(Bloomberg News circulated the following story by Eric Martin on June 6.)
NEW YORK — The Hodges Fund, run by the father- and-son team of Don and Craig Hodges, outperformed all but one competitor in the past five years by buying unloved stocks, especially railroads.
The $700 million fund’s strategy is winning endorsements from billionaire investors including Warren Buffett and Carl Icahn. Both purchased shares of rail companies in the past six months.
Railroads represent 9 percent of Dallas-based Hodges Fund’s assets and more than doubled in value since Don Hodges began purchasing the shares in 2004. Fort Worth, Texas-based Burlington Northern Santa Fe Corp., the biggest holding, rose 176 percent, eight times faster than in the previous three years.
“Everybody thought we were crazy when we started buying Burlington,” Hodges said in an interview in New York. “Now nearly every client we have owns Burlington, and they’re tickled to death.”
The Hodges Fund has gained an average 24 percent a year since June 2002, trailing only the Fidelity Leveraged Company Stock Fund among 142 tracked by Bloomberg that buy shares of companies with above-average earnings growth. The Fidelity fund, run by Thomas Soviero in Boston, has surged 34 percent.
This year, the Hodges Fund has advanced 12.9 percent, placing 27th of 171 similar funds. The benchmark Standard & Poor’s Index has returned 7.9 percent.
Berkshire Hathaway Inc., Buffett’s insurance and investment company, bought 38 million shares of Burlington since the end of September, according to filings with the U.S. Securities and Exchange Commission. He told Berkshire shareholders at the company’s May 5 annual meeting that deregulation and higher fuel prices have made railroads more competitive than trucks.
Deep-Sea Drillers
The Hodges Fund also owns railroad operators Union Pacific Corp. in Omaha, Nebraska, and Norfolk Southern Corp. of Norfolk, Virginia. Union Pacific, the fund’s fourth-largest holding, and Norfolk Southern, the 15th, have doubled since Hodges first built up stakes three years ago.
Don and Craig Hodges said offshore oil and gas drillers may be the next industry to take off as railroad companies have. They started buying shares of Transocean Inc., the world’s largest offshore driller, in November 2005 at $58.99 and now own 182,000 shares, making it the fund’s No. 3 holding.
First-quarter profit at Houston-based Transocean more than doubled after rents for deepwater rigs surged. The stock has risen 24 percent this year to $99. Transocean has won $21.4 billion in contracts for projects extending as far out as 2015, locking in revenue even if crude oil prices fall.
Railroad Messenger
The fund also owns 170,000 shares of Schlumberger Ltd., the world’s largest oilfield-services company, and 255,000 shares of No. 2 Halliburton Co. Both companies are based in Houston.
Don Hodges, 73, and his 43-year-old son purchase out-of- favor companies with the potential to rebound because of competitive advantages. The fund owns about 110 stocks, and every night Don Hodges spends half an hour reviewing a list of 900 to see if any warrant buying or selling.
Hodges grew up in Canadian, Texas, a town of about 3,000 that serves as a point for freight trains to change crews. As a teenager, he was a railroad messenger and later studied history at West Texas A&M in Canyon.
Three years ago, Hodges read an article in the weekly Canadian Record that alerted him to increasing demand for rail capacity from importers, trucking companies and farmers producing ethanol. He then looked into Burlington, the second- largest U.S. railroad company.
Icahn Buys
“What used to be considered a cyclical business is now moving into a growth vehicle,” said Craig Hodges, who received a degree in finance from Baylor University in Waco, Texas.
Buffett isn’t the only savvy investor who is bullish on railroads. Icahn bought a $122 million stake in Jacksonville, Florida-based CSX Corp., the third-largest U.S. railroad, in the first quarter, when the stock rose 16 percent.
“There’s an element of our style that’s similar to what Buffett does, but we’ll buy some crazy things that he wouldn’t touch with a 10-foot pole,” Don Hodges said.
Crocs Inc., the Niwot, Colorado-based maker of the colorful resin shoes, is an example. Though the fund owns 80,000 Crocs shares, Don Hodges said the casual shoes have a fad appeal that may lose luster. The fund bought the stock in November at $46.50, and it now trades at $85.
The Hodges Fund hasn’t always beaten its benchmark. It gained 7.6 percent in 1999, trailing the S&P 500’s 19.5 percent advance. The next year, the fund tumbled 29 percent, triple the loss of the U.S. stock-market benchmark.
Sold Steel
When stocks rebounded in 2003 after a three-year bear market, the Hodges Fund surged 80 percent to the top of its class. The performance “erased a lot of fears that they’d lost their touch,” said Jeff Tjornehoj, an analyst at Denver-based Lipper, a unit of Reuters Group Plc.
The fund’s three-year Sharpe ratio, a measure of risk- adjusted returns, is 1.25, better than the 1.11 average of its peers, according to research firm Morningstar Inc. in Chicago. Morningstar gives Hodges three out of a possible five stars.
Along with railroad shares, steel stocks including Chaparral Steel Co. and U.S. Steel Corp. boosted the Hodges Fund in the past two years. Hodges began buying steelmakers in the third quarter of 2005, anticipating stronger demand from China and India.
Shares of Midlothian, Texas-based Chaparral more than quadrupled by the time the Hodges Fund sold its position in April 2006. Pittsburgh-based U.S. Steel doubled when the managers sold the stock in May 2006.