EnPro Industries Inc. was a troubled stock unloved by others when it first caught John L. Keeley Jr.'s eye more than a year ago. At the time, shares of the North Carolina-based manufacturer of engines and valves were down sharply as investors worried about red ink and asbestos liabilities.
Keeley felt that the pessimism was overdone.
He said that most of the asbestos claims would be covered by insurers, limiting EnPro's exposure. Sensing hidden value, Keeley began buying the stock last year for the Keeley Small Cap Value Fund at $9 a share. The shares zoomed to more than $23 this year as the pessimism lifted and the company reported a sharp drop in new asbestos claims.
For Keeley, it was the equivalent of a grand-slam.
"We tend to fish in ponds where others don't," said Keeley, the fund manager.
That is no exaggeration.
Bankruptcy survivors, beaten-down stocks trading below book value, obscure corporate spinoffs and industries such as cement and struggling utilities are areas avoided by much of Wall Street. But Keeley has handily beaten the market for more than a decade by venturing into such forsaken territory as if he were a shopper looking for castaway goods at a neighborhood yard sale.
"It is one of the best small cap value funds over the last 10 years," said Scott Tanner, a manager for Millennium Media Consulting, who introduced Keeley at a recent investment conference in Manhattan. "You are more likely to see him investing in old-line manufacturing stocks than high flying names that you might see on CNBC."
The fund has returned 15.7 percent a year on average during the past 10 years, better than the 10.9 percent return for the benchmark Russell 2000 index.
This year, Keeley Small Cap Value is up 12.8 percent compared to a gain of 1.6 percent for the Russell 2000. The fund has beaten the index in eight of the past 10 years.
"Keeley's process keeps the fund heavily invested in some sectors and largely clear of others," Morningstar analyst Todd Trubey said in a research report. "Many funds making such bold sector plays are highly volatile, but this fund has a really nice long-term risk/reward profile."
The $192 million fund has beaten 84 percent of its peers during its 11-year history with below-average volatility, according to Morningstar.
Keeley, a resident of Chicago, said his unusual investing approach boils down to carving out a niche in a world where investors are bombarded with choices.
"How do you differentiate yourself among 8,000 mutual funds?" he said. "You have to do something different. You need a story. ... But as much as you try to get the story out, it is the performance that gets people's attention.
"As each year goes by, you try and make fewer mistakes. It is not the home runs, it's the singles and doubles. Consistency in returns is more what people want than the big zig-zags."
Keeley, 64, started his investment company 17 years ago. Over the years, he has found that his style generally held up regardless of the the mood on Wall Street. That's because companies go through bankruptcies, restructurings or spinoffs in good and bad times, giving the fund "a continuous ebb and flow of opportunities," Keeley said.
The fund has had only one down year since 1995 — a period which includes both bull and bear markets.
Keeley and his staff do 80 percent of their own research because many of the companies they buy are smaller names little covered by Wall Street research analysts. The fund is invested in 114 companies with a market cap of $1.5 billion or less.
"Often these are companies you can get into at a relatively low price, which means when we make a mistake, it is not as drastic as it could be otherwise," Keeley said.
Bankruptcy survivors are fruitful opportunities if a company can regroup after exiting Chapter 11, Keeley said.
"When the companies come out of bankruptcy, if the core business is intact, you usually have new management and new corporate financial structure," Keeley said. "The end result is that companies can come out of this process and perform successfully."
Keeley said there also can be hidden values in spinoffs in which a company divests a division that begins trading as a separate stock. Many times, an index fund that owns the parent sells the spinoff because it is not in their index. That can depress the stock to prices that Keeley finds attractive.
Spinoffs "are kind of like orphans," Keeley said. "When they start to trade, nobody cares. ... There is selling pressure on these companies which give us a good entry point."
Levitt Corp., a home builder spun off in December from BankAtlantic Bancorp Inc., a large Florida savings bank, is a recent spinoff stock purchased by the fund. Levitt shares are up 13.1 percent this year.
Keeley also searches for stocks trading under book value. He said one of his current favorites is Providence & Worcester Railroad Co., whose history dates to when Abraham Lincoln was a railroad attorney more than 150 years ago.
"They have a $17 book value, but it is a $10 stock," Keeley said.
The stock is up 20.6 percent in 2004.
The fund also has invested in savings and loan conversions — thrifts owned by passbook holders that go public — that can be overlooked by Wall Street.
In addition, Keeley takes stakes in "busted utilities" trying to rebound from the Enron scandal, lackluster stock prices and troubled efforts at deregulation. Even though many utilities piled on debt and "went into areas that they knew nothing about," Keeley said, many still enjoy stable local markets.
Keeley won't venture everywhere. He shuns airlines, an industry struggling through high-profile bankruptcy reorganizations and layoffs.
"It's a bad business model," he said.
He also generally steers clear of technology companies because he finds the changing product cycles difficult to understand.
"You can't chase fads," Keeley said. "We sat there as value managers during the dot-com craze, and one of the things that we are very proud of is that we did not change what we did."
Keeley and his family own about 11 percent of the fund that earns four stars out of five on Morningstar's rating scale.
