The money management business is never boring. Im always learning and uncovering new opportunities. Its a great feeling when you can make money for your shareholders, especially since one of my shareholders is me. -- Charles Rinaldi">

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INTERVIEWS


Charles Rinaldi Of Strong Capital Management

03/01/01 03:34:26 PM PST
by David Penn

Charles Rinaldi joined Strong Capital Management, Inc., in November 1997 as the head of the firm's small-cap value equity product. Previously, he was senior vice president and portfolio manager at Mutual of America Capital Management Corp. from November 1989. Prior to that, he was a portfolio manager at Glickenhaus & Co., Lehman Management Co., Arnhold & S. Bleichroeder, and Gintel & Co., and was a security analyst for 10 years at Merrill Lynch Capital Markets.

Rinaldi received his master's degree in business administration with high distinction in 1970 from Babson College. He is a member of the Association for Investment Management and Research and the New York Society of Security Analysts. Working Money Staff Writer David Penn interviewed Rinaldi via telephone on January 23, 2001.

The money management business is never boring. I'm always learning and uncovering new opportunities. It's a great feeling when you can make money for your shareholders, especially since one of my shareholders is me. -- Charles Rinaldi



Why don't you tell me how you got involved in finance and how you came to work for Strong Funds. I grew up in the small town of Enfield, CT. I was a child of Depression-era parents. Everyone around me was frugal and careful about what they spent. That's still ingrained in me today. I don't believe in spending more than I should for anything, including stocks. It doesn't mean I'm cheap, but it does mean I expect to get something for my shareholders' hard-earned money.

That makes sense. After I graduated from college, I attended medical school in Washington, DC, but then decided that wasn't the right career for me. I ended up as an analyst at Merrill Lynch. I spent the first 10 years of my career following health care and financial stocks during my time there. Before joining Strong, I was at Mutual of America for eight years and managed that company's aggressive equity fund. I had a five-star rating in that fund from Morningstar.

Was there anything in your background, other than your personal ideas about money and frugality, that would have tipped somebody off that you might be headed toward Merrill Lynch instead of medicine? I guess your first stock is like your first girlfriend. You remember it or you don't. Unfortunately, I don't remember it precisely. I think the company is long out of business. But I do remember that it was hyped. I lost money and have been something of a contrarian ever since. That's how I got into the business, actually. I studied it, found I was interested in it, and then I got a master's degree in business administration (MBA) and went to work in that field. I've been doing it ever since.

I went to work for Merrill Lynch in their research department, which I think is a really good background. I spent 10 years at Merrill and really got a good grounding in the business. You learn a lot of lessons in this business. When you lose, don't lose the lesson. That's a quote from the Dalai Lama.

That's an apt one! So how did you get involved with Strong Funds? Dick Strong personally recruited me. I was extremely impressed with Dick and the organization he built. This is truly a firm that wants to be at the top of the game. Dick has personally recruited a lot of special talent and I think that's really what makes the firm go. Dick has an eye for talent and there are a lot of good people at Strong.

Was it much of a decision when you decided to jump over to Strong? You know, I was at an insurance company. I had done quite well, but when I joined Strong it was really an opportunity to run my own business. It's a nice feeling to run your own team and have all the support of a large organization. We get excellent support in terms of trading, technology, research, and back-office functions. It's a great situation. Dick doesn't micromanage and he encourages you to do big things. That's really one of the keys to the success of the firm. That's how I got there.

Value investing came roaring back into vogue in 2000, according to some. Do you think that was the case? I wouldn't say that value investing is back in vogue quite yet. The money flows into value funds have come nowhere close to the money flows of momentum growth funds that we saw during the last two years. There's still a fair amount of grieving over the huge drop in the Nasdaq last year. I don't think there's widespread recognition or understanding yet of how bad it can really be.

There's a bit of deja vu for value investors like me who've been around and seen this happen before. The lesson here is if investors didn't figure out the importance of diversifying their equity investment to include value, then 2000 was surely a lesson they shouldn't forget. I'm thinking of the quote from the Dalai Lama again.

