IMS Capital Value Fund
By Lori Pizzani
December 30, 2003

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Here’s a bit of a twist. The IMS Capital Value Fund (IMSCX) managed by IMS Capital Management of Portland, OR. artfully blends two investment styles that naysayers might not believe could peacefully co-exist. The fund scouts out undervalued stocks that have fallen on tough times, but that are on a momentum-like roll, growing earnings, and catching stock analysts’ fancies. The fund manager will pick up likable stocks for a song, just as they appear to be coming out of the woods.

The result? A Morningstar 5-star fund that can hold its ground whether it encounters a raging bull market or a grizzly bear market.

The fund is managed by Carl W. Marker, who is also the founder, president and chief investment officer of IMS Capital Management. Marker has managed the fund since its inception in August of 1996. In this issue, Fundemail’s managing editor Lori Pizzani interviews Carl W. Marker.

For additional information on the IMS Capital Value Fund please visit: http://www.imscapital.com

Fundemail: First, let me ask you about your conversion to the world of no-load mutual funds. I see that you dropped the fund’s front-end sales charges in April of 2003. Why?

Carl Marker: We did have a sales charge for a year, but for 6-1/2 of our 7-1/2 years we had no sales charge. We tried adding the sales charge for a year, but we dropped it because it got us nowhere. There were about 16 different ways that you could buy the fund without a sales charge.

Fundemail: How would you describe the fund?

Marker: We hold a diversified collection of undervalued mid-cap stocks with a momentum bent. We target somewhere between 40 and 60 stocks. We are close to 50 holdings now.

Fundemail: Some investors might believe that “value” and “momentum” are mutually exclusive styles. How do these work together in the fund?

Marker: We’re proving that they can work together. You can find undervalued stocks that are showing initial signs of improving sales, earnings and stock price. The stocks in our fund have an average P/E ratio of 17, which is pretty low as compared to the market. But our earnings growth is 20% higher than the S&P500 index of stocks.

Fundemail: Does your philosophy entail buying a group of value stocks and mixing them with a smattering of pure momentum stocks?

Marker: No. We don’t buy momentum stocks. We buy value stocks with momentum characteristics. In this way, we still have a margin of safety. These are not the frothy companies that made the bubble. These types of companies tend to hold up.

Fundemail: Where does your investment process start?

Marker: We start with 3,500 mid-cap stocks and pare that down to about 500 that have value characteristics. Then we look for undervalued stocks that fit into the seven or eight strategic areas -- we call these the “fast moving streams” -- which have historically made the most money. Everything we buy has to fit into one of these fast moving streams.

Then we look for “seasoned” companies; those companies that have been down and out for the last 18 to 24 months. We’ve found that about 80% of these companies are long-term growers, but we’ve also seen that it can take two to two-and-a-half years for companies to lick their wounds and get back on track. We try not to buy too early. We buy them when they are starting to show some movement, when they are still undervalued but are starting to flash some signal of coming back.

Fundemail: Do you rely on identifying certain “catalysts for change” that will bring a company back to life, as some other value managers do?

Marker: No we don’t. We are smart enough to know that we don’t know why a company finally turns the corner. There is not usually an obvious reason. But earnings revisions, earnings surprises, an upturn in sales can cause a turnaround in the stock price.

We don’t necessarily care why it turned around. We are catching it closer to the inflection point than a deep value manager. We’ve found that it doesn’t pay to get into a turnaround situation too early.

Fundemail: Would you describe the “value” part of your value-plus-momentum investment style?

Marker: We use a 36-point scoring model. Some are valuation related and take into account a stock’s price/earnings, price/sales, price/book, and price/cash flow. We ask historically, what’s the market typically been willing to pay for their shares. We look at debt, margin improvement, the use of assets, and improving inventory.

We also look to identify good businesses using some 10 to 12 points of our model. We look for long product cycles, high barriers to entry and low capital intensity.

We do have representation in all of the S&P 500’s sectors, but we tend not to favor energy, utility and capital goods companies because we’ve found that’s not where the money has been made over the long-term.

Fundemail: You mentioned fast moving streams. Which ones are the movers and shakers now?

