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Money managers that like small company stocks

- Alan Lavine and Gail Liberman

When the market gets hammered, it's often a good idea to pick up some small company stocks on the rebound.

Reason: Although small company stocks often get hit hardest in a down market, they also may bounce back hardest and first afterward.

Of course, the opposite also can happen. In bad times, small company stocks may be at greater risk of going under than medium-size and large-size companies. They're often among the riskiest of stocks. So you want to make certain you choose them wisely and only invest money you can afford to lose.

Also, consider that the economy could get worse before it gets better. So it could prove wise not to buy everything at once. By dollar cost averaging your purchases, or buying a little periodically--say monthly--you can pick some stocks up at a lower price next month if the market drops. On the other hand, if your small company stock or stocks go belly-up, you likely won't lose your entire small company stock investment.

So which small company stocks to consider?

Here's what a couple of experts have to say.

"In markets like this, we focus on companies that have a catalyst for change, like new management or restructuring," says Mark Leslie, manager of the William Blair Value Discovery Fund.

Before getting absolutely walloped this year, small company stocks, on average, outperformed the S&P 500 index--a measure of large company stocks--over most of the past five years. So these stocks could lag larger stocks over the near term.

Nevertheless, the recent pull back presented an excellent opportunity for him to buy stocks with strong cash flow, balance sheets and return on invested capital. He is underweight in financial stocks and overweight in industrials and technology.

He's been accumulating shares in companies, such as Varian Inc., a company which sells scientific instruments to health care and industrial companies. The company, he says, is expanding profit margins. He also likes Flowers Foods, a company that produces bakery products. Although wheat prices are soaring, this company's hedging program locks into lower prices. At Minerals Technologies, which makes coatings for paper products, a new CEO recently came on board and improved cash flow and return on capital, he says. The CEO cut back on poor projects and bought back stock.

Leslie is fully invested and optimistic longer term.

Although earnings expectations are uncertain, many companies held by the fund report inventories are being managed aggressively, backlog growth is slowing and order logs are positive.

"We are in for some short-term volatility and downside expectations until we get into the second half of the year, when the economy gets stronger," he says. "We are taking a hard look at cyclicals."

Meanwhile, John Montgomery, manager of the Bridgeway Small Cap Value Fund, is finding values in business services, financial services and industrial materials.

This small cap fund, up 7 percent last year, outperformed the Russell 2000 value index. But so far this year, his stocks had dropped by close to 11 percent. Investors abandoned small company stocks in favor of large company stocks due to the deterioration of the economy.

Montgomery says his proprietary model has been picking up former growth stocks that are now value stocks.

"The market is pulling back (as much as 50 percent) on the small value side," he says. "With the retrenchment of stock prices, we are buying growth at reasonable prices. There are more companies on the value side."

Montgomery says he has been accumulating shares of existing holdings as well as adding new positions. Last February, he bought stocks, like Columbus McKinnon, which manufactures material handling equipment, and Gulfmark Offshore, an oil support services firm. Some of the fund's largest holdings include McDermott International, an engineering and construction company, and industrial materials companies, such as General Cable, Robbins & Myers Inc., and AAR Corp.

"Many of these companies benefit from strong global demand of products and services in developing countries like China," he says.


Spouses Gail Liberman and Alan Lavine are syndicated columnists. You can purchase Alan Lavine & Gail Liberman's latest book Quick Steps to Financial Stability (QUE Publishing 2006) online at www.moneycouple.com or at your local bookstore. E-mail them at MWliblav@aol.com.

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