So you think value funds will continue to perform well? Yes. A good argument for why they will continue to perform well is because of mean reversion. Despite the recent strength of value stocks, they're still undervalued by many historical measures, and growth stocks still look overvalued.

Bob Farrell put it well. I don't know if you're familiar with Bob Farrell at Merrill Lynch, but he was probably the best market analyst in the business for 10-plus years running. He's semi-retired now, but he spent his whole career at Merrill Lynch. In his final published portfolio strategy report, he wrote: "The market is again showing it has a mean streak. Trends can last a long time, but extremes do not. Every new era is fertile ground for tulips. Every market will eventually find a reason to regress to the mean. When markets go in one direction long enough to convince investors the extreme being created is a new permanent reality, risks are great that the mean streak is soon to make its appearance." That's a pretty good quote. And that's what happened last year.

What is value investing as far as you're concerned? To me, value investing means buying stocks that are selling below intrinsic value. But this is just the starting point. The key to our process is finding some positive dynamic for change that is not yet recognized in the stock price. We try to avoid value traps: that is, stocks that may stay cheap for extended periods. Our process really tries to find some dynamic for change. We put a big emphasis on that. I think that has allowed us to do well over the last three years. We ranked fourth in Lipper out of their universe of small-cap value funds over three years.

Does managing a value-oriented portfolio mean selling companies when their value becomes more recognized? What kind of portfolio turnover did Strong Advisor Small Cap Value Fund have in 2000? We don't automatically sell a position when a stock appreciates because you can end up leaving too much money on the table. What we do is recognize what is happening to valuations with respect to the industry that the stock is in. If the valuations are also rising, we stick with the stock until the investment reaches the upper quartile of valuations in the industry, and then we sell it. If the industry evaluation is static, then we look at the stock's valuation relative to its history and determine how far we think this stock will get versus its own historical evaluation. Our turnover was about 60% in 2000. That's pretty typical.

The Securities and Exchange Commission (SEC) has made a couple of comments recently. One is about the names of funds and if they do what they purport to do. Our fund is called the Strong Small Cap Value Fund and that's exactly what we do. The other thing that the SEC's going to do now is to require funds to show the aftertax returns in their prospectuses. What happened with a lot of funds last year was that investors bought them at high prices earlier in the year, and then prices went down because of the correction and the bear market in some market sectors. So not only did their fund shares fall, but they received capital-gains distributions on which they had to pay capital-gains tax. We have very high perform-ance in our category and we have 100% tax efficiency over three years. That's quite a statement. In other words, our pretax return is the same as our aftertax return.

And that's over the past three years? Yes. That's the life of the fund right now. Zero capital gains distributions. We have harvested our losses where feasible to offset gains. We can't guarantee we're going to do that every year, but that's been the case for the past three years and we'll continue to try to minimize distributions going forward. We have top quintile performance and 100% tax efficiency. If you measure all funds like that, you'll see that we're probably way ahead of everybody on an aftertax basis.

When evaluating performance, investors should also look at initial public offerings (IPOS). Our performance was not driven by Ipos. There were a lot of hot IPOS and while we did have some, they were an insignificant part of our performance. In fact, the SEC now requires disclosure if a significant part of the fund's record was due to IPOS. Our performance is really driven by our process, which we think is replicable. Some of these IPOS tripled and quadrupled on the first day. If I were evaluating a fund manager, I would want to know what was responsible for the fund's performance over the last year. If there were any Ipos in a fund it would have performed well, but that may not be the case any more.

Our cumulative return over the last three years was 71.7%. Some of the separate accounts that we manage for institutions actually have even been better than that, because they don't have inflows and redemptions; they are nontaxable entities so we don't need to worry about taxes. But that's our fund.

Tell us about your methodology in selecting stocks for the fund. To begin with, we use some quantitative techniques to help us funnel down the universe. First, we look at multiple valuation measures that focus on traditional ratios like price to earnings, price to cash flow, price to book, and so on. Then we look at what's happening to the revenue line over the past few quarters and focus on those that show positive developments on the top line. We use some proprietary tools to help us identify potential inflection points that correlate with stock price appreciation.