Marker: Technology, healthcare, and financial services. Technology companies, especially software and services companies, have low capital intensity and high margins. Healthcare includes drug companies which have patents on drugs, and the financial services sector is leveraged.

Overall, we focus on sectors where we find good businesses and which can benefit from the demographics of the U.S. population.

Fundemail: Do you have any concerns that the good news the new Medicare legislation brought to drug companies will be offset by the push to offer cheaper drugs sold in Canada?

Marker: We are not concerned. We’ve been through the ups and downs of healthcare legislation. There’s still a huge demand for healthcare services.

Fundemail: Let’s jump to the momentum portion of your investment equation. Please tell us about your strategy.

Marker: We look for earnings momentum in two ways -- has a company had an earnings surprise where they have beat the Street’s predictions, or an earnings revision? Are analysts’ expectations rising? We like to see an upward line. We like to see a sign of positive development and concrete change that explains what’s happening.

We also look for price momentum, and for positive relative strength in a stock over a 200-day moving average. Is the price rising because the market is noticing the company? Is there another negative that’s weighing down the price even if earnings are up?

Fundemail: Once you do find a company to buy, how large a position might you take?

Marker: Two percent is the average starting point for us. Sometimes we go in with a stock being as much as three percent of the portfolio; sometimes only one percent. We actually don’t buy that many companies or even research many companies. But when we do decide to buy, we are pretty sure of the company. We don’t buy unless we think we can hit a double or triple. We’re looking to hit the cover off the ball.

Fundemail: Would you tell us about your sell discipline?

Marker: There are two things that cause us to sell and the two have to happen together, hand-in-hand. If a stock has exceeded the price target we have set, we would sell. Sometimes we adjust that price target. At the same time, the stock must have demonstrated to us that it has lost its momentum. Most value managers sell if the stock grows to a certain price, so as to not become a growth manager. We require both conditions -- it exceeds our target and the momentum stops. We own our companies for three to five years on average, but at some point, companies lose their momentum.

Fundemail: If you continue to hold certain stocks as they grow, do you run the risk of turning into a large cap fund?

Marker: Not really. Maybe 10% of the portfolio stocks ever grow into large cap stocks. We might buy a $7 billion or $8 billion company and see it grow to $15 billion. Sprint, for example, was a mid-cap company when we bought it. But 75% of our portfolio is in mid-cap stocks because we believe that’s the place to be.

Fundemail: Can you please tell us about your favorite stock in each of those three fast streams you mentioned?

Marker: Sure. In the healthcare sector, we like Bausch & Lomb because it’s a play on the aging Baby Boomer, their increasing need for healthcare, laser eye surgery...

In the financial services sector we like Nationwide Insurance. It has a low P/E and is in a position to benefit from the intergenerational transfer of wealth. They are also big in the 401(k) plan business which is growing in importance as Baby Boomers near retirement.

In the technology sector, we like Computer Sciences Corp. They are in the services arena and have a great business model. Their price is down from about $100 and is trading in the $40s. As technology evolves, we view them as a downstream beneficiary. As technology gets more complex, companies hire them as outsourcers to run whole data processing units.

Fundemail: Are you concerned that we are seeing a new technology bubble?

Marker: There is always a concern when you see a run up. But people are forgetting that the Nasdaq was down 70%, so a 50% run up kind of pales.

Fundemail: Would you share with our readers, one of your past mistakes?

Marker: This business is actually a series of mistakes (chuckling). We always could have bought lower or sold higher.

Actually, one mistake we made was with Winn-Dixie, the grocery store chain. We bought it when the numbers looked like it was turning the corner. It was a seasoned company in a defensive industry. It had a couple of positive quarters of earnings surprises. Then, a few months later, it had a negative earnings surprise. Same store sales were down and analysts revised their earnings predictions downward. We took about a 20% bath on that stock. It turned out to be more of a two-quarter flash.

Sometimes the challenge is to see if you are looking at an anomaly or a trend.

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This Fund has been awarded a Lipper Leader for:

1) Total Return -- This fund has provided superior returns when compared to a group of similar funds.

2) Preservation -- This fund has demonstrated a superior ability to preserve capital in a variety of markets when compared with other funds in its asset class.