Prospector Opportunity Fund (POPFX) is a top ranked fund by Morningstar (five stars). Although it is a decent fund in good markets, it is the down markets in which it excels by protecting investors from the steep losses that its peers often experience. Three companies the fund’s managers like for their combination of upside potential and downside protection are Platinum Underwriters Holdings, Ltd. (NYSE:PTP), Franklin Resources, Inc. (NYSE:BEN), and Church & Dwight Co., Inc. (NYSE:CHD).
Although nobody likes to lose money, co-managers Kevin O’Brien, Richard Howard, and John Gillespie certainly did their shareholders a favor by avoiding the worst of the market’s huge downturn in 2008. The fund was “only” down 19%, while the market was off more than double that at nearly 40%. Avoiding big pain in that year has helped the fund earn a nearly 8% annualized return since its September 2007 launch, outpacing its Russell 2000 Total Return Index benchmark by over three percentage points through March of this year.
Looking for Value
The fund has a value orientation and builds its portfolio from the bottom up. Key factors in the purchase process include a review of a company’s balance sheet strength, management quality, products and/or services, overall franchise or brand value, and an assessment of the company’s business model. The co-managers also look specifically for a catalyst that will lead to improved performance, such as a change in management, corporate actions (a unit sale), or changing industry fundamentals.
However, Kevin O’Brien highlighted in my interview with him a single question that the co-managers ask that helps explain the fund’s solid long-term performance: “If this doesn’t work, how much will we lose.” The trio wants to ensure that they don’t get so caught up in the upside that they lose sight of the risks of an investment.
Here are three stocks the co-managers like today based on their upside potential and their downside protection:
Insurance for Insurance
Platinum Underwriters Holdings, Ltd. (NYSE:PTP) is a reinsurer operating in the property, marine, casualty, and finite risk markets. It has a global footprint and a generally conservative management team. For example, O’Brien notes that the insurer would rather not write business than sell unprofitable policies.
While that can mean walking away from business, it also means more stable long-term performance. In fact, management would rather buy back shares than get into a price war. Although industry pricing is good today, over the last six years or so, the company has bought back around half its outstanding shares.
That type of shareholder friendly action is just one reason to like Platinum Underwriters Holdings, Ltd. (NYSE:PTP). The other is that O’Brien believes it is trading at a discount to his estimate of its true worth. A conservatively run business, in a recovering market, selling at a discount. No wonder the co-managers still like Platinum Underwriters Holdings, Ltd. (NYSE:PTP) despite a solid share advance over the last year.
Cash on Hand
Franklin Resources, Inc. (NYSE:BEN) is a global asset manager. Although it has offices in 35 countries, its client list spans over 150 nations. It has over $800 billion in assets under management (AUM) and claims to be the largest cross border fund manager in the world.
This positions the company well to take advantage of the growing middle class around the world. That’s a key focus area for management and one that looks particularly promising in emerging economies with high savings rates, like Asia where Franklin Resources, Inc. (NYSE:BEN) sees the potential for nearly 500% growth in the fund market.
O’Brien highlights the potential for the asset manager to benefit in the U.S. market if investors start shifting money toward stocks after a long period of cash flowing into bonds. Stock AUM earn the company higher fees.
The co-managers also like that the stock has historically traded around 20 times earnings, but currently sits around 15 times. The low end of its range is 12 times, so there isn’t too much downside risk at current price levels. Add in what O’Brien estimates is about $40 per share in cash or liquid investments sitting on the balance sheet, and the risk/reward profile looks even better.
Extensions
Church & Dwight Co., Inc. (NYSE:CHD) is another company that the co-managers like today. The industry in which it operates, consumer staples, has historically been a stable one. So that’s a plus. However, not all companies in the space are created equal.
What impresses O’Brien is Church & Dwight Co., Inc. (NYSE:CHD)’s ability to take old brands and extend them into new markets. The best example of that is probably Arm & Hammer Baking Soda. That product line has been extended into toothpaste, kitty litter, and laundry detergent, among others. This outside the box thinking is perhaps the company’s biggest asset.
Church & Dwight Co., Inc. (NYSE:CHD) has been able to push growth internally, but has also proven an excellent acquirer. For example, the late 2012 addition of Avid Health looks to O’Brien to be a classic brand extension candidate. Avid is a leader in the gummy vitamin market. While this sounds like a product for kids, the adult market is ripe for the picking–particularly as baby boomers become increasingly concerned with their health.
Two other things to like about the company are its low level of debt and valuation. O’Brien believes that recent acquisition activity in the consumer products industry suggests a share price in the $80 range for Church & Dwight Co., Inc. (NYSE:CHD).
Up and Down
Investors often get so caught up in the potential for gains that they forget about the risk of losses. Prospector Opportunity Fund’s management team always keeps both in the back of their minds, a fact that the above examples clearly demonstrate.
The article Prospecting for Safe Stock Gains Part 1 originally appeared on Fool.com and is written by Reuben Brewer.
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