We have three steps to our process. One is quantitative, because you have a big universe of stocks out there. We have intrinsic value screens, screens that find stocks that are cheap relative to their asset value. We also have screens that look for growth at a reasonable price. When we think the economy is going slow, we focus on these screens. But we tend to get a lot of names with our screens, so we focus on those with the best sales growth over the last three quarters.

Then we take the names and go to our second step, which is really trend analysis, where we look for inflection points. We ask ourselves: Is this a good entry point for this stock? Is there room for margins and revenues to improve versus historical performance? We look at a lot of different things in terms of trend analysis, but we're focusing on the indicators that correlate with stock price performance. We look for something that would indicate that a change is going on and some dynamic is present. These could be stocks that nobody's looking at because they're undervalued and have been out of favor.

What kind of a dynamic would that be? In terms of a positive dynamic, many times it's new management because the old one didn't do a good job, or there's a new product, or sometimes it's just the right time in the business cycle for that company. After that, the real work is rolling up our sleeves and learning what's going on at the company.

We spend most of our time doing fundamental work. That's my background and that's the way we operate. We're really more bottom-up. We narrow the universe down to what we think are really good candidates, and then we do a lot of fundamental work. We try to schedule as many meetings with company management as possible and we also use a network of information sources that we've developed over the years. What we ultimately hope to find is some positive dynamic of change that is not yet recognized and that could lead to a significant appreciation. We're looking for cheap stocks with some change present, so there's a good risk-reward tradeoff.

What are the major differences between evaluating large-cap and small-cap stocks? The key difference between larger-cap stocks and smaller-cap stocks is the information flow. There's much more information available for larger-cap stocks than there is for some small-caps. This ultimately translates into a higher risk-reward ratio for small-caps versus large-caps. So for small-caps, you have to be good at digging out information. For larger-caps, you have to be good at sorting out information, figuring out what's going on, and what's going to be meaningful. Our process can be applied to both small and large. It's worked well for a long time. We tweak it and improve it as we go along, but it basically finds cheap stocks that have a dynamic for change. We then do some fundamental work to see if that's the case. If it is, we might add the stock to the portfolio.

Among your top holdings, I noted a heavy weighting toward oil and gas industry stocks, as much as 21.7% back in November. When did you become a believer in this industry? How long do you think these stocks will be value plays? I became a believer when our bottom-up work showed that these stocks were selling at very low cash flow multiples, and that a pint of bottled water was more expensive than a gallon of gas. Many of these stocks are actually still cheap. I own some energy stocks that are selling at two or three times cash flow right now. Don't forget, the energy stocks made up something like 28% of the Standard & Poor's 500 index once, back in the early 1980s. Now rolling blackouts are occurring in California. That didn't happen during the last energy crisis.

So we think there's still room for growth and we think there will be good fourth-quarter earnings and cash flow. Big gains are going to come out when fourth-quarter earnings are reported. I think there's going to be good guidance for another great year in 2001. The stocks are still cheap and they're still underowned by institutional investors. That's an area we're going to stay with. We've been with them for a couple of years now. When they make up too much of the portfolio we trim them back, but it's still a healthy weighting.

What were some of the other industries in 2000 that yielded strong small-cap value plays? Do you expect these industries to remain value plays in 2000? There was a lot of sector leadership rotation during 2000. The first quarter was still technology and biotech, the second quarter was deep cyclicals, the third quarter was financial stocks, and the fourth quarter was energy. So three out of the four quarters were value-play sector plays. When the technology stock bubble burst, it certainly gave value investors long-overdue recognition. The other piece was the Federal Reserve hitting the brakes. It took six interest rate cuts, but it finally did the trick.

The energy story will continue to unfold and reveal the continued high demand-to-supply situation. This will likely create opportunities for increased engineering and construction spending. That's another sector we feel will benefit strongly. We have a few names there: Chicago Bridge & Iron (CBI) and Matrix Services (MTRX), which is a little more diversified but is also in that business. Other than that, I'm pretty much bottom-up. I focus on picking stocks with the right value characteristics and positive dynamics for change.

