Don’t Give Up on Small-Cap Stocks: Don Hodges

Warwick is underweight on small caps, however. "Typically," he writes, "small cap stocks tend to outperform large caps as rates head lower. But in our view, this additional return is not worth the much larger amount of volatility that small caps typically generate."

Hodges, on the other hand, is still a believer in small-cap stocks and the companies behind them.

"The biggest hope we get for the U.S. economy is from talking to companies," Hodges said. "Our big passion is companies, not what gold or the dollar are going to do."

Hodges Capital comprises five fund co-managers, including Hodges and his son, Craig. Don's name is listed as an HDPSX co-manager, but he credits his son as well as Eric Marshall and Gary Bradshaw for active management of the small-cap fund.

Don Hodges credits mutual fund pioneer John Templeton, with whom he worked earlier in his career, as a stock-picking mentor. Established in 1954, the Templeton Growth Fund was known for buying low and selling high. Each $10,000 invested in the fund's Class A shares at its inception would have grown to $2 million by 1992, when Templeton sold his family of funds to the Franklin Group.

Today, Hodges advises clients who can't take stock market volatility of the sort seen this summer to think about moving at least some of their money into a more sheltered place. But for those with an appetite for risk, there's plenty of opportunity, he said.

Hodges Capital's five analysts keep a database of more than 2,000 company contacts, and they spend a lot of time talking to them. Right now, Hodges sees a shortage of inventory at a variety of firms in all sectors, including railroad manufacturers, cement companies and hydraulic equipment makers. And compared to the period just before the recession hit, he said, companies are well-positioned for growth.

"In 2008, everybody was over-leveraged," Hodges said. "Now a lot of companies have no debt on their books. There was a shortage of cash back then, and this time it's different. They're in good shape financially, which is a safety factor for the whole economy."

Stocks are now trading at their lowest price-to-earnings multiples in years, at approximately 12 to 13 times versus the historical average of 14 to 15 times, Hodges said. And that, he asserted, means opportunity in small-cap stocks.

"You won't hear it on CNBC, but this is the time to buy stocks," he said. Quoting Shelby Davis, once named "America's most reliable fund manager" by Money magazine, Hodges added: "You make your money in a bear market. You just don't know it at the time."