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Small Cap Picks for the Long Haul

Katie Rushkewicz Reichart, CFA

Katie Rushkewicz: I am Katie Rushkewicz with Morningstar. I'm here with Jeff Cardon of Wasatch Small Cap Growth. Thanks for being here, Jeff.

Jeff Cardon: It's great to be here Katie, thanks.

Rushkewicz: About 17% of the fund is invested in foreign stocks. I know that Wasatch has expanded internationally, its international efforts over the years. Can you talk a little bit about that?

Cardon: Well, you know it really started way back when maybe 15 years ago, we've invested in companies that traded on the American stock exchanges that were foreign, and over the years, what we found is that more of our domestic companies were competing on a global basis. And we felt that to be a world class investor, you really had to understand what was going on internationally.

And so, we've spent a lot of time and money building up what we think is a world class international team, and we like to leverage that team so that we can really get a feel for what's happening here in the United States, but in addition, we also think that there is great opportunity overseas. And we've always really struggled with the idea that borders mean a lot in terms of investing, because we have American companies that are traded in America who do most of their business overseas. And so, there is a big gray area, and we've really fought hard against thinking of the world in terms of black and white, and think of it as more gray. And we just go out and try to find the best growth companies that there are in America, and we do it consistent with our policy of our fund, but if we can we'll find the best companies anywhere and invest in them. So that's really what our investment philosophy is internationally.

Rushkewicz: Domestically speaking, Hibbett Sports has been in the fund for years, why is it such a great long-term holding?

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Cardon: Well, it's funny, I'll connect the dot that maybe you wouldn't think would get connected, but we owned a company and still do called O'Reilly Automotive and it was in our portfolio, I think, for maybe 20 years, and O'Reilly was a retailer there. If you know an AutoZone, they sell auto parts for cars, and the really interesting thing about O'Reilly, back in those early days, is they were a regional company and they expanded across the United States. And one thing about their product, auto parts, is it's a very stable product, so it's unlike a women's fashion retailer where you could get in and out of fashion, and the company could really have problems with that. Selling auto parts is a very stable business. And in fact when the economy weakens, the demand for auto parts goes up, because people drive their cars longer. So, we really like the idea of a super well run company starting out in a region and then growing across the country in a business that's stable.

And so, now I'm going to connect it back to Hibbett; Hibbett is a sporting goods company in small towns and they have come out of Alabama and they sell a lot of kids baseball uniforms and bats and balls and basic sporting goods equipment.

And it's not exactly like O'Reilly, but it has the same theme we think, a very well run company, coming out of a region, and we think that they'll expand across the country. And so, really you're in like the third inning of a maybe a 10 or 15 years growth opportunity and that's what we like to do. If you look at the top 10 holdings of our fund there, the length of stay is really high, I mean, 8 years, 10 years, 15 years, that kind of thing. And so Hibbett really just follows that.

Rushkewicz: Your strategy focuses a lot on high quality growth companies, but then also you do own some more speculative names like biotech companies, Seattle Genetics. I'm curious how you become comfortable with a name like that when it has negative earnings.

Cardon: Well, the way we do it, first of all, we have very few of our companies have negative earnings. If you look at our portfolio 80% of our portfolio names have no debt in them. So they have net cash. And so when you buy the Small Cap Growth Fund, you're really buying super high quality. And over the years as growth managers we've always felt uncomfortable saying it's all going to be the super high tenure growth stories. We like the idea of putting small amounts of capital in our fund in more aggressive names like high technology would be a classic example of that or biotech that you mentioned.

And instead of during the Internet bubble where we had competitors had their top 10 stocks were all dotcom names, which didn't make any sense to us. We think as growth investors it's okay to buy faster growing companies, again tech is the perfect example of that.

But when we do that, we take really careful weight, and so we'll have a portfolio of these Hibbett-type companies with 5%, 10% kind of weights in them. And then there will be a long tail of lower weight companies that are going to be a little bit more risky. But so we think really hard about those positions, and when you notice some names in there that look like quite aggressive for Wasatch in fact it's very consistent with the way we run the portfolio over the 30 years I've been at Wasatch.

Rushkewicz: And a recent hold or a recent stock that you bought in the first quarter was Ritchie Bros. Auctioneers. I am curious why you decided to buy it.

Cardon: Yeah, it's really funny, because Richie Brothers is a name that we followed for a long, long time. It's a name – it's a company that we really admire. They do auctions for large machinery, I mean, if you think about a big Cat tractor, it would be that kind of thing. And what's happening is that business is becoming very much global and so farmers or construction workers who want to sell this equipment can do it through a Richie Brothers auction as opposed to making a bid in their local community through the newspaper. And so it's very much of a way that these people can efficiently move their equipment around.

And we haven't been able to buy Richie Brothers, because the stock has just been expensive over the years. And of course with the global recession, you can imagine that business is somewhat cyclical. And it's still a little bit expensive. So we've take a small weight. It's like less than a three-quarter weight in the portfolio, which again with that previous conversation we had, will go way higher on a name like Richie Brothers, if their valuation gets better.

So depending on how this whole economy plays out, if there is a weakening economy or weakening stock market, and Richie Brothers stock weakens further. That's a name that we can easily see owning a lot more of.

Rushkewicz: Well, thanks for being here, Jeff.

Cardon: It's always a pleasure. Thanks, Katie.

Rushkewicz: I'm Katie Rushkewicz for Morningstar. Thanks for watching.,