Morningstar Advisor - June/July 2009 - 53

If it’s a cheap tobacco company or an expensive solar company, we’re not going to have that. Josh Strauss, comanager there are lots of opportunities for this type of investing.” Go Anywhere, Sort Of Having two sets of constraints puts certain limits on the types of businesses that can be included in the portfolio. At times, the managers find themselves outsiders of both the value and SRI camps. “If it’s a cheap tobacco company or an expensive solar company, we’re not going to have that,” Strauss says. But he stresses that there are plenty of opportunities elsewhere. “We do not find that we’re restricted all that much,” he continues. Part of the reason the team feels unfettered is that it invests all along the capitalization spectrum, from giants like drugmaker Pfizer PFE to tiny names such as John B. Sanfilippo & Son JBSS, a peanut and almond seller with a market cap of just $55 million. Stock ideas are generated in a variety of ways. Sometimes a manager or an analyst has an idea; other times the crew hunts for stocks that meet specific criteria. Regardless, all the names in the portfolio share certain attributes: They do not derive revenue from the sale of tobacco, alcohol, gambling, weapons, or pornography. In addition, they should also be businesses that have solid human rights and environmental records and invest in their communities. Having made sure the sustainability measures are met, the team then drills down into the financials. “We’re big balance-sheet guys,” Strauss says. Among the characteristics the five look for are low amounts of debt, plenty of free cash flow, and a defensible competitive advantage, characteristics that happen to play well to today’s treacherous market environment. They particularly like companies that have stumbled recently, yet not so much that the missteps have impaired their free cash flow. This research process is identical to the one they use in the $500 million separate accounts business. The value and SRI restrictions seem to be a winning formula, at least lately. For the 12 months ended April 17, Appleseed is in the top 1% of mid-cap value funds tracked by Morningstar, with a negative 5.6% return. (The fund’s large-cap names together with its tiny ones average out to a mid-cap weighting.) Value Helps a Lot the stock looks even more appealing. The firm has a sizable cash cushion on its balance sheet for its $130 million market cap and a price/book ratio of 0.5. And there is no debt. Then there’s the hidden gem that makes value hounds like the Appleseed managers giddy. In addition to the clothing business, Gaiam is also the majority owner of Real Goods Solar RSOL, an installer of solar panes, giving Appleseed an entree into the richly priced alternative-energy sector. “It’s a backdoor way to play solar,” Strauss says. “There has been a bubble in all energy— including alternative energy—and this is one way we could participate in the sector at a reasonable valuation.” Regardless of whether Gaiam is an alternativeenergy stock, a purveyor of healthy living, or a dirt-cheap security, its stock is up 17.3% for the year to date through April 17. Concentrated Portfolio Much of the fund’s recent strong showing can be attributed to the value orientation that steers the managers to businesses with low debt and ironclad balance sheets. “When the capital markets blew up, anyone who had any debt had their stock blow up because suddenly the market got worried that they would not be able to refinance that debt,” says Michael Breen, the Morningstar analyst who follows the fund. “The companies that had a lot of cash and no debt held up better.” The stocks in Appleseed generally don’t have such financing concerns. Case in point is Gaiam GAIA, maker of organic clothing, including yoga gear. The company’s commitment to environmental stewardship (the firm has a carbon-neutral shipping program) and social responsibility (the company purchases fair-trade materials) make it a shoo-in. When the value screen is applied, With just 23 names, Appleseed is one of the most concentrated portfolios around. “That’s a sword that cuts both ways,” says Seacrest, of Natural Investing, who began investing in Appleseed in January. “Anytime you have a manager who is running the portfolio that way, you want to have a high degree of confidence in his or her ability to pick stocks.” Morningstar’s Breen agrees, especially because the managers have no qualms about taking sizable positions in small-cap and micro-cap fare. “You have a better chance of being wrong on a tiny company,” he says. “On the flip side, no one else is covering the stock, which gives you a huge advantage if you’re right.” To the minds of Appleseed’s managers, the MorningstarAdvisor.com 53

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Morningstar Advisor - June/July 2009

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