Q&A: MARIKO O. GORDON — "YOU CAN’T HAVE 200 BEST IDEAS"

With more than 3,000 stock mutual funds in existence, startups need a shtick. So when Mariko O. Gordon rolled out her Daruma Mid-Cap Value Fund in August 1996, she stuck to her strategy of holding no more than 35 stocks, making the fund live up to its name — after a Japanese folk doll that is a symbol of focus and resilience. She’s hardly the first to run a tight portfolio, but she’s already at the top of her game. No-load Daruma handily beat its benchmark and outpaced its peers by more than 10 percentage points in the year ended Feb. 28.

No stranger to money management, Ms. Gordon recently sold her stake in a former employer, Valenzuela Capital Management in New York. Before co-founding $75 million-asset Castlerock (soon to be renamed Daruma) almost three years ago, she also ran money for New York-based Royce & Associates, a $2.5 billion shop.

Q Describe your style and process for picking stocks.

A I’ll look at everything. It’s not like I have one or two magic things.

When I see some of the momentum guys show up in my stocks, it’s usually a sell signal for me.

Q What’s your definition of a value stock?

A A classic stock that we love is Keane (Inc. of Boston), a contract (computer) programmer. Sales and earnings growth had decelerated a lot. It all had to do with IBM, which consolidated its suppliers and forced price concessions.

If you took away the impact of the IBM business, their business was growing 20-25% and you were paying 12 times earnings. The business is great and the industry is great, and the year 2000 opportunity took the multiple up. We ended up selling it at something obscene like 34 times earnings.

Q How long do you typically hold a stock?

A We are looking for 50% upside in two years based on what we think the earnings are going to be. With 35 stocks you need something that is going to earn its keep. It’s got to be something that’s meaningful with little downside.

Q For instance?

A International Multifoods Corp. is a big position. You have a company that’s been
a chronic underperformer, but the businesses are solid and there is new management taking a fresh look at them.

Another interesting holding is Tupperware Corp. A lot of the company’s problems are self-inflicted. They grew faster than they could handle in Latin America, and are repairing a couple of major sales engines. Meanwhile you’ve got a great brand and distribution system. The company throws off a lot of cash. You won’t see year-over-year improvement until the second half of this year. The stock kind of blew up and drifted down to $21 and now it has settled back up in the high $20s.

Q Do you focus on specific sectors?

A Our largest sector is business services at 16%. Antec Corp. (of Rolling Meadows, Ill.) is in there. They make and distribute widgets that are used by cable companies to upgrade their plants. Tele-Communications Inc. is a very big customer. When TCI shut down its capital spending, an enormous amount of revenues vaporized. The company has done a good job taking costs out and TCI has indicated it will loosen its purse strings.

We would invest in companies that don’t have any earnings but have positive cash flow. For example, Wang (Laboratories Inc.) is something we’ve owned a long time. It came out of bankruptcy court with fresh-start accounting, good-will amortization. So they reported negative earnings but you had real cash flow, as opposed to a biotech stock that is still burning through cash.

Q By concentrating on 35 stocks, aren’t you adding risk?

A You can’t have 200 best ideas. Concentration doesn’t have to imply more risk. From a security diversification point of view, that’s plenty of stocks. And we don’t take too-big sector bets.

Q When do you sell?

A It’s a lot easier to buy than sell. We sell when our investment thesis is wrong, when something reaches our sell target or when there is something that has more upside.

It can be difficult to let go of something and watch it go up, but you have to do it.

You have to sort of kiss them goodbye and sign the no-regrets cl
ause, and wait until they miss a quarter and the growth guys puke up the stock and you can buy it cheap again.

Q What do you think about the market’s valuation?

A It’s hard to talk about the market when it’s not acting like the market.

By any traditional measure blue-chip large-cap stocks are overvalued. The gap between small- and mid-cap and large-cap is enormous and might actually be at historical highs.

Am I overwhelmed with a lot of screamingly cheap ideas? No. Do I think that there are opportunities? There are 10,000 stocks out there. I ought to be able to find 35 that are reasonably cheap.

Vitae

Mariko O. Gordon, 36, president and chief executive officer, Castlerock Capital Management Inc., manager, Daruma Mid-Cap Value Fund.

Daruma Mid-Cap Value Fund: (assets: $2.2 million): year-to-date, 5.22%; one-year, 39.97%.

Mid-cap peer group: year-to-date, 7.03%; one-year, 28.87%.

Standard & Poor’s mid-cap 400 index:

year-to-date, 6.22%; one-year, 36.52%.

Fund expenses: Capped at 1.5% a year.

Returns through Feb. 28 Source: Lipper Analytical Services Inc.