Out of the Box

Out of the Box

Money managers by Jean Gruss | Editor/Lee-Collier

Fort Pitt looks for high equity returns on undervalued stocks.

Don't pigeonhole Charles Smith.

The chief investment officer at Fort Pitt Capital Group will go anywhere there's opportunity: small stocks, big stocks - even bonds.

At a time when many stock money managers peg themselves to a certain style of investing, Smith takes a go-it-alone approach that has served investors well.

Smith, who splits his time between offices in Naples and Pittsburgh, says he'll buy bonds if they look better than stocks. In 1999, for example, 25% of the firm's assets under management were invested in bonds. This protected investors from the subsequent three years of the last bear market in stocks.

"The most important thing is to think independently," says Smith, who worked 11 years with iconoclastic fund manager Ron Muhlenkamp before helping start Fort Pitt in 1995. "The only way to be better is to be different."

Snowbirding with clients

Founded in Pittsburgh in 1995, Fort Pitt's partners realized that many of their clients wintered in the Naples area in communities such as Bonita Bay and Pelican Bay and some of them had moved here permanently. So they opened an office in Naples in February 2005 headed by Pat Antonetti, the firm's senior vice president. Now, Smith estimates about 10% of the firm's assets are from Naples clients.

Today, the firm manages more than $1 billion in assets, mostly for wealthy individuals. It does this through what's called "separate accounts," which means the managers run portfolios in which they buy and sell stocks directly for individual investors. The firm charges a management fee that starts at 1% for the first $1 million and drops to 0.5% for $5 million or more. The account minimum is $250,000.

The firm's long-term track record has exceeded broad stock benchmarks. Over the past 10 years through Sept. 30, Fort Pitt Capital's total returns have annualized 10.94% net of fees, versus 8.59% for the Standard & Poor's 500-stock index and 8.62% for the broader Wilshire 5000-stock index.

Over the last five years, the firm's returns have been even more impressive as its bond holdings helped its clients weather the 2000-2005 bear market. On an annualized basis, Fort Pitt's total returns over the last five years through Sept. 30 were 12.32%, versus 6.97% for the S&P 500 and 8.64% for the Wilshire 5000.

Currently, the firm's top three investment sectors are industrial, finance and technology. Top holdings include insurer Loews Corp., drug maker Allergan and memory producer Sandisk.

Meanwhile, in the depths of the downturn in December 2001, Fort Pitt launched a stock mutual fund called Fort Pitt Capital Total Return (symbol FPCGX). Unlike separate accounts, a mutual fund pools together investor assets and invests them in a basket of stocks or other investments.

The advantage of starting a mutual fund is that Fort Pitt doesn't have to build a big staff to cater to each fund investor. Instead, Smith and his investment team can leverage what investment analysis they've already done for individuals in separate accounts and replicate it in the mutual fund.

The fund is sold through brokerage firms such as Charles Schwab and Fidelity Investments. It doesn't charge a sales load, but the fund levies a 1.5% annual management fee. That's a bit higher than the separate account fees and 1.13% that investors on average pay for stock funds.

The mutual fund has performed well since inception. It reached its five-year anniversary on Dec. 31 and returned 13.23% on an annualized basis over that time, seven percentage points better than the S&P 500. The fund's top three holdings are AT&T, cable operator Comcast and Sandisk.

So far, the fund has gathered about $40 million in assets. However, now that the fund has reached its five-year anniversary, Smith hopes Morningstar will analyze the fund and award it a top rating. A top grade from Morningstar generates lots of publicity and is likely to boost the fund's assets.

How Smith picks stocks

Because he doesn't box himself into picking stocks of any particular size or style, Smith goes fishing in a lake of 8,000 stocks.

First, Smith looks for companies that grow profits without spending a lot of cash. By that score, he says return on equity (ROE) is the best measure of profitability.

However, Smith does have a penchant for value because he doesn't want to overpay. So he looks for stocks with the lowest price-to-book ratio and intersects that with stocks with a high ROE. "We're trying to buy as much return on equity for as low a price-to-book as possible," he says.

