Q:  Can you give us another example of the difference between undervalued and cheap in your way of calculating it?

A: Most of our opportunities come when a company stumbles for a quarter or two. We will look at those stumbles and what causes them.

Let’s take Kronos Software, as an example. They are a workforce management software company and have a good share of the market in the industry. They had a couple of quarters where they missed earnings expectations due to lower than projected sales. Orders got pushed off to the following quarters and with technology and particular software stocks, this business can be lumpy due to those orders that come in or get pushed off by customers in any particular quarter.

Kronos has a growing market share in that business. The whole workforce management market is growing very well, as more and more companies understand how managing the workforce pro- T cess can save them a lot of money with very little investment. Kronos has a very strong balance sheet and good return on equity. We found that the couple of quarters of missed earnings, where they had stumbled, were bumps in the road that the company had encountered. These bumps were not any sort of indication that the company had a long-term problem selling its software. In our belief, Kronos became an undervalued stock as opposed to a cheap stock as its stock price was hit when it missed earnings expectations.

Q:  What kinds of risks do you monitor and what do you do to mitigate them?

A: We use a bottom-up approach, but we are aware of our sector weights compared to the Russell 2000 index.

Our fund is diversified. We limit our largest holding to 4% and right now our biggest holding is closer to 3%. With approximately 90 names in the fund, the average position size is a little over 1%.

We try and limit the downside risk with the valuation work that we do, using reasonable assumptions and not just continuing a growth mode that a company may have been in over the last year or two. We try and normalize earnings, cash flow, returns and margin assumptions.

Companies go bankrupt because they don’t have enough time to fix operational problems because the balance sheet is potentially overleveraged. If a company has a strong and conservative balance sheet, it gives it the capability to ride out difficulties on the operational side that could come up. A frequent occurrence with smaller companies. We search for companies with conservative balance sheets.