Q:  Would you tell us about the history of the Croft Value Fund? A : We expanded our business from separately managed account management to mutual fund products with the launch of Croft Value Fund in May 1995. Croft Leominster, Inc., the advisor to the Croft Value Fund, was founded in 1989 by my father Gordon Croft and brother Kent Croft. We are based in Baltimore, Maryland and my brother Kent and I manage the fund with the help of five research analysts. Currently, the firm manages $830 million, of which $300 million is the asset base of the Croft Value Fund. Q:  What core principles drive your investment philosophy? A : We are a family-owned management company investing along with our investors. In other words, our interests are aligned with those of investors in our funds. Although we prefer to hold on to the companies for at least three years, we may sometimes hold them for periods longer than five years. Since we look for out-of-favor companies that offer longer term value, we are prepared to hold them until the value is realized in the market price. As contrarian investors, we are not afraid to take views that are not in sync with Wall Street or the popular view in the marketplace. Q:  How does your philosophy translate into the fund’s investment strategy? A : To start with, we look at one stock at a time and consider ourselves bottom-up investors. Our long term investing orientation enables us to consider stocks that may be in unpopular industries or neglected by investors. Furthermore, we believe that value is not limited by the market capitalization, so if we can understand a business and if the stock meets our value criteria, we will purchase the stock regardless of market cap. In general, we pursue the following types of companies. Those that are trading at a discount to their intrinsic value, those that are at a distressed multiple of earnings, or names that seem to be temporarily out of favor due to short term issues. Our contrarian approach to investing helps us in evaluating companies that possess earnings power. However, when a company is out favor because of a temporary problem it may offer us good value too. These companies may be suffering from a product launch delay, management turnovers, market shifts or many other issues that are short-term in nature and can be solved in few quarters. Yet, investors are not willing to wait for the management to rebuild the broken trust and they may avoid buying the stock. In addition to buying out-of-favor stocks at a discount to their net assets, we also screen for companies whose inherent business model allows them to regain earnings and revenue growth. Ideally, we seek companies that can eventually grow organically. There are two potential developments when companies that were once off the track could regain their momentum. First, investors recognize the earnings power of the company and start bidding up the stock, and, second, earnings multiples start expanding. Consequently, both reactions of the market lead to increasing the stock price. Q:  How do you research companies? A : For our idea generation we primarily rely on our internal and external experts. Additionally, we receive a lot of research reports from brokerage firms on Wall Street and from independent research providers. We scrutinize these reports for broader themes, market dynamics and general trends. Once that information becomes available, we begin our analysis by focusing on companies with business models that demonstrate earnings power and that we understand well. As part of our research process, our internal team of analysts meets every Monday to put forward new ideas for discussion. Additionally, we like to visit companies and meet management. We look for companies with the potential to grow at a faster than expected rate and with the financial strength to weather a downturn in the economy or at an industry level. Although we traditionally evaluate companies based on earnings multiples and cash flows, we also want to find stocks with near-term earnings catalysts and valuations that do not reflect the earnings power of the company. Our preliminary watch list comprises 200 companies that we generally follow by keeping a close eye on their business development and stock prices. However, we do not run any specific screens all the time. Q:  Would you illustrate your research process with some examples? A : One good example is Valmont Industries, Inc., a global producer of fabricated metal products and irrigation equipment. Valmont makes high end irrigation systems that save farmers 50% of the water usage while increasing their crop yields. We bought Valmont back in the spring of 2009, when the valuation was much cheaper and we estimated a good growth rate going forward. Initially, we identified the stock after talking to some analysts, before spending a lot of time to learn about the company and the industry. When we acquired the stock it was trading at a multiple of less than six and since then it has appreciated a lot. The stock is neither cheap, nor expensive, and it is currently trading at 12 times earnings. However, we still believe that the company can further sustain its earnings growth as farmers look for ways to improve crop yields and cut operating costs. Q:  Would you give another example? A : Another example would be International Paper Company, the largest pulp and paper maker. At the time when we bought the stock it was quite cheap, but now it trades at about eight times next year’s earnings with a 3.8% yield. The company has consolidated good businesses over the past few years in the container board packaging business area, in addition to having their traditional paper business. After their last peak earning per share of $2.33 back in 2008, they are likely to earn this year close to $3 a share. In our view, people have not given enough credit as to how the company has transformed the business and leveraged it to build a platform for higher earnings. Moreover, their nearly complete