Issue #8, May 2002

Less is More: How Bjurman, Barry MicroCap Fund Became the #2-Performing Fund in Last 5 Years (+351%)

By Richard Hefter, Editor, Small Cap Manager

In March of 2000, with 70% of his fund in technology, Tom Barrys screens said to shift quick and fast out of the hyperventilating sector. As the bubble burst, his Bjurman, Barry Micro-Cap Growth Fund finished the year up 46%. This helped the Los Angeles-based fund, now with $310 million in assets under management, to a recent ranking by USA Today as the #2 performing fund among all domestic mutual funds over the last five years, up 351% annualized as compared to 26% for the Russell 2000 Growth Index. But Barrys back again in tech, as he discusses along with his winning strategy and the benefits of going micro.

What distinguishes your strategy?

One thing thats important is that our sell discipline is just as significant a factor in our returns as the purchase discipline. Generally well sell stocks when they reach $1.7 billion in market cap, no matter how good they are. We will sell stocks that begin to report worse than expected earnings. Well sell stocks that on a relative price strength basis start to deteriorate to the market. And well sell stocks that get overvalued, where the P/E ratio gets astronomical relative to the future growth of the company. Thats one of the main reasons in March of 200 we went from a 70% tech position down to 40% and ended up with 20% by year-end.

Youre primarily a growth fund?

Yes. Id say its a 90% growth portfolio. The selection process screens about 1900 companies that have market capitalization between $30 and $300 million, looking for growth with some value.

What screens do you use?

Earnings growth over the last 12 months. Next 12 months expected earnings growth.

Time-weighted rate of change in the analyst earnings expectations where I can determine the momentum of growth. And two value models: the price-earnings ratio relative to growth (the PEG ratio) and a cash-flow to price model.

We screen these 1900 companies and identify the top 10% based on growth characteristics and valuation characteristics. At that point we look at the relative strength of the price of a stock, analyze the companies, what they do, how consistent the earnings growth has been. If, in fact, the numbers that have been plugged into the computer look realistic and accurate, we then pick approximately 130 names that have the best of all the above characteristics.

Thats fairly diversified.

You need to be diversified when youre in the micro-cap sector because individually they can be fairly volatile, although collectively they tend to be less volatile than larger-cap stocks, which is contrary to conventional wisdom. There arent that many institutions in these micro-cap stocks. Institutions tend to move in and out very rapidly in stocks and if these micro-cap stocks are not in their portfolio they dont have quite as major an impact.

What are the other advantages, if any, to being in micro caps?

One of the most important factors in the micro-cap sector is that its probably the least efficient sector of the market because theres very few analysts following the stocks. The growth rates are up much higher than the large-cap stocks or even small- and mid-cap stocks. For instance, for our past year the median growth rate for the stocks held in our portfolio is 43.7%. Thats compared to a minus 3% for the Russell 2000 Growth Index. And yet its selling at 19 times earnings versus 22 for the Russell 2000 Growth.

Arthur LEVitt ENdoRSES OUR INDEPENDENT RESEARCH MODEL: A Message from Our Sponsor

By John Dutton, Director of Research, JM Dutton & Associates, LLC www.jmdutton.com

In an interview with Bloomberg on May 8, former SEC Chairman Arthur Levitt said that an alternative to the inherent conflicts of interest in Wall Street research (and its ties to investment banking) would be a model like ours.

Asked if firms will simply have to stop doing research altogether due to the economics of bias-free research, Levitt replied, "I think that's part of the risk. And part of the answer to that could be the development of independent research boutiques that sell their research to the very firms that they're researching in the same way that the rating agencies, such as Standard & Poor's, sell their ratings. That's a possible development."

What Levitt is suggesting is exactly what we do at JM Dutton & Associates. Our compensation is modeled after the S&P's credit rating program -- we're prepaid in cash for our year-long program of coverage, do not accept or trade shares in the companies we cover, and do no investment banking or brokerage that can create conflicts of interest. At a time when small-cap coverage is shrinking, our model is expanding in terms of companies under coverage (by 5-7 companies per month), distribution network, and credibility and real interest within the investment community.

Dutton & Associates recently released initial reports on three smaller-sized growth companies.

They include Neurobiological Technologies (Nasdaq NMS: NTII), covered by the head of our healthcare group, Sherry Grisewood, CFA. The 19- page report is must reading for many of us for its information on and discussion of the status of treatment for Alzheimers disease and other dementia. NTII is expected to be the first company to introduce the next generation of product for the treatment of moderate to severe Alzheimers disease. NTII is run by former Syntex CEO Paul Freiman, who sold Syntex to Roche Holdings for $5.3 billion, and accomplished other well known development and marketing milestones.

