Author: capitismedia
Q1 2024 Commentary
Stocks marched higher in Q1 2024 with participation broadening from the mega cap winners of 2023 tomid-cap and smaller capitalization companies. U.S. economic growth, a steady consumer, and high expectations for interest rate cuts by the Federal Reserve promoted continued risk taking by investors. Gains in equity markets were largely multiple driven as earnings gains were modest and the stocks of lower quality small cap companies outpaced the returns of higher quality companies during the quarter. Using the Russell Stability indexes as proxies for high and low quality, the Russell 2000 Defensive index, containing businesses with higher Returns on Assets, lower leverage, and lower volatility underperformed low-quality businesses, as measured by the Russell 2000 Dynamic indexes, by 375 basis points for the quarter. More information including since-inception performance for each QSV strategy may be found at www.qsvequity.com.
QSV Strategy Quarterly Performance
QSV Small Cap returned .78% and .72%, gross and net of fees, respectively, lagging the Russell 2000 Value Index return of 2.90% and the Russell 2000 Index return of 5.18%. Security selection in Communication Services, Financials, and Information Technology companies aided performance relative to the index. Security selection detracted from performance in Industrials as did an underweight and company selection in Energy holdings.\ Energy delivered the strongest absolute returns in the Index during the quarter due to elevated geopolitical risks and higher demand. QSV remains significantly underweight relative to the sector due to challenges in finding quality businesses at reasonable valuations.
QSV Small Cap Top Contributors
PubMatic Inc. (PUBM), a leading platform provider of digital advertising technology, was the leading contributor to performance in Q1 2024 as it continued to expand its customer base and the volume of ad impressions processed. A rebound in digital ad pricing also lifted revenue growth to levels beyond management’s prior forecast. Competitive advantages include switching costs – the time, effort, and money required to transfer platforms once an advertiser is set up on PUBM’s platform – and cost advantages through its investment in infrastructure and off-shore research and development. PUBM produces returns on invested capital of 12% on average.
Contract research organization Medpace Holdings Inc. (MEDP) contributed to performance as strong quarterly earnings exceeded expectations. MEDP is a leading provider of full-service drug development and clinical trial services to small and midsized biotechnology, pharmaceutical, and medical device firms. The company benefits from high switching costs as its tools and testing are highly scripted in regulation and practice. MEDP produces returns on invested capital of 25% on average.
QSV Small Cap Top Detractors
Forward Air (FWRD) fell 50% during the quarter due to pessimism over its acquisition of Omni Logistics. While FWRD stands as a leader in the less-than-truckload shipping business, concerns over its debt levels and integration risks persist. QSV is closely monitoring this integration and FWRD’s business performance. Despite its near-term headwinds, FWRD benefits from its substantial network of 92 terminals located at or near airports throughout North America. This network provides economies of scale and creates high barriers to entry, making replication of its capabilities a challenge.
Malibu Boats(MBUU) shares fell due to reduced forward guidance and concerns that higher interest rates will dampen sales of the company’s brands. Combined, its Malibu and Axis brands are the largest player in the ski/wakeboard market, one of the fastest-growing segments of the powerboat market. Malibu has been acquiring strong brands in a very fragmented industry and selling through its extensive dealer network of over 350 independent dealers, including 250 in North America. MBUU shares are currently at a significant discount to our estimate of intrinsic value, and QSV added to its position during the quarter.
QSV Small Cap Portfolio Activity
Shares of AMN Healthcare (AMN) and MGP Ingredients (MGPI) were sold for valuation reasons. Proceeds were invested in health management company Astrana Health (ASTH) and Vestis Corporation (VSTS), a provider of uniforms and other workplace supplies.
QSV Mid Cap returned 4.66% and 4.42%, gross and net of fees for the quarter, trailing the 8.23% return of the Russell Mid Cap Value Index and the Russell Mid Cap Index return of 8.60%. Security selection in Healthcare and Communication Services companies helped relative performance, as did our underweight to Communication Services names. Selection in the Financials, Industrials and Energy sectors detracted.