purchase of Temple-Inland, Inc. is going to take their market share in the container board to 37% in North America and is going to be earnings accretive. Having said that, International Paper bought Weyerhaeuser’s containerboard business and acquired debt for the transaction at the worst time right before the big downturn. As a result, the company got punished for that. After reviewing the cash flow of the company, we were pleased to learn that the paper maker managed to generate a lot of free cash flow and increase dividend from 33 cents a share in 2009 to $1 a share in 2011. At the same time the stock still yielded 4%. As the cash flow improved the company was poised to pay down its debt first, and then buy back shares that will improve earnings per share. Here was a company that was not only in an out-of-favor sector but was also not well understood by investors. Those were the main reasons why we decided to purchase the stock. In our view, the completion of the purchase of Temple-Inland, Inc. is going to add to earnings for the next few years. What is more, we think the container board business is actually quite good. They are in a good situation because of their market share to keep decent pricing going forward. On top of that, the stock trades at about 10X times 2012 earnings, and earnings in 2013 and 2014 are expected to be even higher. With the purchase of International Paper we are not only getting peak earnings in a pretty tough global environment that should go higher, but we also have a good dividend yield and a high quality management team focused on shareholder value. Q:  What do you find appealing about the water and agricultural themes? A : At present, the population growth in the world, coupled with the increase of the middle class in emerging markets such as China, India and other parts of the world, has really put a strain on the agriculture and water sectors. For example, China has roughly 20% of the world’s population with only about 7% of the fresh water. We feel that a theme like that will eventually drive investments for the long term. In a similar way, today’s agriculture is expected to feed a lot more people in the world with the same amount of arable land. Not only does it have to rise up to this challenge but at the same time the emerging middle class in economically surging regions leads to a substantial increase in protein consumption. As a result, the growing needs for feeding cattle, hogs, chickens, and other animals lead to more and more pressure on grain harvesting. Therefore, what we need is a more productive use of the arable land around the world. That is why a company like Valmont fits right in, as it increases the return on land for the farmer, and the drip irrigation systems use about 50% less water than traditional flood irrigation systems. To use a different example, ITT Corp. is a firm that does water transportation and treatment, pumps and valves in U.S., Europe and emerging markets. This diversified manufacturing company broke up into three separate companies because they wanted to get full value for their water business. Right now, they have strong order book and business. For us, that is a purely water industry focused company with good prospects. Another company we had is Nalco Holding Company, which we purchased to take advantage of the water theme. A lot of their business is based on water treatment, and we were forced to sell the stock after a buyout offer by Ecolab Inc. We do not own it any more but that was certainly a very good stock for us. Q:  How do you build your portfolio? A : We do not allocate more than 5% into any given stock, or 20% in one industry group, because of our self-imposed diversification restrictions. Having about 80 names in the portfolio on average, we do not follow a benchmark per se because we do not compare our holdings to any allocation weights in a specific benchmark. Essentially, we like stocks that are very much part of the global economy and that, for the most part, have good reasons to grow at a global level, and not just in the U.S., Europe or any specific region. We like to focus on companies that have good and diverse businesses overseas. As of this moment we like a large number of the energy and industrial companies, as well as some of the material companies, because of our belief that they can do really well over the next few years. We like the blue chip names that fall into our growth-at-a-discounted-price theme, as we think that they have good balance sheets and dividends along with compressed multiples. Our portfolio turnover tends to be about 20%, and we measure our performance against the S&P 500 Index. The overall multiple of the portfolio will be generally less than the multiple of the S&P 500. Q:  How do you control risk in the portfolio? A : As mentioned before, our investment style is organized around looking for companies that are out of favor or trading at a discount to their intrinsic value. That alone takes out a lot of risk in our holdings, but we can still make mistakes due to market volatility. Since we consider permanent loss of capital the biggest risk that we face, we are always trying to minimize risk by picking companies that trade at a significant discount yet still maintain solid balance sheets or have significant asset bases. Our long term views about markets and our preparedness to hold stocks for more than three years also help us in riding out market volatility. We are not market timers and we do not have any price targets for the stocks we hold. Another way of managing risks is by diversifying our portfolio across sectors and various names, which also limits our exposure to no more than 5% per stock. Q:  What are your views on holding cash? A : Our view is that it is always good to have some cash. Over the past three years our cash position has been between 8% and 12%, and that has given us the purchasing power when things are cheap. We think that having some cash is a good idea in times of uncertainty.