Liquidity improves, however, as more research firms pick up coverage of a stock or if it is added to a small cap index such as the Russell 2000. This creates incremental demand stock and quite often improves the multiple.

Q:  Could you give us examples of how the information advantage has worked out in your favor in the past?

A: Currently we own a company called Raven Industries based in South Dakota. We learned of them about three years ago by screening for 20% earning s growers that had no street coverage at the time. This was despite the company having been around for 50 years and the fact that the stock had more than doubled in the previous two years. We took some time to research the company in late 2003, trying to understand their business. Essentially, they have four business lines. Their original business was making high-altitude research balloons for NASA back in the 50’s and the 60’s. In the mid 90’s they had become a mini-conglomerate, owning 11 different businesses. Unfortunately they were not earning an appropriate return on capital for the investments they had made.

In the late 90’s they called in Holt Advisors, now owned by Credit Suisse First Boston. Holt focused on returns on invested capital and advised Raven on how to improve their returns. Management successfully implemented the recommendations and began shedding underperforming segments in the late 90’s. In the last 6 years Raven has grown their earnings more than fivefold. As the company’[s cash flow began to grow, they used excess cash to buy back stock. Because they were still unknown, they were able buy back stock in the public market at book value. The stock now trades at close to 6 times book value. Book value is not a metric we use as growth managers, but it gives you an idea of how cheap the stock was, partly because many people did knot know the story.

We took the time to go through the different business units, thinking that there were some secular drivers there. For example, they have a growing business in engineered films where the products are sold to the energy, agricultural, and housing industries. They are one of the few suppliers of disaster film for hurricanes. In late 2004 they began to get more coverage because analysts’ attention was drawn by the plastic film orders following the 2004 hurricanes season.

One analyst picked up coverage with a sell based on the belief that the 2005 hurrricane season would not match 2004. The analysis also did not fully appreciate the other growth drivers for that business segment. The stock sold off on this new coverage, but we bought more because we knew that the hurricane business was small and transitory and was not the real driver for Raven. They have continued to grow earnings and we still hold the stock. Liquidity has also improved, as coverage has expanded and the stock is now included in the Russell 200. Originally we bought the stock under $15 and now it is about $30. We’ve taken some profits when the stock has appreciated rapidly and we’ve added some back around oura core position when we think its oversold.

Q:  Would you describe your sell discipline?

A: A great deal of our turnover comes from what we call trimming and reseeding. When a position becomes 3% of the portfolio, we monitor it closely and generally take profits. We don’t let any single name dominate the portfolio, so our top ten names are generally less than 25% of the fund’s assets. After we have trimmed some of our winners, we often look to rebuild postion in names that may be out of favor.

Fundamental disappointments, particularly when we feel the original investment thesis may no longer be valid warrant immediate consideration for sale. Short term or transitory disappointments will trigger a review, but we like to circle back with company management and try to fully understand a situation before selling.

Q:  Based on your experience, how much of the sector knowledge is critical? Or is the company-specific information more important?

A: We find small-caps exciting because of the company-specific knowledge and finding the companies before other people do. You don’t always have to be the first one there, but you want to be there before the crowd. Knowing the company is critical because in the current market environment, you have to either trade rapidly and frequently or have a longer term perspective. As a long-term manager, we think we can make the big returns come from buy and hold approach. If a company misses expectations by a penny because they are hiring or investing for future growth, their stocks can sell off 10 or 15%. We think our shareholders benefit more by seeing a stock double or triple over three years rather than selling a stock down 10% and trying to get back in.

Q:  How many names do you have in the portfolio and what’s your turnover?

A: We have held beetween70 to 90 names over the last four years. The turnover has been between 50% and 60% per year on average, lower than most smallcap growth funds. We tend to have fewer names and lower turnover because we’re trying to spend more time on the names we own to establish a higher level of conviction.

Q:  How do you monitor and control the risks?

A: We control risk by analyzing stock weights, sector weighs and by diversification of growth rates. We also place a lot of importance on a company’s financial strength and quality, as well as the liquidity in the company’s shares. Our sell discipline helps to maintain this balanced approach to risk.