Right now, we're seeing some technology names on our screens. There might be a short-term recovery in some technology stocks, and I think we can find some of the babies that have been thrown out with the bathwater, so to speak. However, we're going to be cautious about these and be quick to take some money off the table if there's rapid appreciation. But some of them have come way down. For example, we bought Earthlink, Inc. (ELNK), when it was selling for less than the cash on its balance sheet. I think the outlook is improving.

I had read that the fund is currently closed to new accounts, though investors may gain access to the fund through certain company-sponsored retirement plans. How was the decision made to close the fund? What likelihood is there that the fund will be reopened or that another class of shares will be offered to new investors? Actually, the fund is still open to new accounts, but subject to a sales load. Investors who were in the fund before we went load are grandfathered in and can continue adding money on a no-load basis. We really wanted to attract long-term investors who understood the value and potential reward of being in this asset class over time. We will be managing a multicap value fund beginning in the next quarter or two, and that will be no-load. We're probably going to be more small- to mid-cap initially but we'll have flexibility to add large caps over time.

You said the new fund would be no-load? Yes. We're going to apply the same investment process. There will be some overlap but not too much. We are aware of a lot of companies with a market cap larger than $1.5 billion that we can't use in our small-cap fund. This new fund will give us a place to use those names. Investors who like what we've done in small-cap value should take a close look at our multi-cap value fund.

What is your view of technically oriented stock analysis? Do technical factors play any role in your analysis of out-of-favor small-cap companies? I look at charts, but I'm a fundamental analyst by background. Everybody in the business looks at charts. But I don't really know what technical analysis is and I can't say that I understand it. A lot of momentum-oriented high-turnover funds use technical analysis. The only thing that creates shareholder value in the long term is a consistent process that identifies cheap stocks with the driving force that we call a positive dynamic. The company's ability to generate profits is what ultimately creates true economic shareholder value. My focus is on that ability, which is why I'm looking for that positive dynamic for change. Otherwise, you can fall into a trap of buying value stocks that stay cheap.

What makes a portfolio manager choose a value strategy over a growth/momentum approach? Is it a matter of temperament, preference, or training, or is it a matter of the type of portfolio any given manager is hired to manage? I can't speak for others, but for me, a value orientation is part of my upbringing as a child of parents who grew up during the Depression era. In addition, as bad as 2000 may have seemed for many investors, to me the 1973-74 bear market seemed far worse. Value investors tend to be the ones who survive when the market gets really bad. If you've lived through those periods, as I have, value would be a part of your religion. If you haven't, it would be important to read history and take a hard look at what the numbers tell you.

Now, this isn't to say that you shouldn't invest in growth stocks. When we look at a stock, we don't say that this is a "growth" or "value" name. We look for cheap stocks. Some of these are fallen growth stocks and sometimes they turn out to be our best stocks. But we use a value discipline when we buy, so we're really looking for growth stocks, too. The difference is, I try to be there early and buy these stocks when the growth is still unrecognized.

We're trying to watch our risk-reward ratio. This way, when I'm wrong, the downside tends to be less than if I bought a high-priced stock. And when I'm right, I'm selling my stock to a growth/momentum investor at a substantial profit. Growth stocks can be bought at value prices. We really don't differentiate between value and growth stocks. The ideal situation is when we buy a cheap stock that's as yet unrecognized, then it becomes popular, momentum money comes in, and there's a ready market to sell, because liquidity is a consideration in this category. I think the entire small-cap value sector looks promising right now and it could be one of the leading areas over the next several years.

Earlier, you mentioned that a stock would be undervalued and cheap when you bought it and might rise during the period of holding, but as long as it doesn't pass over a peak valuation, you might well remain holding it. Yes. We tend to do a lot of work on our companies. You find some value managers who sell their stocks when they get to a certain valuation level. We don't automatically sell our stocks when they are no longer small-cap value names. We may not buy them anymore, but we feel we've put a lot of time into the name, and as long as it is not overvalued in terms of its industry, we'll stay with it -- particularly if the industry is popular at the time and valuations are rising. But when it gets to the upper quartile in valuation, we'll sell it.