QSV Mid Cap Top Contributors
Contract research organization ICON PLC (ICLR) was the leading contributor to performance as it bounced back following concerns over its acquisition of competitor PRA Health. The cultures of ICLR and PRA Health are similar, and the combined organization will bring synergies and the benefit of reduced client concentrations. ICLR produces returns on invested capital of 10% on average, and its shares sell at a discount to our measure of intrinsic value. Lincoln Electric Holdings (LECO) also contributed to performance during the quarter with revenue and margin results that exceeded expectations. Founded in 1895, LECO is a trusted name in welding, cutting, and brazing products, with a leading global market share. While still in the commercialization phase, LECO is developing an EV charger business that represents a growth opportunity the business. The company has raised its dividend for twenty-two years and produces returns on invested capital of 20% on average.
QSV Mid Cap Top Detractors
MarketAxess Holdings (MKTX) was the leading detractor to performance during the quarter despite earnings results that exceeded analysts’ expectations and strong forward guidance. MKTX is the leading platform for trading fixed income securities, where it continues to grow market share due to the growing adoption of electronic execution. Greater adoption by retail and institutional investors and by the company’s network of dealers improves liquidity and the effectiveness of the platform for its clients. MKTX produces returns on invested capital of 27% on average and its shares are at a discount to QSV’s measure of intrinsic value.
Akamai Technologies (AKAM) detracted from performance during the quarter. AKAM operates through its Security, Compute, and Content Delivery Network (CDN) segments. AKAM is known for its CDNs that the company estimates deliver between 15% and 30% of global web traffic supported by over 350,000 servers arrayed in over 4,100 networks across the globe. Its growing network and application security business is a major focus for AKAM. With revenue growth in the mid-teens, this segment is expected to produce one-half of AKAM’s revenues in 2024.
QSV Mid Cap Portfolio Activity
There were no total sales or purchases of positions during the quarter. QSV did add to its position in the payroll and human capital management platform Paycom (PAYC) on weakness in its share price.
QSV Select returned 3.61% and 3.39%, gross and net of fees, lagging returns of the Russell 2500 Value and Russell 2500 Indexes of 6.07% and 6.92%, respectively. Select is a high conviction strategy that holds QSV’s best ideas from our Small Cap and Mid Cap strategies. Security selection was positive in Healthcare and Real Estate holdings. Selection detracted from returns in Industrials holdings while company selection and an underweight to Energy companies hurt performance.
QSV Select Top Contributors
Primerica Inc. (PRI) was the leading contributor to performance during the quarter. PRI provides financial services to middle-income households in the United States and Canada, offering life insurance, mutual funds, annuities, and other financial products. While earnings from life insurance were down for the quarter, asset-based revenues from annuities and mutual funds rose with the markets and PRI successfully grew its sales force. PRI’s shares continue to sell at a discount to our measure of intrinsic value.
Booz Allen Hamilton (BAH) rose on continued strong business performance and its reputation, as one analyst coined, as “AI at a Reasonable Price.” BAH has scale advantages as a provider of cybersecurity, data analytics, augmented reality, and artificial intelligence projects for the Department of Defense that, like all U.S. government contracts, are subject to elevated levels of scrutiny that serve as barriers to entry for competitors. The company has earned a position as the leader in artificial intelligence solutions and support for modernizing the U.S. military.
QSV Select Top Detractors
MarketAxess Holdings(MKTX) was the leading detractor to performance of QSV Select during the quarter and is discussed above.
Storage REIT National Storage Affiliates (NSA) detracted from performance during the quarter. Funds from operations in the trailing quarter were below analysts’ estimates and NSA’s guidance for 2024 revenues and net operating income were down on lower occupancy. In the long term, we remain positive on NSA as a REIT that has seen strong occupancy rates, the ability to pass along single to low double-digit rate increases, and the financial flexibility to pay down debt with an eye toward future acquisitions.
