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Finding High-Quality in Small Places

Jeff Cardon, manager of Wasatch Small Cap Growth, tells Morningstar that this tough market gives the high-quality companies preferred by his fund an opportunity to shine.

Karin Anderson: Hello. My name is Karin Andersen. I'm a mutual fund analyst with Morningstar. I am here today with Jeff Cardon, the President of the Wasatch Advisors and also a manager of Wasatch Small Cap Growth, one of our Analyst Picks in the small cap growth category. Hi, Jeff. Thanks for being here.

Jeff Cardon: Thanks for being here, Karin.

Anderson: Thank you. First, just to give people a sense of kind of what you're looking for in a small-cap firm. You're focused on firms that have earnings growth potential of 15% or more for the next five years. So given that you look for this sort of growth company, I'm just wondering if you can talk a little bit about how you are navigating 2008 and how you are stress testing some of your long-term holdings and perhaps also things that you are interested in purchasing.


Cardon: The thing about our strategy--I've been managing this portfolio since its inception, I think as you know, since '86. And so, our strategy has never changed. I think in an environment like we had last year, that's a nice thing to have because you're not floundering around wondering what you're supposed to do. And so our strategy is a high-quality growth strategy. A couple ways we can define what high quality is: Quantitatively, if you look at our portfolio, over 75% of our companies don't have any debt on their balance sheet.

And so when you go through an environment like we just went through in '08, where people are wondering if companies are going to survive and what is the debt structure, we didn't have any issues like that. It was more, the prices are coming down. But the franchises, the businesses that we own, really hadn't changed very much. And so, that's one important element in terms of how last year looked to us.

The other part of it, too, in terms of quality is we spend a lot of time looking for great managements to run the companies that we invest in. And so we know the people. We have a really good sense of how passionate they are about running their businesses. And of course, that's not going to change in a tough year.

And I think our view of tough markets like this is that it gives high-quality companies really an opportunity to shine. And if you look at our long-run track record, small-cap growth, even though it's a risky growth in a risky growth sector, we outperform in down markets. And I think why that happens is there tends to be a gravitation towards quality in those kinds of markets.

That doesn't mean we weren't down last year. It was a very painful year. But if you look at the relative performance of our fund, in the summer of '08 we started outperforming quite dramatically. And that was coincident with oil prices peaking. And then, of course, everything else fell apart, and our relative performance picked up even more during that period.

And so I think, when you get into bubble markets where people are looking for something like an oil company that's margins are going from break-even to 3%, that's hard for us quality companies to compete against because those are 100% earnings growth. They're not going to last, of course, because they're cyclical.

But a slow growth economic environment is really good for us because 15% all of the sudden looks really good. And so that's how we think about what's happening in the world. We think it sets up really well for our strategy, but of course it's a 30-year strategy we've pursued and we haven't really changed it. We think it's a decent time to focus on long run kind of issues.

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