Can you give me an example of a stock that you got at a real bargain and managed to hold on to even as it was increasing in value? We bought some stock of a company called Coherent (COHR), a leading laser company. Sort of like the Ibm of the laser business. Roughly two and a half years ago, we bought the stock at $12 or $13. It offered growth at a reasonable price and the valuation was relatively low. The company was out of favor at the time, just as IBM was out of favor several years ago. For IBM, a lot of competitors were taking market share at that time. So what happened was that Ibm got new management, the company reorganized, cut costs, and invested in new-product development for high-growth markets, and then Ibm stock went up five or six times. Well, the same sort of thing happened with Coherent.

The laser business is considered a growth business. This company was represented in the industrial, medical, and semiconductor industries. Other companies were coming along and absorbing market share, so Coherent started to emphasize new-product development and began winning back business. Well, the stock went from $12 to $107. We sold it really on a valuation basis when it got up to around $71, so we made a really good gain. We sold because it started to get overvalued, and we saw momentum money coming in. After going to $107, the stock declined all the way down to the mid-$30s.

We knew the company. If you looked at it on the straight multiple basis -- earnings per share (EPS) in fiscal 2000 was $1.32 and estimated 2001 EPS is $1.70 -- you'd say this is a high-multiple growth stock. However, it spun off a company called Lambda Physik, which sells lasers for photolithography used to make semiconductors -- expensive lasers, $500,000 a laser, that kind of thing. It trades on the Neur Markt in Germany, which is like the Nasdaq here. Lambda Physik was picking up a lot of new business and was just turning profitable.

Even though Coherent spun out Lambda, it still owned eight million shares of it. We figured out that alone was worth like $16 per share of Coherent. In addition, they did an offering when the stock was up higher, and they had another $6 per share in cash. The Lambda Physik investment and cash totaled $22 per share, so we had $1.32 in trailing earnings with a stock that was $35 and unrecognized asset values of $22.

Then, the stock dropped from $35 to $25 and we bought it all the way down. We added and bought a larger position on the decline, because it came down with all the tech names. Because we think we know it better than most investors, we repurchased an even larger position than we had the first time we owned the stock. The stock is now back up to $48. They reported great earnings for their fiscal first quarter and I think it will continue to do well.

You mentioned that you bought Earthlink for less than cash. Could you comment on that? Yes, we bought it recently. The stock had declined from something like $66 a little over a year ago to $5 1/4. That's when we started buying it.

Earthlink has approximately five million subscribers. It's the no. 2 Internet service provider (ISP), a far second to America Online (AOL). If you look at the company's balance sheet, they have close to $6 per share in cash and no debt. We started buying it at $5 1/4. Our average cost is a little higher than that because the stock started going up. We just started buying it about two or three weeks ago and it's at $9 now. Our original position was less than cash, so that's a value. You can agree with that, right? The company is losing money, but they're going to turn cash flow positive this year.

One of the things I've been reading in the newspapers lately is that a lot of Internet companies have been losing money. It's been a disaster. Many of them are going out of business and the survivors are trying to cut costs dramatically. They are also planning to raise prices. Ebay's raising prices, Yahoo!'s raising prices. In yesterday's Wall Street Journal, I think I saw three or four instances of Internet-related companies raising prices.

The industry talk is that AOL will probably increase prices. Earthlink is already pricing its services below AOL. Since Earthlink is analog, it doesn't have a lot of broadband customers right now. Broadband is a higher-margin business. It does have some broadband, though, and it's expanding that with digital-subscriber lines and cable modem customers. As that happens, Earthlink's profitability will improve. It's already priced below the others, so it has room to increase prices. I believe the others will increase prices, so Earthlink can move up, too. Increasing its number of broadband subscribers will help. The thinking is that by the end of the second quarter, the company could turn cash flow positive. If not by the second, then certainly by the third. Maybe by year-end they could turn earnings positive, also.