QSV Select Portfolio Activity
QSV continued to prune and add to Select to upgrade quality and address valuations. Freight broker Landstar System (LSTR), pool supply provider Pool Corporation (POOL), and Toro (TORO), an operator of oil tankers, were sold for holdings in which we have more conviction. New positions were initiated in Doximity (DOX), a digital platform for U.S. medical professionals, dating platform Match (MTCH), elevator and escalator provider OTIS Worldwide (OTIS), and Progress Software (PRGS), a provider of cloud-based security solutions.
Our Focus on the Long Term
We believe a good deal of 2024’s potential returns were pulled forward in Q4 2023. We also feel that market prices reflect near perfection in the economic and geopolitical outcomes of the coming quarters. Unfortunately, the world is imperfect and uncertain. At QSV, we do not invest in markets, but focus on building portfolios of quality businesses with durable competitive advantages purchased at reasonable valuations. We anticipate that 2024 will bring both surprises and the consequential market volatility. To prepare for this we recommend that long term investors focus on businesses with solid balance sheets, strong free cash flows, and high returns on invested capital. We continue to find these traits in the small and mid-capitalization businesses in each of the QSV portfolios and invite you to join us as we invest alongside our clients.
Disclaimer:
Returns are for the respective composites of QSV Equity Investors. Gross returns are calculated net of trading fees. Net returns are calculated net of trading fees and net of the firm’s management fee. All dividends are assumed to be reinvested. The returns of the QSV Small Cap strategy are compared to the historical performance of the Russell 2000 Indices as they are a widely used benchmarks for small capitalization securities. The returns of the QSV Mid Cap strategy are compared to the historical performance of the Russell Midcap Indices as they are a widely used benchmarks for mid capitalization securities. The returns of the QSV Select strategy are compared to the historical performance of the Russell 2500 Indices as they are a widely used benchmarks for SMID capitalization securities. An investment with QSV Equity Investors should not be construed as an investment in a program that seeks to replicate, or correlate with, these indices. Market conditions vary between the QSV products and these indices. Furthermore, these indices do not include any transaction costs, management fees and other expenses, as do the QSV products. Lastly, QSV may invest in securities and positions that are not included in these indices.
No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries risk of loss.
QSV Equity Investors, LLC claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of the CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. To view a GIPS report, please visit www.qsvequity.com.
QSV Equity Investors, LLC is a registered investment advisor. For additional information about the firm and its professionals please visit the SEC’s website at www.adviserinfo.sec.gov.
Risk Matters
We founded QSV in 2016 to answer the question “how would we want our personal assets to be managed?” With more than twenty-five years of managing client accounts together, we had a philosophy and process in place and knew we could continue to learn and enhance how we invest. A meaningful pillar in our mission statement is to provide a “smoother ride” or the ability for clients to sleep soundly each night without the drama or volatility that some investment styles may deliver. We also founded our business with the belief that attention to risk and setting expectations for clients on how and when we would perform is paramount. QSV’s strategies will not outperform passive benchmarks or our peers in every market environment, but will, we believe, deliver strong risk-adjusted returns and outperformance over full market cycles. Our record to date has proven that to be true.
MEASURING UP (DOWN?)
Tools to evaluate QSV’s performance since the inception of our products include measuring the downside participation that QSV has captured. The downside capture ratio measures how much of the index’s losses a portfolio captures when the market is declining and is calculated by dividing the fund’s returns by the returns of the index during periods when the index is down. In the trailing five years, QSV Mid Cap has delivered downside participation that ranks in the lowest quintile of the Morningstar mid-cap value peer group (rankings sorted from 1st to 100th percentile (with 1st being the highest downside capture to lowest / most favorable in the 100th percentile).
While we strive to improve further on these results, they do reflect well on another pillar of QSV’s mission: to deliver lower drawdowns in challenging markets. Standard deviation of returns is a commonly used measure of volatility to compare an investment portfolio with its benchmark or peers and gives investors a sense of the return “swings” they will endure with a particular portfolio. Here, too, QSV Mid Cap compares favorably with its peers, and ranks in the 86th percentile (with the 100th percentile representing the lowest standard deviation) relative to the Morningstar mid cap value peers. Beta is another tool used to assess the risk of a portfolio. While it is thought that the return potential of a lower beta portfolio is below its benchmark, QSV believes otherwise. In our whitepaper, The Myth of High Beta, QSV questions the long-held belief that higher risk, high beta stocks deliver the highest returns and presents studies that show how the “low volatility anomaly” creates opportunities to beat the market and create long term wealth. QSV Mid Cap has a beta since inception of .73 that ranks in the 90th percentile (with the 100th percentile representing the lowest beta) of the Morningstar Mid Cap Value peer group.
