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Investing Specialists

A Stock for Your Radar from Our Small-Cap Superstars

We provide an update on our performance and add a stock to our watch list.

As we discussed in previous articles, one of the best and easiest ways to screen for new investment ideas is by monitoring the activity and holdings of successful fund managers. The aim of Morningstar's Small-Cap Superstars is to combine some of the best ideas from our favorite small-cap fund managers with our fellow analysts here at Morningstar. (Click to subscribe to free Small-Cap Superstars e-mail alerts.)

Performance Update
We launched Small-Cap Superstars a little more than a year ago and have been encouraged by the performance of our stock picks in this very difficult market. An investor buying equal stakes in our stock picks, at the time of our recommendations, would have preserved his or her capital and even generated a modest profit as of Oct. 14, 2008. Considering that our benchmark, the Russell 2000, is down nearly a third since our first article was published, we consider this a resilient performance. Plus, we see further upside for all of our stock picks, which average a price/fair value ratio of just 0.56.

 Small-Cap Superstar Picks
Size of
FV Est*
UCBH Holdings  NoneExtreme0.84162.4181.7
Navigant Consulting  NarrowMedium0.7226.458.8
Cimarex Energy  NarrowMedium0.546.839.2
Whiting Petroleum  NarrowHigh0.43-1.930.5
Markel (MKL) NarrowHigh0.59-9.412.7
Carter's (CRI) NoneMedium0.65-20.811.6
Administaff  NarrowVery High0.51-25.6-2.5
Int'l Speedway  WideMedium0.52-36.9-5.8
Amer Reprographics (ARP) NarrowMedium0.38-40.3-7.9
Pinnacle Entertain  NoneVery High0.45-52.3-33.1
* as of 10-14-08
** Total return from eve of article publication date first highlighting the stock pick (10/2/2007 for WLL, XEC, NCI, ARP, and CRI; 10/30/2007 for ISCA; 6/30/2008 for UCBH and PNK; 7/29/2008 for MKL; and 8/26/2008 for ASF) to 10/14/2008

As seen in the table above, six of our picks have handily outperformed the Russell 2000, while three modestly trailed the benchmark and just one,  Pinnacle Entertainment , underperformed by a wide margin. We remain very bullish on five of our picks,  Cimarex Energy ,  Whiting Petroleum ,  Carter's (CRI),  International Speedway , and  American Repographics (ARP), all of which are rated 5 stars and are still held by several of our favorite fund managers.

Our Morningstar analysts are not quite as bullish on  UCBH ,  Markel (MKL),  Administaff , and Pinnacle Entertainment. However, many of our favorite fund managers continue to hold positions in these four stocks. That leaves  Navigant Consulting , which is rated 4 stars but is no longer as widely held by our Small-Cap Superstars. 

A Stock for Your Radar
As a reminder, deciding which stocks to highlight as picks is pretty simple: First, the stock must have a Morningstar Rating of 5 stars, and second, it must be held by at least a handful of the 25 small-cap fund managers on our watch list (see below). We also consider the size of the holding in the respective funds as well as their recent trading activity as ways to further refine our selection process. After running our screens and analyzing the respective merits of the Superstars' holdings, we did not uncover any additional stocks that presently meet our criteria. But, we've added one stock to our watch list that we'd definitely consider highlighting if it  pulls back into 5-star territory.

The company is narrow-moat-rated  MSC Industrial Direct (MSM), which distributes industrial supplies through field salespeople, catalogs, and the Internet. The company, which stocks 590,000 less-common items for next-day delivery (compared with 140,000 at Grainger), provides unmatched selection and quick turnaround times. Despite its higher inventory carrying costs, MSC is also a low-cost provider, according to Morningstar associate director Matthew Warren. Warren expects that MSC will gain share as the industry consolidates, which should lead to increasing free cash flows. Risks include a deeper and/or longer than expected recession, domestic manufacturing moving offshore, and the integration of an acquisition. For Warren's full take on MSC,  click here to read his Analyst Report. MSC is currently a holding in seven of our Small-Cap Superstar's mutual funds. The stock is rated 4 stars and currently trades at about a 24% discount to our fair value estimate.

 Manager List
 Baron Growth (BGRFX)Ronald Baron
 Baron Small Cap (BSCFX)Clifford Greenberg
 Century Small Cap Select Inv (CSMVX)Alexander L. Thorndike
 Champlain Small Company Adv (CIPSX)Scott T. Brayman
 Columbia Acorn USA A (LAUAX)Robert A. Mohn
 Diamond Hill Small Cap A (DHSCX)Thomas P. Schindler
 FBR Small Cap (FBRVX)Charles T. Akre Jr.
 FPA Capital Robert L. Rodriguez
 Gabelli Small Cap Growth A (GCASX)Mario J. Gabelli
 ICM Small Company (ICSCX)Robert D. McDorman Jr.
 Janus Venture (JAVTX)William H. Bales
 Keeley Small Cap Value John L. Keeley Jr.
 Longleaf Partners Small-Cap (LLSCX)G. Staley Cates, O. Mason Hawkins
 Pennsylvania Mutual Inv (PENNX)Charles M. Royce
 Presidio Kevin C. O'Boyle
 �  Royce Select I Inv Charles M. Royce, Lauren Romeo
 Royce Special Equity Inv (RYSEX)Charles R. Dreifus
 Royce Value Service (RYVFX)W. Whitney George, Jay S. Kaplan
 Schneider Small Cap Value Arnie Schneider III
 T. Rowe Price New Horizons (PRNHX)John H. Laporte
 T. Rowe Price Small-Cap Value (PRSVX)Preston G. Athey
 Third Avenue Small-Cap Value (TASCX)Curtis R. Jensen
 Wasatch Small Cap Growth  (WAAEX)Jeff Cardon
 Wasatch Small Cap Value (WMCVX)Jim Larkins
 William Blair Small Cap Growth N (WBSNX)Karl W. Brewer

John Owens does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.