So why the no. 2 player and not the no. 1? I'm looking for survivors that are going to start turning a profit and are selling for less than cash. To me, that's a great play. I have a no. 2 player now. The government agreed to the merger of Time Warner and AOL on the condition that Time Warner open its cable system to other ISPS besides AOL. Guess who's in line for that? Earthlink. So customers might be able to choose between AOL and Earthlink on Time Warner's cable network. I like it, and I think it's more than just a short-term play. And look at who owns Earthlink stock. Sprint owns 50% and they paid $28, and Apple owns maybe 5% or 6%, and I believe they also paid something like $28.

Adding small-cap value funds to a portfolio certainly adds to diversification. How much should an investor allocate to small-caps? When I started in the business, it was typical for a portfolio manager in a regular fund -- they weren't as specialized as they are today -- to have 20% in small caps. Now I look at small-cap value and it's my largest personal holding. I'm a large shareholder in my own fund. People like to hear that because they know my money is in the same place as theirs.

The small-cap value sector has been out of favor for quite a while, but I think we're starting a new cycle. The cycles usually last anywhere from three-plus to eight-plus years. And really, on a long-term basis, small-caps do better than large-caps and value does better than growth. We've been in an extended period of underperformance. So if we're really coming off a bottom, I think this is the best time to add more. But certainly 20% in small-caps at this stage of the game, depending on what your stage in life is, is a reasonable allocation, particularly because that's a sector I've been following for a long time and it looks like it's very early in the cycle for small-caps. There are a lot of things happening in the small-cap universe right now. The whole sector is really attractive.

If you look at small-cap and even mid-cap value, long-term dominance is small-cap versus large-cap. There are definite advantages and asset-allocation diversification benefits in this sector. Over the years, small-caps and large-caps have performed differently. When you invest in both large-caps and small-caps, you're really diversifying, because they don't move in unison; it is a complementary relationship. The correlation to large-caps has declined progressively and is at a record low going way back, so it represents a true diversification benefit.

What about small-cap value versus small-cap growth? If you look at the long-term record of small-cap value versus small-cap growth, you'll find that small-cap value dominates. If you look at the Russell 2000 Index and the two small-cap indexes, the Russell 2000 Value and the Russell 2000 Growth Index, going back to 1978 when they all started, you'll find that value wins. Even with the recent underperformance of small-cap value versus small-cap growth, it's still the leading overall index. I was surprised when I saw that, because during the last several years, you know how well growth did and so did small-cap growth. But small-cap value is the long-term winner. And right now, especially in the second half of last year, the Russell 2000 Value really reasserted itself versus the growth.

Merrill Lynch put out a research report in which they commented on the relative earnings performance of small-caps, mid-caps, and large-caps over the next five years. Small-caps are still growing faster than both large- and mid-caps. The gap has narrowed, but they're still faster and they have attractive valuations.

One of the key factors increasing interest in the small-cap group is mergers and acquisition (M&A) activity. If you look back to 1992, there was a trough in the number of mergers and acquisitions and leveraged buyouts in small-cap areas. That's picked up every year since 1992. It hit the peak level in 1999 and stayed at quite a high level in 2000. That was because the stocks were so cheap that management felt Wall Street was not paying attention to the stock. So they were paying a premium and taking these companies private, or others were just buying these companies. Because of the valuations that attracted these buyers, there was a lot of interest in the small-cap group.

We certainly have had our share of M&A activity in our portfolio. In a small-cap value fund, every stock in the portfolio is subject to a takeover because they're cheap and small enough for somebody to buy them. I never prepare a list of all the names, but we had a whole bunch of them last year. Silicon Valley Group (SVGI) is one that we own; it was acquired by ASM Lithography NV (ASML). We had quite a few of them last year, and that's helped our performance, too. It has caused the corporate buyers to come in. As a parallel to that, we manage separate accounts for institutional investors and we're seeing more institutional interest in the small-cap value sector. Eventually, you're going to see it in the mutual funds. We're pretty early in the cycle and we think it's going to be a long cycle.

You talked about how the 1973-74 downturn was much worse compared to the one in 2000. How were they different? What we had in the technology sector was certainly just as bad. There was a really big jump. Some of the stocks that were at $200 went down to $4. Now that's serious. What you had in 1973-74 was a two-tier market. You had the nifty 50, and then the rest of the market that nobody cared about. Everybody just kept buying the Mercks, the Avons, and the Colgates, and they didn't care about anything else. And then those leaders collapsed, just as the big leaders collapsed in recent months. There's some similarity there, because you certainly had very high valuation in those tech names and in some of the growth areas versus the rest of the market.

