BlackRock Fund Has Eye On Valuation

"That's a fair description," said Wagner, lead manager of BlackRock Small Cap Growth Fund (NASDAQ: - ). "Another term people often use is GARP -- growth at a reasonable price. I'm a growth investor who pays attention to valuation. A lot of other players are agnostic about valuation. For us, it's important."

Wagner's $843 million fund uses more than one metric to measure valuation. The measuring stick depends on a stock's industry and sector.

"Our strategy not only helps us find leaders," he said. "It also cuts our volatility."

Applying his valuation discipline has been tough this year.

"Momentum markets like this one are the most challenging for us," he said. "Prices keep going up. It's hard to find things that are undervalued."

That explains the portfolio's smaller size vs. May 2002, when Wagner took the helm. Today the fund holds about 80 names. In 2002 it held more than 100. "It was easier to find undervalued names then that fit our criteria," he said.

Still, this year's market helps Wagner's buys meet their price targets. And Wagner looks for companies whose target price is twice as far away as the stock's projected worst-case-scenario fall would be.

"To put a new stock in the portfolio, its risk-reward ratio must be 2-to-1 in our favor," he said.

Two more factors characterizing the current market environment help Wagner. One is the tilt toward large caps. The other is the credit crunch, which began in August.

"Liquidity problems have made many investors risk averse," Wagner said. "As they fled into larger stocks, it pushed down valuations on small caps."

The benefit of Wagner's approach is in the fund's outperformance. The fund was up 17.01% for the year, going into Thursday. Its small-growth rivals tracked by Morningstar averaged 13.57%. The S&P 500 was up 8.44%.

Over the past three years, the fund's average annual gain was 19.14% vs. 14.87% for its peers and 13.51% for the big bogey.

Captive Campuses

Blackboard (NasdaqGS: - ), a top holding as of the fund's latest disclosure, is up 55% so far this year. The company makes software that runs college computer networks.

"Let's say you're a college student who signs up for Psych 101," Wagner said. "You know that course has its own Web site. You can go online and read the syllabus or see the homework assignments."

Blackboard was a pioneer in this field. The firm bought a key competitor, WebCT, in 2006.

"They own their market now," Wagner said. "They have cost synergies from that takeover. They can cross-sell products they have that WebCT didn't to universities. And once they sign up a college, they collect rent for their software forever."

Wagner began to buy shares more than a year ago. His average cost is about 28. The stock now trades around 46.

B/E Aerospace (NasdaqGS: - ), another top holding, is up 75% this year. The firm makes interior components of airliners. Those include seats, galleys and oxygen systems.

The company benefits from orders for new and upgraded aircraft by foreign carriers. Foreign carriers are spending money on their first- and business-class cabins. "Those interiors carry higher profit margins for B/E Aerospace than the crummy coach seats all of us usually ride," Wagner said.

The company is also positioned to benefit from a cycle of upgrades by U.S. carriers, he adds.

IHS (NYSE: - ), a third top holding, is up 51% this year.

The company makes databases. Its engineering databases consist basically of spare parts for the aerospace, defense and other industries. "If your business performs things like manufacturing, refurbishing and maintenance in those industries, you need the databases to get parts," Wagner said.

IHS' energy databases provide drilling and seismic information. The information is collected from governments, which typically require exploration companies to provide it.