“The lower volatility that QSV has delivered does, we believe, provide the “sleep at night” comfort that many seek.”
QSV MID CAP PERFORMANCE
These statistics and their relative ranking are important but are only part of the picture. Returns relative to our benchmark matter to our investors, as well, and QSV has delivered outperformance from its inception through March 31, 2024, fulfilling another of our goals.
Based on this performance, one final statistic and ranking to consider is the Sharpe ratio for QSV Mid Cap. The Sharpe ratio divides a portfolio’s returns in excess of a risk-free rate by its standard deviation of returns to assess its risk-adjusted performance. QSV’s since-inception information ratio of .77 ranks in the 9th percentile (where the 1st percentile is the highest Sharpe ratio) of the Morningstar Mid Cap Value peer group, underscoring the risk-adjusted performance we have delivered for our clients.
WHERE DOES QSV FIT?
We believe that the QSV Small Cap, Mid Cap and Select strategies are great core holdings for clients seeking solutions that will permit them to participate in rising markets while protecting in falling markets, resulting in outperformance relative to passive benchmarks over the long term. The lower volatility that QSV has delivered does, we believe, provide the “sleep at night” comfort that many seek. Choices abound and many clients also wish to have small and mid-cap options in their portfolios that may outperform when QSV lags. This typically happens in times such as rapidly rising markets following recessions and periods of stimulative policies, such as we experienced following the COVID pandemic. QSV has been paired by such clients with deep value managers and high-beta growth managers, where, in both cases, our strategies have offset the periods of underperformance by the other and QSV’s portfolios have dampened the overall risk in the clients’ portfolios.
WHERE ARE WE NOW?
In both Q4 2023 and the first quarter of 2024, QSV noted that we felt much of the potential returns for 2024 had been pulled forward in the performance enjoyed in 2023. Markets got ahead of themselves as investors anticipated waning inflation, multiple interest rate cuts by the Federal Reserve, persistent corporate earnings and continued economic growth. Investors awakened in April to the possibility that these expectations may not come true and their change of heart resulted in volatility and a drop in equity markets. While the markets began 2024 with 150 basis points of rate cuts priced in, valuations currently have seventy-five basis points priced in – what the Federal Reserve had communicated in late 2023 and to which investors failed to pay heed until this recent valuation correction.
We believe that mid-cap stocks are attractive for long-term investors, with valuations relative to large capitalization stocks not seen since the late 1990s. The protracted outperformance of large cap stocks has led to underinvestment in small and mid-cap companies; while mid-caps represented 19.7% of the Russell 3000 Index at year-end, the average investor had only a 10.2% allocation, according to Morningstar. With current economic and geopolitical uncertainties, investors should keenly focus on active management and the ownership of quality businesses to build durable portfolios that can withstand the volatility that may continue. A focus on companies that have strong balance sheets and cash flows in today’s environment is critical.
About QSV Equity Investors
QSV Equity Investors, LLC (formerly Ballast Equity Management, LLC) is an employee-owned asset management firm that invests alongside its clients in high conviction portfolios of quality small and mid-capitalization businesses. QSV manages these portfolios of publicly traded companies for individuals, family offices, and institutions. Based in Naperville, Illinois, QSV was founded in 2016 by Jeff Kautz and Randy Hughes, investment professionals who previously held senior roles at Janus Henderson subsidiary Perkins Investment Management and have invested together for 25 years. For more details on the specific performance and characteristics of QSV’s strategies, including a fully GIPS compliant presentation, please contact Dave Mertens at dmertens@qsvequity.com.