Now there is a broader participation in the market. Among many of the companies that have been neglected, you will find good companies that have real earnings. A stock comes out, goes public at $10, and goes to $80 with no earnings. What is that? And that's sort of what's happening now. That's one of the reasons value tends to come back and do better over time, because these other things collapse. People look for a safer area and a better investment, which means they go back to fundamentals. Some of the ones I mentioned earlier were a little growth-oriented, but they are still value.

Like what? There are some inexpensive stocks that we like. One of them just reported today and the earnings were slightly disappointing. It's a small loan company called World Acceptance Corporation (WRLD). The company's in the small loan consumer finance business in the Southeast. It has 422 offices in 10 states. The company offers unsecured personal loans. It does have chargeoffs, but it collects high rates of interest to cover the risk.

Overall, the company has a good record. Its return on equity has been more than 20% consistently, and this is very conservative accounting. They're buying back a million shares. The stock was $16 back in 1994-95, when they were earning $0.49 per share. We think the company will do about $0.80 in the March fiscal year when they announce earnings and the stock is between $5 and $6. So the stock has come down and the earnings have gone up.

We also think the growth rate has been good in terms of earnings over the last several years. This is also an interest rate play because the company makes better spreads as rates come down. Management is repurchasing stock, the company's loan volume is growing, and it has a tax-filing business that could add some incremental earnings to the company. So it's between $5 and $6 with $0.80 in earnings. We like that one. We have a good-sized position there.

One of the energy plays, which if you go back a few years was probably in the $23 or $24 area, is an oil and gas exploration and production company (E&P) called Range Resources (RRC). It had a few quirks. It got a little overleveraged. It was formed by the combination of two companies, one of which was Lomak Petroleum and the other was Domain Energy. They merged and as a result increased their leverage at the wrong time, so the stock came all the way down. Actually, we got on board around $7. It got all the way down to $2 and we bought a lot more in the $2 or $3 area, which was the average price we bought it at. The stock is above $6 or $6 1/2 now, and the cash flow is really starting to improve. They're paying down debt and hedging their production positions at higher prices in the natural gas area. We think the stock can double from here. It's really cheap, has really good management, and the company is doing what it should be doing.

You mentioned leverage. It depends on the situation, but how much is leverage a red flag for you with some of these companies? Typically, we look for companies not overburdened with debt. But this was a company that I think has the wind at its back. The energy area is coming off a bottom. If you have a company that's going to survive, leverage works in its favor. But this particular company came close to serious problems. It almost didn't survive. It had to hedge all its positions down lower, and now as those hedges come off and prices are higher, it's getting higher prices. Typically, we do not like highly leveraged companies, but in this case, we made an exception. We know the company has strong management, the management is deleveraging the company, and insiders have been buying the stock.

How about one more example, if you have a good one? I own stock in a company called Matrix Services (MTRX), which is a relatively smaller-cap stock than we normally buy. This is a small company in the engineering and construction business, an area we are interested in. It also does turnarounds for refineries, and refineries are doing really well now. In a turnaround, which is done every 12 months or so, the refinery is closed down and all the fittings and valves are changed and do some extensive maintenance and repair work is also done. The third piece of Matrix's business is an above-ground storage-tank business. The company builds and maintains these storage tanks used to hold petrochemicals. In addition, this is a company with new management. During the down cycle, they cleaned up the company, paid down all the debt, and sold off their losing businesses. The company's in three good businesses now. The engineering and construction business is picking up after a long drought, the refinery business is operating at a high level of capacity, and the storage business is fairly steady.

