Microcap Equity
At a Glance
- We expect to add value primarily through stock selection, rather than industry or sector weightings.
- We generally invest in 50-75 companies.
- Our positions in cash and cash equivalents are not actively managed, but generally account for less than 5% of portfolio assets, though our cash position may reach 10% during periods of active portfolio trading.
Objective
We seek to outperform the benchmark over a 3-5 year period, while maintaining a portfolio with consistent microcap equity characteristics.
Philosophy
As value investors, we seek to buy businesses for less than they are worth. However, often stocks with low multiples are not attractively valued but efficiently priced. Rather than focus on traditional value factors, our process relies on multiple valuation methodologies to determine intrinsic value while also applying a margin of safety and downside protection. Each business is different, with different cycles, capital needs, and reinvestment opportunities. We believe using the same valuation framework for every situation may produce underperforming results. In our view, value creation can best be assessed by evaluating owner earnings or cash flow. We also believe that growth and value are not mutually exclusive, which may result in the strategy reflecting a greater or lower traditional value orientation at times.
Fundamental Analysis
We apply rigorous bottom-up analysis, utilizing financial documents, other pertinent company information, in-person interviews, and additional data sources, as the first step in determining the nature of the business and the company’s potential for long-term value creation. We attempt to understand management’s philosophy toward growing the business, addressing risk, allocating capital, and creating shareholder value. Our process subjects potential holdings to thorough fundamental analysis and calculates intrinsic value using a variety of metrics, including free cash flow, net asset value, or potential return on capital. Reviews are conducted by at least two analysts, with the second analyst providing an opposing view to counter any possible “motivated reasoning” or other behavioral biases. Prospective holdings are vetted by the team with the final determination made by the lead portfolio managers.
Portfolio Structure
Portfolios are constructed on a bottom-up basis with sector weights incidental but consistent with our 40% policy maximum. Individual holdings are limited to a maximum of 5% at cost. Weights are determined based on quantitative and qualitative risk/reward characteristics.
Sell Discipline
We employ a disciplined approach to sell decisions, generally selling a stock when:
- The stock appreciates to our target price without commensurate gain in intrinsic value.
- Long-term fundamentals deteriorate, negatively impacting intrinsic value.
- The existing holding is replaced with a more attractive reward/risk opportunity.
- The market capitalization drifts.