A Trove of Ideas from an Under-the-Radar Fund

 | Nov 16, 2012 | 2:30 PM EST
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Before we move into a weekend that promises to be full of manatees and football, I want to visit 13HF filings one more time. As expected, the rock stars of the investing world are getting all the attention: The largest hedge fund managers' quarterly moves are being watched like a hawk by the media. While I do review those filings, I find this activity less useful than I did years ago, when no one else was paying attention to them. These days, I get more value following the results from those firms that have great track records, but not as good a press agent.

One of the managers I follow each quarter is Donald Smith & Co. Mr. Smith has been a value investor for three decades, and has a style very similar to my own. The firm buys stocks trading below tangible book value that haven hidden or undervalued assets, as well as the potential for significant earning potential over the next two to four years. A little digging around the Web tells me the firm has delivered solid returns to investors over the past 30 years, and has better than doubled market returns. As with so many of my favorite managers, Mr. Smith has direct ties to the father of the value-investing discipline -- while at UCLA, he volunteered to help Ben Graham research stocks with low price-to-earnings ratios.

The firm was more active than usual in the third quarter, taking profits in some stocks that have seen pretty good moves over the past two years. Refiner Tesoro (TSO) has been a huge winner over the past several years, and Mr. Smith reduced his stake in it by more than 60%. He also owned shares of Kimball International (KBALB), one of my favorite holdings in 2012. The stock has more than doubled, and the firm reduced its stake in it by one-third. He appears to share some of my concerns about utility stocks, as he also reduced his position in Avista (AVA).

He continues to add to his gold-mining stocks, as well. I have talked about this sector a few times in the past couple of months. I do not believe in gold as an investment, but when you value the miners as businesses, some of them look cheap. Jewelry, industrial and perhaps misguided investment demand should provide solid demand even as mine output continues to decline. That should help margins for the surviving companies. Mr. Smith's funds were buyers of AuRico Gold (AUQ) in the quarter.

One of his newest positions will look familiar to Real Money readers. Over the course of the summer, the firm bought Nabors Industries (NBR), the world's largest land-drilling contractor. The company has seen weak oil and gas prices cap revenue and profit this year, and the fourth quarter may see delayed spending as customers near the end of their 2012 drilling budget. Drilling trends will remain soft into 2013 unless we see an increase in natural gas usage activity from a cold winter. However, Nabors will be the first to rebound when activity does pick up. In the meantime, the stock is very cheap at 70% of book value.

Another new buy for the quarter also trades at the 70% of tangible book level. Stancorp Financial (SFG) is an Oregon-based company that offers insurance programs and asset management services. The firm has seen some weakness in its group insurance business because of the weak economy and lack of job growth. Like most insurance companies, Stancorp is also being hurt by the low-interest-rate environment and a resulting decline in investment income. However, the company has been able to grow book value, and it recently raised its dividend by 4.5%. The business environment is difficult, but the stock is cheap and the company has a good balance sheet. When we see job growth on a consistent basis in the future, this company should see strong growth on its top and bottom lines.

Mr. Smith appears to still be a big believer in the future of airlines, as he increased his stake in Southwest Airlines (LUV) and JetBlue (JBLU) in the quarter. He also owns share s in U.S. Airways (LCC), Air France and Republic Airways (RJET). In addition, his fund purchased more shares in aircraft-leasing firm Aircastle (AYR) during the three-month period.

It is highly unlikely we will see Donald Smith or any of his associates on the cover of the financial weeklies anytime soon, nor are we likely to see them on television every few days. However, it is quite probable that these stock picks will continue to be a valuable source of information and potential profits for long-term investors.

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