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Kicking the Tires with Ronald Muhlenkamp

By James Anderson Whatever drives Ronald Muhlenkamp's picks for his value fund, he makes it sound awfully easy -- like buying a car. "We're in this business to find Buicks or Pontiacs at Chevrolet prices," he says. "Occasionally we'll land a Cadillac at the same amount, but if we regularly pick up the Buicks, we're doing fine."

Muhlenkamp, who has been running his $481 million mutual fund since 1988 from his headquarters in Wexford, Pa., has evidently been shopping the right showrooms, especially of late. In a year that hasn't been kind to value stock-pickers, his Muhlenkamp Fund (MUHLX) -- a member of BusinessWeek's elite A list of high-return, low-risk funds -- was up 11.6% in 2001 as of the market's close on June 1. That's almost 16 percentage points above this year's shaky performance by the Standard & Poor's 500. It's also a good deal better than the 6.2% mid-cap value funds have averaged so far this year, according to Morningstar.

NEVER PAY TOO MUCH. The manager's mix of stocks as large as Citigroup (C) and as small as Winnebago Industries (WGO) has held up well over the long term, too. Over the past three years, the Muhlenkamp has rewarded fund holders with a 12.5% average annual total return, vs. 6.3% for the S&P 500 over the same period. During the last 5-year and 10-year periods, the fund has averaged annual returns of 20.6% and 18.2%, respectively. The benchmark's record over the same time is 15.2% and 14.8%.

Muhlenkamp, an Ohio native who grew up on a farm not far from Dayton, attributes his success to a few benchmark rules. First and foremost is getting a well-performing company at a reasonable price. To Muhlenkamp, "good" translates into a return on equity of at least 14% annually. "We, of course, do the background work to make sure those numbers are real," he is quick to add. That means Muhlenkamp is ready to crunch numbers himself and do whatever homework it takes to verify figures and trends. Meanwhile, to satisfy his taste for inexpensive holdings, he looks for stocks selling at a price-to-earnings multiple below its company's ROE.

Just because a stock passes those preliminary tests doesn't mean Muhlenkamp is going to buy it. He'll then contact the brass at each company on his short list of candidates and pose three questions.

SITTING PRETTY. First, he wants to know which Wall Street analysts do the best job of following their industry. "We're looking to save some time if possible," he says, explaining that analyst estimates give him both a yardstick by which to check his own calculations and a second opinion, should he need it. Next, he makes a point to ask management what criteria they use to judge their company's performance. Finally, there is the third question: What goals must be met for employees to earn a bonus. "We love management to earn a bonus," says Muhlenkamp, "just as long as they're taking shareholders along with them."

For example, Stanley Furniture (STLY) may not show up on a growth manager's top-10 list, but it's a company Muhlenkamp says he's been glad to own since he bought it in 1993 at about $5 a share. The small-cap company, which makes furniture, has averaged an annual ROE of 15% to 20% according to Muhlenkamp's calculations, yet sells at a p/e multiple of 14.4 by Morningstar's numbers. "That's definitely a Buick at a Chevy price," the manager says. That might be a bit of an understatement. Stanley, which closed May 31 at $33.49, is up 38.8% so far in 2001.

Other solid picks for Muhlenkamp are homebuilding companies, such as NVR Inc. (NVR) and Beazer (BZH). Over the last year, housing shares have made a run in the market -- but Muhlenkamp has reason to believe the group could have more upside. "The industry's ROE has moved from the low-teens to 20% or more in the last few years," he points out. "And yet a lot of these stocks are selling at p-e's of no more than 10." At Friday's close of $170.00 a share, NVR was up 37.5% so far in 2001. At a price of $61.50, Beazer had gained 53.8%.

"OUTSTANDING JOB." A key component of the Muhlenkamp Fund's success has been its low overhead. Muhlenkamp likes to park in solid positions as long as possible, which gave him turnover of a slim 19% over the past year. By way of comparison, Morningstar, which categorizes the fund as a mid-cap value portfolio, reports that funds in the same group churn their way through 113% of their holdings a year. "You take a look at the fund's numbers and it's obvious the manager has done an outstanding job," says Brian Portnoy a Morningstar analyst, who adds: "The fund is incredibly tax-efficient and has played long-term bets in financial companies and industrial cyclicals to its advantage."

Among the fund's long-term holdings: Fannie Mae (FNM), a Muhlenkamp staple since 1988, Merrill Lynch (MER), which the fund picked up on in 1991, and Conseco (CNC), which has been a holding since 1989. Muhlenkamp, who holds about 30% of the fund in banks and other financials according to Morningstar, says he likes the sector more for its grit than its polish. "It's not a sexy group," he concedes, "but look back over the past decade and it's done as well as tech or healthcare."

But his patience can wear out. The fund parachuted out of tech positions in such stocks as Applied Materials (AMAT), ATMI (ATMI), and Intel (INTC) last March, stocks which had made up as much as 24% of his portfolio at the end of 1999. The quick footwork helped him avoid the nosedive that burned technology investors for much of the year. The fund manager says that today, tech constitutes no more than 9% of his portfolio.

HARD TO DIGEST. What's to take tech's place? Muhlenkamp points to Reader's Digest (RDA) as a stock that has been a slow starter. The publishing company fits the manager's criteria: A ROE of close to 30 and a p-e of 19. Still, since the beginning of year the stock has tumbled 25.5% to a June 1 close of $29.05. Muhlenkamp says he's staying put, nonetheless. "The company's had a setback in marketing Reader's Digest through sweepstakes and that caught us a bit by surprise," he reports. "That said, we think the market's reaction to the stock was overdone."

So far, Muhlenkamp's formula hasn't turned up too many slouches. "If we like a stock's fundamentals and its share price just isn't reacting the way we like, we'll sell on technical reasons," Muhlenkamp says. "The funny thing about management is they can't tell you enough about the things that are going right, but when things aren't, they don't let you know until it's too late to do anything."

Small wonder why, in this environment, Muhlenkamp is keeping an eye on fundamentals. "We're keen on examining earnings growth and revenue growth as good way to ensure that ROE in sustained," he explains. "We want to look for free cash flow, and a tight balance sheet is going to be quite important in this economy. Put it all together, and we should

keep on pulling in the Buicks and avoiding the Yugos." Anyone for a test drive? Anderson teaches journalism at the City University of New York. Follow his twice-monthly Sector Scope column, only on BW Online

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