A Value Manager Who Thinks Small

Buzz Zaino is a contrarian. Growing up in the 1950s, the Bronx (N.Y.) native rooted for the Brooklyn Dodgers--the Subway Series rival to his borough's home team, the Yankees.

Now, Zaino's contrarian bent has found an outlet in his approach to investing. The manager of the $275 million Royce Opportunity Fund hunts for small-cap value plays. That entails buying beaten-down stocks, betting on recovery.

For the past three years, that strategy has suffered as small-stock buyers clamored for tech stocks, not the gritty manufacturing and industrial companies of the value universe. But unlike most value managers, Zaino thrived. In the three years that ended on Dec. 8, Royce Opportunity returned 16.6% vs. 1.8% for its small-cap value peers. This year, it is up 18.3%, vs. 12.5% for its rivals.

Many value managers shun technology, but Zaino--who once worked as an office-equipment analyst--is not afraid to jump in when the sector gets cheap. "That's what a value manager should do--go where the best values are," Zaino says. His high-tech pick for the BUSINESS WEEK contest is Westell Technologies, a maker of telecommunications products that sells for 5.38, or just about book value (assets minus liabilities).

Zaino also finds value in small suppliers to the aerospace and defense industries. Many have yet to recover from Asia's 1998 downturn, when overseas buyers canceled orders. That's left Fansteel (FNL), Titanium Metals (TIMET), and Evans & Sutherland Computer (ESSC) each selling below book value. Another, Ladish Co. (LDSH), sells at a 44% premium to its book value but is cheap compared to its industry and growth prospects.

The rest of Zaino's picks hail from a number of industries. Contract manufacturer Deswell Industries Inc. (DSWL), says Zaino, is highly profitable, cash-rich, and debt-free. At 15.50, it's trading at 6.7 times next year's projected earnings of $2.30 a share. Another favorite is staffing company Volt Information Sciences Inc. (VOL) Hit by big expenditures on one of its divisions, Volt's stock has slid from 39.88 to 19.13 this year. Zaino figures the stock will return to 39 if, as he expects, earnings rise from $2.25 this year to $2.60 in 2001.

In the health-care sector, Zaino likes medical-product manufacturer Colorado MEDtech Inc. Although a thwarted suitor bid 12 a share for the company, the stock is languishing at 4.47. Thanks to new management, Zaino thinks it's only a matter of time before the $12 bid looks too low. "This is a bet on management," he says.

Likewise, he says, retailers Donna Karan International Co. and Spiegel Inc. are trading at or below discounts to their book values. But the turnaround under way at each company should jump-start earnings, propelling their stock prices up as well.

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