Disclaimer:
This information is provided solely for informational purposes. Full holdings for the QSV Mid Cap strategy and additional information are available by request at customerservice@qsvequity.com. Morningstar Rankings are relative to the Morningstar Mid Cap Value separate account peer group as of March 31, 2024. Returns are for Mid Cap composite of QSV Equity Investors. Gross returns are calculated net of trading fees. Net returns are calculated net of trading fees and net of the firm’s management fee. All dividends are assumed to be reinvested. The returns of the QSV Mid Cap strategy are compared to the historical performance of the Russell Mid Cap Indices as they are a widely used benchmarks for mid capitalization securities. An investment with QSV Equity Investors should not be construed as an investment in a program that seeks to replicate, or correlate with, these indices. Market conditions vary between the QSV products and these indices. Furthermore, these indices do not include any
transaction costs, management fees and other expenses, as do QSV products. Lastly, QSV may invest in securities and positions that are not included in these indices.
No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries the risk of loss. QSV Equity Investors, LLC claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of the CFA Institute. The CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. To view a GIPS report, please visit qsvequity.com. QSV Equity Investors, LLC is a registered investment advisor. For additional information about the firm and its professionals please visit the SEC’s website at adviserinfo.sec.gov.
QSV Named to PSN Top Guns List of Best Performing Strategies for Q4 2023
QSV Named to PSN Top Guns List of Best Performing Strategies for Q4 2023
Quarterly PSN Top Guns List published by Zephyr identifies best-in-class separate accounts, managed accounts, and managed ETF strategies.
Naperville, IL – February 23, 2024 – QSV Equity Investors announced today its QSV Select strategy has been named to the celebrated PSN Top Guns List of best performing separate accounts, managed accounts, and managed ETF strategies for 4Q 2023. The highly anticipated list, published by Zephyr, remains one of the most important references for investors and asset managers. QSV was honored with a Five Star Ranking for its Select strategy in the Small-Mid Cap Universe, highlighting its top ten ranking on a risk adjusted basis over the trailing three years.
“As the needs and viewpoints of investors are becoming more diverse, investment advisors must incorporate strategies capable of being customized to their client’s goals. SMA strategies are becoming increasingly important as an efficient tool to provide custom investment solutions for portfolios of all sizes and have seen asset growth of over 19% in 2023. It is also increasingly important for managers to identify quality SMA strategies. Zephyr PSN has been helping advisors find quality products for 40 years and achieving Top Gun status confirms that QSV Equity Investors has outperformed their peers in a meaningful way,” said Nick Williams, Product Manager of PSN at Zephyr.
“Small and mid-cap stocks currently present exciting opportunities, but selectivity is important,” noted QSV Chief Investment Officer Randy Hughes. “QSV’s Select strategy holds our firm’s best ideas. We believe its focus on businesses with durable competitive advantages will continue to reward our clients over time.” QSV CEO Jeff Kautz added that “this Top Guns rating highlights the long-term competitiveness and risk management of QSV Select that we continually seek to deliver.”
Through a combination of PSN’s proprietary performance screens, the PSN Top Guns List ranks products in six proprietary categories in over 75 universes based on continued performance over time. QSV Select was awarded a Top Gun 5-Star rating, meaning that QSV Select had an r-squared of 0.80 or greater relative to the style benchmark for the recent five-year period. Moreover, Select’s returns exceeded the style benchmark for the three latest three-year rolling periods. Products are then selected which have a standard deviation for the five-year period equal or less than the median standard deviation for the peer group. The top ten returns for the latest three year period then become the 5 Star Top Guns.
QSV manages three fundamental strategies, Small Cap, Mid Cap and Select, each of which seeks to reward clients with performance that is above its benchmark and peers over a full market cycle with less volatility. QSV ’s investment team invests alongside its clients in small and mid-cap businesses they believe can sustain high returns on invested capital through durable competitive advantages. QSV believes that selectively owning shares of these businesses, purchased at reasonable valuations, offers investors an attractive opportunity to diversify their portfolios and grow long-term wealth. The complete list of PSN Top Guns and an overview of the methodology can be located at https://psn.fi.informais.com/. Registration is required. For more details on the specific performance and characteristics of QSV ’s strategies, including a fully GIPS compliant presentation, please visit www.QSVequity.com.
