x and 4.5x earnings. The shares represent an excellent value for speculative investors seeking above-average appreciation potential relative to its peers.

AXESSTEL - Fast Growing Wireless Supplier Rated Speculative Buy In Initial Report
May 07, 2003. Axesstel produces subscriber terminals for wireless local loop (WLL) networks utilizing CDMA technology. WLL, because of its fast deployment and capital efficiency, is a leading technology being utilized in many developing countries where the availability of telecommunications services is limited. The Company enjoys a low risk operating strategy. Axesstel capitalizes on its expertise in CDMA engineering to deliver leading-edge hybrid products, which meld non-compatible wireless technologies. Axesstel won an engineering contract from Verizon Avenue, which we believe gives management a lot of credibility. Despite its short operating history, Axesstel recently reported impressive sales and earnings for 2002. More importantly, management believes it may see sales triple to $24.5 million in 2003, and we expect 2004 sales of $48.9 million. We believe the Company has the ability to ramp sales and earnings steeply off a small base. The stock could trade over $4.49 per share by mid 2004 by applying a market multiple of 17 times our 2004 EPS estimate of $0.26.

We invite you to view our full coverage list and read our reports at www.jmdutton.com