Sherry also recently added a research note to her April 17 initial report on Questcor Pharmaceuticals (AMEX: QSC). Questcor reported outstanding first quarter 2002 results, with Q1 revenue of $3.85 million and a reduced loss per share to $(.01). 2001 Q1 revenues were $1.02 million with a net loss of $(0.07) per share, she noted. [It] was the 5th consecutive quarter of increasing revenue for Questcor. VSL#3 will be officially launched this month, and a very strong launch together with continued growth in core products will prompt us to raise our estimates. Our current Buy recommendation is under review for an upgrade.

Outside of biotech, Jerry LaKarnafeaux, CFA, released his initial report on Vita Food Products (AMEX: VSF), a specialty food company. Since release on May 7 at $4.41, the report has received strong interest, with the stock rising 20% on high volume. With $42 million of revenues and EPS of $.51 forecast for this year, VSF is the classic story of a company overlooked by these markets. It has completed the transition from a turn-around situation to a growth company, and a comparison of its stock price ratios to its industry indicates that Vita is undervalued.

We encourage you to read these and other of our reports on our Web site at www.jmdutton.com and learn why Dutton & Associates, as Arthur Levitts endorsement suggests, is increasing commanding the readership and respect of Wall Street.

Please read disclaimers at www.jmdutton.com.

So all of the growth factors and valuation characteristics are in these micro-cap stocks, but theyre really not followed by Main Street because theyre too small for Main Street to buy them in large amounts. So theres tremendous value in this sector of the market, and despite the last 2 ½ years of market declines, we were actually up 19 ½ % last year and 46% the year before that when most everybody else was down.

Doesnt the outperformance of smaller companies in recent years suggest people are buying them?

Yes, but the biggest buyers of these micro-cap stocks are the owners and company management and the local citizens of the cities and towns the company is in because they know the company generally, and then the few micro-cap funds that are out there. These are the ones buying them.

The key issue in buying micro-cap stocks is to get them before everybody else does. If you can get them in the $30-$300 million market-cap range before they get up to a billion, which is where most everybody starts buying, thats where you get your biggest return.

What about liquidity concerns?

Theres always liquidity concerns. We buy a little bit at a time. We dont have any more than 2% in any one issue. Generally we start out with a half percent to a percent in each issue, and we take a few days or weeks to buy these stocks. They are thinly traded.

The liquidity issues is precisely the reason why were going to close the fund at $400 million, because we dont want it to get so big that we cant really move in and out of these stocks.

What stocks do you like currently?

Im going to focus on the tech issues right now because techs been beaten down so badly in the last three years. We have found several of the small tech stocks that look very attractive based not only on the factor that theyre low in price but theyre also starting to show significant relative strength. Applied Materials just reported better-than-expected earnings revenue growth, and Texas Instruments did the same thing, and the Street appears to start to recognize at this point that the tech stocks are likely to come back and they have for the past few days and they come back real strong when they do.

Any in particular?

Cray (CRAY) is one I like. They market high performance general purpose computer systems for all kinds of science and engineering and commercial applications. Revenues rose 13% last year and they seem to be one of these out of many tech stocks that should do fairly well.

Nam Tai (NTAI) is one of my favorites. They design for original equipment manufacturers consumer products, telecom products, palm-sized PCs and personal digital assistants. Thats another one thats doing very well and likely to continue to do well in the future.

I also like Merix (MERX). They make printed circuit boards for use in sophisticated electronic products. The stock was one of those $65 stocks that fell to about $10 a share and now is selling at 1$7, starting to show some relative strength.

Standard Micro (SMSC) is another one, a worldwide supplier of circuits for personal computers. I think that the chip sector is going to be doing very well coming out of this economic slump weve been in. That stock has been as high as $30 a share and its gone down to less than $10 and now its up to about $24.

Hopefully, your timing getting back into tech will be as good as it was getting out.

Most of the tech sector right now is looking very positive. All these companies are part of the general trend in the next 6-12 months of companies going back in and improving their productivity by enhancing their technological capabilities.

Were looking at the forward P/E relative to the growth of the company over the next 3-5 years, which is a little longer-term oriented than a lot of investors focus on, but these stocks have come off a lot over the last 2 ½-3 years. We have had our economic decline, the economy is turning around, and these stocks are looking very good on not only a future earnings growth basis but also on valuation levels.

Any parting shots?

I think its important to recognize that small- to micro-cap stocks tend to do very, very well coming out of an economic recession relative to large- and mid-cap stocks. They have in practically every economic turnaround that weve had in history, so I think theyve pretty well poised for some continued significant growth and earnings and price appreciation.