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Investing Specialists

The Return of Morningstar's Small-Cap Superstars

We highlight two 5-star stocks held by leading small-cap fund managers.

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As we discussed in a series of articles last fall, 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.

Deciding which stocks to highlight is 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 a way to further refine our selection process.

Two New Picks from Our Small-Cap Superstars
After running our screens and analyzing the respective merits of the Superstars' holdings, we'd like to highlight two new stocks, UCBH Holdings and Pinnacle Entertainment. See our analyst takes on these stocks below.

 UCBH Holdings (UCBH)
UCBH is just one of three banks dominating an attractive niche that serves the ethnic Chinese population in the United States. Senior stock analyst Michael Kon likes UCBH's customer-focused strategy. The bank presents products and services in various Chinese dialects, develops relationships in the community, and customizes offerings to meet the unique demands of its target demographic. Kon also notes that the Chinese American community grows much faster than the total U.S. population, generates higher average income, and tends to saves more of that income. In addition, Chinese Americans are more loyal clients. These differences translate into solid growth in deposits, superior credit quality, and a very sticky deposit base. Risks to the stock include heavy exposure to California's real estate market and a sizable construction loan book, which seems to be performing worse than its peers.

 Pinnacle Entertainment (PNK)
Senior stock analyst Sumit Desai believes that Pinnacle Entertainment could join the major leagues of casino operators. The company owns eight properties in regional gaming markets such as Louisiana and Indiana, as well as smaller properties in Argentina and the Bahamas. Pinnacle demonstrated its casino development capabilities with L'Auberge du Lac, which was completed in May 2005. The casino is now the top property in Louisiana, and expansion is already under way. The company also has ambitious plans for St. Louis, with Lumiere Place, which opened in late 2007, and with a second property slated for a mid-2009 opening. Desai believes these two casinos will become the premier properties in that market. Headwinds for the company include the challenging consumer environment and poor credit market conditions, which could make future developments more dicey.

Performance of Previous Small-Cap Superstars' Picks
Overall, we've been very pleased with the initial results from our picks last fall. Several of our favorite fund managers, along with Morningstar senior stock analyst Justin Perucki, deserve credit for our two best performers,  Whiting Petroleum (WLL) and  Cimarex (XEC). We also give kudos to a handful of our superstar managers and senior stock analyst Brett Horn for the nice runup in  Navigant Consulting's (NCI) stock. The only pick that has not outperformed the Russell 2000 is  Carter's (CRI). We'd note that Morningstar analyst Michelle Chang cut her fair value estimate on the stock in February to account for a weaker outlook for the current year. Still, several of our fund managers have held on to the shares, and Chang believes the stock remains undervalued. We also continue to be bullish on  American Reprographics (ARP) and  International Speedway (ISCA).

 Previous Picks
 

Morningstar
Rating

Price/
Fair Value*
Total
Return (%)**
+/-
Russell 2000
Whiting Petroleum (WLL) 0.92121.8137.0
Cimarex Energy (XEC) 0.8182.898.0
Navigant Consulting (NCI) 0.8041.757.0
Amer Reprographics (ARP) 0.57-9.45.8
Int'l Speedway (ISCA) 0.63-9.44.3
Carter's (CRI) 0.57-30.1-14.8
* As of 6/27/2008
** Total return from eve of article publication date first highlighting the stock pick (10/02/2007 for WLL, XEC, NCI, ARP, and CRI; 10/30/2007 for ISCA) to 6/27/2008.

Some of Our Favorite Small-Cap Fund Managers
All the fund managers that we selected primarily focus their efforts on the small-cap space, boast excellent track records, and generally perform a bottom-up analysis of individual stocks (that is, they don't blindly buy stocks without concern for the underlying valuation). Premium Members can learn more about these managers by reading Morningstar's Analyst Reports written by our mutual fund staff (just click on the fund name). If you're not a Premium Member, you can still read the reports by taking a free 14-day trial.

 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)Ric H. Dillon Jr., Thomas P. Schindler
 FBR Small Cap (FBRVX)Charles T. Akre Jr.
 FPA Capital (FPPTX)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 (KSCVX)John L. Keeley Jr.
 Longleaf Partners Small-Cap (LLSCX)G. Staley Cates, O. Mason Hawkins
 Pennsylvania Mutual Inv (PENNX)Charles M. Royce
 Presidio (PRSDX)Kevin C. O'Boyle
 �  Royce Select I Inv (RYSFX)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 (SCMVX)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, John Mazanec
 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.