That exercise usually narrows the field of 8,000 stocks to about 300 to 400 companies. In recent years, telecommunications companies that relied on land-based lines such as AT&T and Verizon routinely passed Fort Pitt's return-on-equity screens.

While most people assumed these companies were dying because of competition from wireless providers, Smith believed that the transformation would take years longer than most expected. Meanwhile, the old-line telecom companies were generating plenty of cash to carry them through as they diversified their businesses.

Fort Pitt bought shares of AT&T and Verizon as other investors were slow to recognize their value during the telecom downturn in 2002 and 2003. In 2006, AT&T's stock rose 52% and Verizon's jumped 35%.

In addition to cheap stocks with high returns, Smith screens for risk such as legal threats or high debt levels. "A cheap stock is often cheap for a reason," he says. He wants to see a minimum of 15% insider ownership of the company. "That's very much a positive for us," he says.

For example, the Tisch family and other insiders own 27% of the shares of Loews (symbol LTR), Fort Pitt's top holding. Smith says Loews' compounded returns in the last three decades have exceeded those of Warren Buffett's Berkshire Hathaway.

"We try to think as business owners," Smith says.

Smith and his team also like to probe the management of the companies they think will make the cut. Rules that took effect in 2000 now require public companies to widely disclose information material to their operations. As a result, regular conference calls by company managements with investors let smaller firms such as Fort Pitt ask probing questions.

"It's leveled the playing field for us," Smith says.

What's more, Smith says he also gathers information about Pittsburgh's hometown companies, such as Mellon Financial, by speaking with executives of those companies at various functions around town. "We can get a window into what management thinks," Smith says. Mellon Financial is one of the firm's top holdings.

Finally, the firm will make sure its picks are in line with the broader economy, though poor general economic conditions won't necessarily veto a stock pick.

Smith won't let any single stock exceed 6% or 7% of a portfolio's total holdings. Fort Pitt will typically hold a stock for seven to eight years and turnover is a relatively low 15%. The firm's separate accounts hold about 30 to 40 stocks, while the fund holds about 45 stocks.

Generally, Smith says the firm prefers to own stocks rather than bonds.

"The returns from ownership are always greater," Smith says. Fort Pitt uses the 30-year U.S. Treasury bond to gauge whether stocks provide a better return. With the 30-year bond recently yielding 4.71% and stock returns expected to average 8% over the next three to five years, the choice is clear.

What would make Pitt buy bonds again? The 30-year bond would have to yield over 6% with low inflation. "Long-term rates are dropping, making stocks even more attractive," Smith says.

REVIEW SUMMARY

Company. Fort Pitt Capital Group, Naples and Pittsburgh.

Business. Money management.

Key. Successful money managers look for good stocks anywhere they can find them.

Three stock picks for 2007

Charles Smith, Fort Pitt Capital Group's chief investment officer, says betting on the developing world might pay off. "Their economies are developing so rapidly," he says.

But he's not suggesting that investors rush to invest directly in risky markets such as Brazil, China or India. Instead, investors could benefit by buying shares of U.S. companies that provide equipment to build roads, sewers and airplanes.

Three U.S. companies are well positioned to take advantage of this long-term trend:

• General Electric (symbol GE; recent stock price, $38). One of America's blue-chip companies, General Electric is a global competitor. Smith says the stock will benefit from the company's strength in selling aircraft engines. For example, Chinese airlines are expanding their fleets to criss-cross the vast country and all those new planes will need new engines to power them.

• Ingersoll-Rand (symbol IR; recent stock price, $39). Automobile purchases are likely to soar in developing countries as consumers earn enough money to afford a car. That means these countries will need to build and widen new roads, a fact traffic-weary Floridians can appreciate. Ingersoll-Rand makes paving equipment and continued growth in developing countries bodes well for the company's products.

• ITT Corp. (symbol ITT; recent stock price, $57). As developing countries' economies grow, there's going to be increasing demand for water and wastewater treatment plants. Among other things, ITT makes industrial valves and pumps to move vast quantities of water and wastewater. In addition, the company also develops advanced electronics for the military.

-Jean Gruss