About QSV Equity Investors, LLC
QSV Equity Investors is an employee-owned asset management firm that invests alongside its clients in high conviction portfolios of quality small and mid-capitalization businesses. QSV manages these portfolios of publicly traded companies for individuals, family offices and institutions. Based in Naperville, Illinois, QSV was founded in 2016 by Jeff Kautz and Randy Hughes, investment professionals who previously held senior roles at Janus Henderson subsidiary Perkins Investment Management and have invested together for over 25 years.
About PSN
For nearly four decades, PSN has been a top resource for investment professionals. Asset managers rely on Zephyr’s PSN to effectively reach institutional and retail investors. Over 2,800 firms, 285 universes, and more than 21,000 products comprise the PSN SMA database showing asset breakdowns, compliance, key personnel, ownership diversity, ESG, business objectives and strategy, style, fees, GIC sectors, fixed income ranges and full holdings. Unique to PSN is its robust historical database of nearly 40 Years of Data Including Net and Gross-of-Fee Returns. For more details on the methodology behind the PSN Top Guns Rankings or to purchase PSN Top Guns Reports, contact Robby Resendez at PSNdata@informais.com Visit PSN online to learn more.
Media Contact:
Dave Mertens
QSV Equity Investors, LLC
dmertens@qsvequity.com
(630) 376-4392
Q4 2023 Commentary
Q4 2023 Commentary
Q4 2023 reminded investors that the only thing constant is change. While the prior quarter saw markets fall due to the Federal Reserve’s commitment to keep rates higher for longer in its fight against inflation, the fourth quarter brought an “everything rally” with stocks, bonds, and crypto all rising in anticipation of interest rate cuts and a belief that a soft landing for the economy is likely. Small and mid‐cap stocks participated in the rally, notching most of their calendar year gains in the final three months of 2023. Each of the QSV strategies, focused on quality businesses that possess competitive moats, delivered strong outperformance for the calendar year relative to its respective value index. More information including since‐inception performance for each strategy may be found at www.qsvequity.com.
QSV Strategy Quarterly Performance
QSV Small Cap returned 15.03% and 14.93%, gross and net of fees, respectively, slightly lagging the Russell 2000 Value Index return of 15.26% while leading the Russell 2000 Index return of 14.03%. The most significant positive impact was made in Energy companies, where an underweight to the index aided performance, and Communication Services companies, where QSV’s overweight detracted but security selection added value. An underweight and company selection in Consumer Discretionary companies detracted from relative returns. QSV’s overweight to Healthcare helped returns, but security selection detracted.
QSV Small Cap Top Contributors
After a significant drop in Q3 on news of its restatement of three quarters’ financial results, Napco Security Technologies (NSSC) was the leading contributor to performance during the quarter as its shares rose 54%. NSSC is a global provider and manufacturer of high‐tech security, and internet connected home, video, fire alarm, access control, and door locking systems. QSV was concerned about management’s controls that led to the need for the restatement and closely monitors the business. NSSC delivers returns on invested capital of 14% and sells at a discount to our measure of intrinsic value.
PubMatic (PUBM) was a leading contributor to performance as revenues, earnings and forward guidance all exceeded expectations. PUBM is a leading platform provider of the digital advertising technology, helping publishers that supply digital ad inventory to better manage their inventory, selling a high percentage of their inventory and maximizing revenue per ad sold. Competitive advantages include switching costs ‐ the time, effort, and money required to transfer platforms once an advertiser is set up on PUBM’s platform – and cost advantages through its investment in infrastructure and off‐shore research and development. PUBM produces returns on invested capital of 18%.
QSV Small Cap Top Detractors
Core Laboratories (CLB) fell 26% during the quarter, detracting from performance. The company has competitive advantages in reservoir analysis and production enhancement services, serving hydrocarbon exploration and production companies as they seek to improve production levels and economics. The company also anticipates significant future growth from the application of its technologies to carbon capture and sequestration projects. A risk inherent to the business is the cyclicality of oil prices, as was seen in Q4 2023.