They're on a May fiscal year and are probably going to earn around $0.60. They said they may not make earnings, but I think they're going to earn around $0.60 plus. They certainly have much higher earnings power. The engineering and construction activity has bottomed out, but it's still a little slow in picking up. The refineries operating at full capacity are not shutting down as readily as they should to do turnarounds because of the strong demand for gasoline and heating oil. But it's a company that is debt-free, the stock is selling at around $57/8, which is below book value of about $61/2, they announced a 20% share buyback, and insiders have been buying. I see very little downside. It's a very small-cap, though. Its market cap is below $100 million, but it's a very cheap stock and I think its outlook is good.

That certainly gives us a good example, and there are some familiar ones, too. Earthlink's certainly a familiar name. We have also taken a position in Burlington Industries (BUR), the textile company. They've fallen on hard times. I think this could be interesting. It's a little more risky because it does have debt. There was some problem about the company refinancing its debt, but it just announced within the last month that the banks have extended its line of credit by about $600 million. They just reported a loss today, which I think was a little less than expected. So it has its financing in line. It's also reduced inventories and debt.

This is a big textile company. You can get a really good move on a stock like this if it can get through the trough. This stock has something like $1.5 billion in revenues. It has an $88 million market cap. When we looked at tech stocks, we were talking about 20 times revenues. Well, this is selling at a little over 12% of revenues. Burlington's leveraged, but they've been rationalizing their business. They're in the denim business. They're in different apparel fabrics. They've closed down a lot of their inefficient plants. They've moved certain ones down to Mexico -- they've got new plants with low-cost production. This is a stock that in the past was at much higher prices. Certainly, in 1998 the stock was around $19 and now it's less than $2. But I think it's going to make it; it's doing all the right things. The company's got its financing redone. Of course, it had to pay a higher rate because it hasn't been making money. But if the dollar weakens a little, they can be more competitive in Europe. The earnings can be very significant in a company like this.

And very quick. Yes. You can get big numbers in a little stock and then suddenly people will come back to it. We look for stuff like that. I think it's going to be all right. Burlington's got another thing that could be sexy, actually. You know how Gore-Tex is a big thing? They have something called Nano-Tex. This is a hot thing. You've heard of microfiber. Well, this is based on something called nanotechnology, which is even smaller and has interesting properties.

Nano-Tex is a company in which Burlington has invested and in which it now owns a controlling stake. And Burlington's just announced a deal with Galey and Lord. This is a thing you can manufacture into fabrics to do all sorts of different things. For example, you can make cotton fabric water-resistant or wrinkle-resistant, or prevent fabric colors from fading. This business eventually could be spun off and be a hot little stock. Eventually, it could be an IPO. Plus, they can get all kinds of license fees for letting others use the product. It's got sex appeal.

Does Burlington Industries fit under the small-caps umbrella? Burlington has $1.6 billion in revenues, but it's a micro-cap. If you look at it in terms of market cap, it's under $100 million market cap right now.

Do you run across a lot of companies like that? There are a lot of other companies like that. You've got to make sure they're going to be survivors, though.

What about companies in which you had a certain amount of confidence, yet... A lot of things could happen with a company like this. When the stock goes below $5, a lot of institutions can't own it or they get nervous about owning it. They don't want to show it in their portfolio. We've been buying it under $2. I think it's going to work out. It is a large textile company, and textiles are a competitive business.

If the companies are managed right, even in a difficult environment, are cutting costs and doing the right things in terms of relocating plants and getting out of unprofitable businesses, if they keep rationalizing their business and get a couple of breaks in terms of currency and costs and are well positioned for it, then it could be a good opportunity. And then you've got this Nano-Tex thing, so I like this company.

Well, it's certainly worth watching. Everyone's heard of Burlington. Yes. It's one of the old-economy stocks. Maybe they'll be using a lot of new-economy tools to improve their business. I like the risk-reward. I think they're going to be a survivor. We have a good process that's worked over the years. We have performed well for our clients and we're entering a period now where the wind is going to be more at our back in terms of the market.

Any last comments? The money management business is never boring. I'm always learning and uncovering new opportunities. It's a great feeling when you can make money for your shareholders, especially since one of my larger shareholders is me. I've been in the business for nearly 30 years, but I still wake up every morning ready to go.

That's a good sign. Thanks, Charles.

Charles Rinaldi may be reached through the Strong Funds website at http://www.estrong.com.




David Penn

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