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Investing Specialists

A New Pick from Morningstar's Small-Cap Superstars

We highlight one new 5-star stock held by leading small-cap fund managers.

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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.

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. After running our screens and analyzing the respective merits of the Superstars' holdings, we'd like to highlight our latest pick,  Markel Corporation (MKL) (which is technically a mid-cap company, with a market capitalization of $3.6 billion).

According to Morningstar equities strategist Justin Fuller, Markel's strong underwriting and disciplined investment approach garner this insurer a narrow moat. The firm's underwriters focus on developing expertise in specialty insurance products that are too small or too difficult for larger rivals to underwrite. This helps to avoid fierce pricing competition. Fuller also likes the fact that Markel's underwriters' total compensation is contingent on the product generating underwriting profit, which means underwriters are compelled to refuse business that doesn't meet the firm's rigid pricing criteria. The company generates significant float (temporary cash holdings that accrue because premiums are received well in advance of claim payment), which it invests to boost shareholder returns. The firm has a successful long-term track record in public equity investments and has started making private-equity investments as well, a move that Fuller endorses. Risks for the company include the prospect of management overpaying for a large insurance acquisition, exposure to asbestos claims, and increased competition from Bermuda startups.

We'd note that several of our favorite fund managers hold a position in Markel, including Charles T. Akre Jr. (who has about 10% of his  FBR Focus(FBRVX) assets invested in the company) and G. Staley Cates and O. Mason Hawkins (who have nearly 5% of their  Longleaf Partners Small Cap (LLSCX) fund invested in the business). The 5-tar stock also currently trades at about a 37% discount to Fuller's fair value estimate of the company.

Our New Small-Cap Superstars' Blog
If you'd like to learn more about Small-Cap Superstars, we'd encourage you to check out our new blog, which features more discussion on our stock picks. The blog also provides you with a forum to share your thoughts on these stocks as well as to ask questions. Click here for more.

Performance of Previous Small-Cap Superstars' Picks
Overall, we continue to be pleased with the performance of our past picks. Five of our stocks have delivered outstanding returns and handily outperformed the Russell 2000, while three just modestly trailed the benchmark. We remain very bullish on  Cimarex Energy (XEC),  American Reprographics (ARP),  International Speedway (ISCA), and  Carter's (CRI), all of which are rated 5 stars and continue to be held by several of our favorite fund managers. (For more on Carter's, see my recent blog post.) We also see further upside for  Whiting Petroleum (WLL) and  Navigant Consulting (NCI). At the time this article was published, both  UCBH (UCBH) and  Pinnacle Entertainment (PNK) were under review by our Morningstar analysts, as they reassess their assumptions for these companies. The two stocks, however, continue to be held by many Small-Cap Superstar fund managers.

 Small-Cap Superstar Picks


Fair Value*
Return (%)**
Russell 2000
UCBH Holdings (UCBH)Under ReviewUnder Review101.398.3
Whiting Petroleum (WLL) 0.7786.8100.5
Cimarex Energy (XEC) 0.6546.860.5
Navigant Consulting (NCI) 0.7634.047.7
Amer Reprographics (ARP) 0.5634.047.7
Pinnacle Entertain (PNK)Under ReviewUnder Review2.3-0.8
Int'l Speedway (ISCA) 0.62-15.6-3.5
Carter's (CRI) 0.64-21.3-7.6
* As of 7/25/2008
** 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; and 6/30/2008 for UCBH and PNK) to 7/25/2008.

 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.