Here we scrutinize the company's financial statements and SEC filings, review analysts' reports, if any, talk or meet with the management, competitors, and customers. What we do in this step is to try to identify if there is a positive dynamic of change that is occurring within the company or throughout the industry that is unrecognized. The most important criteria for us is an attractive valuation, along with a positive dynamic of change. This may include elements such as management changes, new products, industry consolidation, insider stock purchases, regulatory change, or even the right point in the business cycle. After all that screening, you must own some real fundamental gems.
Valuation can be a function of asset value, cash flow, or free cash-flow multiples.
In the Strong Advisor Small Cap Fund, our average stock is priced at 12 or 13 times this year's forecast earnings. However, that still understates the portfolio's fundamental merit. Having solid fundamental valuation gives you a fair degree of downside protection when the market gets volatile. We certainly saw that happen last year. Dan Lew, who was with me when we started the Advisor Small Cap Value Fund, will work with me.