Bottom-up stock picker Ralph Lindenblatt is surprised at the market's significant surge since March. "We had one of the largest moves for our own fund in a very short time," says Lindenblatt, 40, lead manager ofBissett Small Cap Class A 
, which has rebounded 40.6% in the three months ended in May.
"Stocks were beaten up quite badly over the last year to year and a half," he says. "If you look at what drove the market, and the fund, they were some of the names that had declined the most."
Lindenblatt, vice-president at Calgary-based Bissett Investment Management, observes that one holding, auto-parts company Linamar Corp. ( LNR/TSX), had dropped 80% from its peak, but then tripled over a recent 60-day period. "Given how far stocks had declined, we were expecting things to return to more normal levels. To see stocks move so fast is somewhat surprising."
Small caps have been highly volatile, as valuations peaked in 2007 at an average of 20 times earnings, compared to the historic average of 15, Lindenblatt said. By March 2008, multiples had dropped to around six to seven.
"That was the lowest range we'd ever seen for the fund," says Lindenblatt, adding that the average price-earnings ratio is currently around nine. "To get to more normal levels, we would have to return to a more normal macro environment. We're not quite there yet."
While Lindenblatt says it could be some time before small caps trade at "normal" levels, he is not relying on multiple expansion to drive fund returns. Rather he is focusing on companies with strong balance sheets or those that are in the process of repairing them. "The key metric is return on equity. Right now, the average ROE [in the fund] is 11% to 12%, compared to 8% for the average small cap."
Portfolio holdings are limited to about 6.5% in Bissett Small Cap. Turnover was low last year, at 25.8% of fund assets.
Although Lindenblatt tends to run a low-turnover portfolio, he has taken advantage of market volatility and added to existing holdings. One example is Linamar, which is best known as a key supplier to the major auto companies.
Lindenblatt notes that Guelph, Ont.-based Linamar is also active in industrial equipment such as hydraulic lifts. "It's done a good job of moving away from the GMs, Fords and Chryslers in recent years."
Concerns about the firm's balance sheet drove the stock to a 52-week low of $2 in the first quarter. However, it has since almost quadrupled as the firm generated strong earnings and worries about receivables subsided. "Business is a little better than the market first thought," says Lindenblatt. "As the car companies downsize, they can outsource a lot of business to a company like Linamar."
A native of Prince Rupert, B.C., Lindenblatt has been in the investment industry for more than a decade. After graduating in 1992 with a BSc in economics from University of Victoria, he went home and spent three years at pulp and paper firm Repap Inc.
Working in quality control, Lindenblatt got a firsthand taste of the boom-and-bust forest products industry. "I learned some valuable lessons about the business cycle, and commodity-type companies," he says.
In 1997, Lindenblatt moved to Calgary and joined TD Green Line's call centre. But he was set on becoming a portfolio manager and that year enrolled in the Chartered Financial Analyst program. Later, he joined TD Asset Management Inc. in Calgary and handled trading, client services and account maintenance.
In 2001, Lindenblatt earned the CFA designation and was hired by Bissett as an equity analyst covering micro-caps and large-cap stocks. He soon became co-manager of the small-cap fund, as well asBissett Microcap Class A. When co-manager Chris Fernyc left the firm in November 2007, Lindenblatt assumed responsibility for both funds.
Performance has been disappointing, Lindenblatt acknowledges, as Bissett Small Cap has been in the fourth quartile for the past few years. He attributes the poor showing in 2006-2007 to limited exposure to the materials sector, although the fund did have a sizeable energy weighting. Underweighting commodity-based sectors helped in 2008, but the fund still had a 42.7% loss.
Among the stocks that Lindenblatt is counting on is a new holding, Norbord Inc. ( NBD/TSX), a forest products firm that makes structural panels. "It's in a really cyclical business, very economically sensitive. But Norbord has some of the lowest cost assets, with facilities across North America as well as Europe," says Lindenblatt, who bought the stock at around 70 cents, and has seen it double since then.
"When you look at it from a full-cycle perspective, we think it will do very well," he adds. "If we look out five to 10 years, and assuming we get a recovery in the residential real estate market, the company will return to its past level of profitability."
