James Stratton, whose Stratton Growth Fund outperformed the Standard & Poor's 500 Index for the past five years, expects industrial-equipment...

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James Stratton, whose Stratton Growth Fund outperformed the Standard & Poor’s 500 Index for the past five years, expects industrial-equipment makers and energy companies to benefit most from a strengthening U.S. economy.

The Stratton fund has 22 percent of its $1.7 billion in industrial-equipment stocks, about four times the industry average, and 17 percent in energy-related companies. The mutual fund’s biggest holdings include Rockwell Automation, the world’s No. 1 maker of factory controls, and Occidental Petroleum, the fourth-largest U.S. oil producer by market value.

Stratton, who started the fund in 1972, began piling money into equipment makers such as Rockwell about 1 ½ years ago, after he noticed companies were buying machinery again following a period when they were more focused on reducing debt.

“We bring to the table lots of years of experience to make judgments about who will benefit and who won’t” in different economic environments, Stratton said.

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The Stratton fund is considered a value fund because it invests mostly in stocks that are perceived as cheap relative to earnings and other financial parameters. The fund is up 1.8 percent this year, through March 30, the fourth-biggest advance of 210 value funds tracked by Bloomberg.

In the past five years, the Stratton fund climbed at an average annual rate of almost 15 percent, ranking 10th of 137 funds in its group.

Economy gains

An improving U.S. economy will help companies such as Milwaukee-based Rockwell and Occidental Petroleum of Los Angeles produce above-average earnings growth, Stratton said.

The economy expanded at a 4.4 percent rate in 2004, the best year for growth since 1999, the Commerce Department said March 30. Analysts estimate the economy will grow about 3.8 percent this year, according to a Bloomberg survey.

“We’re in what I call the third inning of an economic expansion,” said Tim McGee, chief economist at U.S. Trust in New York. The last two periods lasted about 10 years, ending in the late 1980s and about 2000, he said. “This could be another quite long expansion.”

Companies are doing more business with fewer employees working longer hours, and that’s boosting productivity, Stratton said. In some cases, a 20 percent revenue gain will result in a 60 percent earnings increase because companies don’t have the costs, he said.

Rockwell said fiscal first-quarter profit more than doubled because of higher demand for motors, software and machinery-control systems for manufacturing plants. Occidental Petroleum said fourth-quarter profit almost doubled as energy and chemicals prices increased.

U.S. oil futures surged to an all-time high in March, beating a previous record in October.

Crude oil on the New York Mercantile Exchange rose 46 percent in the past year to $52.85 on March 30 as production failed to match the rise in demand around the world. The S&P 500’s energy index has gained 14 percent this year, the best performance among industry groups, and 41 percent in the past 12 months.

Tesoro, PacifiCare

The Stratton fund has risen during eight of the past 10 calendar years. The fund fell 21 percent in 2002, the second most in its history, surpassed by the 24 percent drop in 1973.

Tesoro, a San Antonio, Texas-based oil refiner, accounted for much of the loss in 2002, as investors sold the stock on concern the company had taken on too much debt to expand refining capacity. By the end of the year, the stock had more than tripled, as the company sold assets to reduce its debt.

“The worst mistakes have been when we sold too soon,” Stratton said.

One of the biggest success stories for the fund is PacifiCare Health Systems, the largest U.S. manager of Medicare health-care plans. The fund holds 60,000 shares of PacifiCare.

Stratton invested in PacifiCare in December 2001, after the stock declined on concern about the Cypress, Calif.-based company’s ability to cover rising medical costs in its home state.

The stock has risen more than fivefold since then. “We got that when everybody was talking it down,” Stratton said.

Penn Virginia

Penn Virginia, a gas-exploration company, is another winner, having more than quadrupled since Stratton bought the stock in May 2000. The fund holds 80,000 shares of the Radnor, Pa.-based company.

Stratton said he uses “common sense” and at times “deliberately dismisses what analysts forecast” to choose industries and stocks. Watching earnings and industry trends is most useful, as analysts don’t see the whole picture, he said.

“Analysts have underestimated the power of this economic cycle,” Stratton said.