Seeking Big Winners In Smaller Stocks

• Paul Katzeff
• On 6:45 pm EDT, Thursday September 24, 2009

Its name should tell you something about a fund. That's the case with Gamco Westwood Mighty Mites.

Like the younger divisions of many youth sports, this $194.9 million fund (NASDAQ:WEMMX - News) focuses on small fry. "We're looking for companies with market caps under $300 million, which have room to grow substantially," said manager Mario Gabelli.

More than 83% of the fund's stocks were micro caps as of June 30.

Nearly 15% were small caps.

Gabelli is also chairman, CEO and chief investment officer of parent firm Gamco Investors (NYSE:GBL - News). Gabelli Funds LLC is an advisory subsidiary. Mighty Mites is run by Teton Advisors, a recent spinoff from Gamco, with Mario Gabelli and Walter Walsh at the fund's helm.

B.B. Micro-Cap Growth -- which used to be Bjurman, Barry Micro-cap Growth -- merged into Mighty Mites last March.

The fund looks for stocks when they are undervalued vs. an estimated private market value. That's the price an investor would pay for the entire company.

Gabelli's approach has led to a 23.79% gain this year going into Thursday. The fund's small-blend rivals tracked by Morningstar averaged a 27.36% gain. The S&P 500 was up 19.64%.

Over the past three years, the fund's average annual gain was 4.37% vs. a 4.66% average annual loss for its peers and a 4.82% average annual loss for the S&P 500.

The fund's cash was 35% of assets on June 30. That's down from nearly 50% at year-end. The fund has not been able to put money to work as fast as it has flowed in, Gabelli says.

Nabbing Neogen

"Our analysts cover companies in an industry vertically," Gabelli said. Analysts studying water purification and medical diagnostics firms came across medical products firm Neogen (NasdaqGS:NEOG - News).

A top holding as of the fund's latest disclosure, the stock is up 22% this year. The fund bought Neogen nine months ago. The stock was trading in the low to mid-20s. That was off its high in September 2008 near 32.

Now the stock is trading around 30 again.

The late 2008 slide took place as last fiscal year's earnings growth slowed to 14% from the prior year's 25%.

The firm's four business lines fall basically into two groups: food safety, and animal safety and control.

"The company puts up 15% to 20% top-line growth year after year," Gamco analyst Kevin Kendra said. "Their intellectual properties have enabled them to expand internationally. Now 40% of their business comes from overseas. A lot of that is from China customers worried about food safety."

The company has zero debt. Pretax margin rose in each of the past three years.

Middleby (NasdaqGS:MIDD - News) was a top buy as of the fund's latest disclosure. The overall market was in a tailspin. Investors were especially leery of heavily leveraged stocks. Middleby's debt-to-earnings was twice its earnings, Kendra says.

"That's not terribly high in the overall scheme of things," he said. "But it was more than enough to concern investors at that point."

Covenants with lenders capped its debt-to-earnings ratio at 3.5, Kendra adds. If the ratio goes above that, lenders can call in their loans.

"It was an excuse for some investors to get out," he said.

As the stock slid, Mighty Mites bought shares early this year.

Now the stock is up 107% this year.

Health foods maker Lifeway (NasdaqGM:LWAY - News) is 23% off its July 13 high. But the stock is still up 28% this year.

A key product is kefir, a yogurtlike beverage.

The stock slid in 2008 amid the overall market meltdown. Its own tumble was fueled in part by rapidly rising dairy costs.

"That hurt sales and profits," Kendra said. "Now that dairy costs are going down, their margins will benefit, so profit will be up. That will also give them room to offer customers better promotions, which will help sales."

Buzz up!