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    Managers Struggle to Locate Cheap Stocks
    By DAISY MAXEY
    May 27, 2007

    Bargains aren't easy to find in the stock market these days, with prices surging upward.

    Just last week, the Standard & Poor's 500-stock index came close to topping its record closing level of seven years ago. The Dow Jones Industrial Average has set numerous records this year and the technology-heavy Nasdaq Composite Index has been at its highest levels in six years.

    The advances have made things tough for "value" mutual-fund managers, who look to grab stocks on the cheap. "It's very difficult to find truly bargain-priced issues in the large-cap U.S. markets," says Ty Nutt, a senior portfolio manager and leader of the large-cap value team at Delaware Investments in Philadelphia.

    Still, most value managers are managing to keep their cash busy. While it's hard for them to find stocks they consider "deep value," or trading deeply below the value of their assets or operations, they say there are "relative values" to be found, meaning stocks that appear cheap relative to the overall universe of stocks.

    Here's a look at what they've been finding.

    Hunting Stock by Stock

    Mr. Nutt says that with no "screamingly inexpensive sector," the value hunt is more of a "bottom up" stock-by-stock search than it's been in years. Among the stocks he considers "great relative value" are semiconductor maker Intel, which he purchased last year, and global communications company Motorola, which he bought in March.

    Intel is financially strong, with low debt relative to its capital, Mr. Nutt notes.

    At Motorola, price competition battered profit margins of the firm's popular Razr cellphones, clobbering the stock. But Mr. Nutt is betting on "an intermediate- to longer-term recovery" in that core handset business.

    Some stock-market sectors traditionally seen as value fare because of their relatively slow growth are now trading at fairly expensive price/earnings ratios, says Jeff Tjornehoj, senior research analyst at research firm Lipper. "We're finding energy-sector stocks with higher P/Es and it's similar with utilities and anything related to natural resources," he says.

    In this environment, Lord Abbett America's Value Fund, based in Jersey City, N.J., has about 3% of its assets in AT&T. The communications firm's long-term growth rate is better than that of most utilities, says fund co-manager Edward K. von der Linde. AT&T is trading at about 13.3 times expected earnings, while the dividend is at 3.5%, he says. In contrast, many electric utilities have multiples in the high teens and have dividend yields well below 3%, he says.

    Some value managers are buying technology stocks and other shares that traditionally would have been seen as fare for "growth" managers who emphasize fast-expanding businesses.

    "We're looking for companies that are cheap currently on a price-to-forward-earnings basis," that is, based on earnings the company is expected to generate in the next three to five years, says Adriana Posada, who oversees the multiple sub-advisors of American Beacon Large Cap Value Fund. "If you define value that way, you might run into some traditional growth stocks that are cheap enough right now."

    A Bargain in Software?

    The fund, based in Fort Worth, Texas, has more exposure than it usually does to technology. One holding is software giant Microsoft, trading at an estimated eight to 8.5 times forward earnings, while the S&P 500 is at about 12 times to 12.5 times.

    Although the American Beacon fund doesn't have a large overall exposure to energy, its single largest holding is ConocoPhillips. That's the cheapest of the oil companies and the most diversified in terms of business lines and geography, and it also pays a good yield, Ms. Posada says. The fund's largest sector exposure is to financials, and insurer American International Group is among its top 10 holdings.

    Curtis Jensen, co-chief investment officer of Third Avenue Management in New York, says he is managing to find value in industries others hate. "I suppose you could say our friends today are pessimism, scorn and adversity," he says.

    The key is finding companies that are well-financed and have staying power -- and also being willing to be more patient than other investors, Mr. Jensen says.

    He says one example of a "well-hated industry" is the paper and forest-products industry, particularly in Canada. The strong Canadian dollar and high fiber and energy costs have decimated the industry and prompted what he expects to be a period of more cost cutting and possible merger activity.

    Third Avenue's holdings currently include Vancouver paper companies Canfor and Catalyst Paper.

    Another unloved industry is homebuilding and related areas. Third Avenue holds USG, a construction-materials holding company. "This is probably dead money for a time," Mr. Jensen says, but has a fairly bright longer-term outlook.

    Bob Olstein of Olstein All Cap Value Fund in Purchase, N.Y., seeks out companies which may be misunderstood by the market or have short-term problems, but are basically sound financially.

    One stock he likes is apparel retailer Gap, where sales have languished and bungled efforts to turn things around have made Wall Street impatient. The shares could reach $27 a share, from Friday's close of $18.18, if management "gets it right," Mr. Olstein says.

    Advice for Fund Buyers

    For investors buying mutual funds, many financial advisers suggest always holding a mix of growth-oriented and value-oriented funds. Value funds have outperformed growth funds for years now, and some fund managers are now predicting a resurgence in growth stocks.

    There's no doubt that value managers have to look harder now than they did a few years ago.

    Says Mr. Tjornehoj of Lipper: "I think there are so many [value] managers turning over rocks on that same path that all the big ones have been flipped over and now they're looking for smaller or less intriguing value plays than they did years ago. As well, they're holding on to their winners because they have to."

    Nevertheless, investors should have exposure to the area, Mr. Tjornehoj says. At some point, he says, the market will weaken and "the private equity or hedge funds or whoever is adding a great deal of value to the market is not going to feel that way, and people are going to seek safety in firms with steady dividends and low debt on the balance sheet -- the typical characteristics that make a value play attractive."

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