Ituran Location and Control Ltd. (ITRN) shares fell in response to the war in Israel where the company has operations and a sizable portion of its client base. ITRN provides stolen vehicle recovery, fleet management, and other value‐added services. Its subscription‐based model adds 80,000 to 100,000 net new customers per year, derived from after‐market sales, OEMs, and insurance companies, and currently reports over 1.8 million subscribers across Israel and Latin America. ITRN management affirmed that the company has not seen any impact to its ongoing operations in Israel. Company headquarters are in the center of the country, just outside of Tel Aviv, and not near any borders. ITRN produces returns on capital of 19% and its shares are currently at a significant discount to intrinsic value.
QSV Small Cap Portfolio Activity
Trims and additions were made in five holdings during the quarter, but there were no new positions added. Shares of foodservice packaging company Karat Packaging (KRT) were sold for valuation reasons. QSV had sold portions of the KRT position two other times in 2023, taking gains in this long‐term holding.
QSV Mid Cap returned 12.32% and 12.05%, gross and net of fees for the quarter, leading the Russell Mid Cap Value Index return of 12.11% before fees while narrowly lagging the Index after fees. Mid Cap lagged the Russell Mid Cap Index return of 12.82%. Security selection in Information Technology and Financial companies helped relative performance, while selection in the Energy and Industrials sectors detracted. Underweights in Energy and Materials businesses helped relative performance, while over weights to Healthcare and Technology companies detracted from performance.
QSV Mid Cap Top Contributors
Monolithic Power Systems (MPWR) was the leading contributor to performance in the quarter as the company delivered strong earnings growth. MPWR is a global provider of high‐performance, semiconductor‐based power solutions. As a “fabless” company – one that does not manufacture the chips used in its products – MPWR has benefitted from devoting more resources to chip design rather than capital expenditures, resulting in greater free cash flows, higher margins, and Returns on Invested Capital of 24%.
Shares of Bank OZK (OZK) gained more than 35% during the quarter, supported by strong business performance including loan growth in its Real Estate Specialties Group that was greater than expected. OZK management noted that they will focus less on share buybacks in 2024 versus 2023 due to their expectations for further loan growth. OZK has a long history of exemplary credit, best‐in‐class profitability, and strong management. The bank produces Returns on Tangible Equity of 18% and its shares are trading at 1.1 times tangible book value.
QSV Mid Cap Top Detractors
Core Laboratories (CLB) was the leading detractor to QSV Mid Cap performance and is discussed above. Oil and natural gas producer APA Corporation (APA) detracted from performance during the quarter. While both revenues and earnings beat analysts’ expectations for the quarter, APA shares declined along with commodity prices. APA produces strong free cash flows and is committed to returning 60% to shareholders in the form of buybacks and share repurchases. Following the end of the quarter, APA announced its acquisition of Callon Petroleum (CPE) in an all stock deal, furthering the trend of M&A to build scale in the exploration and production industry. The combined company should see meaningful synergies through reduced overhead, interest expenses and operating synergies.
QSV Mid Cap Portfolio Activity
There were no total sales or purchases of positions during the quarter. QSV did add to its position in the payroll and human capital management platform Paycom (PAYC) on weakness in its share price.
QSV Select returned 13.98% and 13.74%, gross and net of fees, leading the 13.76% returns of the Russell 2500 Value before fees, while slightly lagging the Index after fees. QSV Select outperformed the 13.35% return of the Russell 2500 Index. Select is a high conviction strategy that takes QSV’s best ideas from our Small Cap and Mid Cap strategies. Security selection helped performance in Financial, Information Technology and Real Estate holdings, while detracting from performance in Industrials, Energy and Consumer Discretionary businesses. An underweight in Energy holdings aided performance.
QSV Select Top Contributors
Napco Security Technologies (NSSC) was the leading contributor to performance during the quarter and is discussed above.
Glacier Bancorp (GBCI) rose as quarterly results were better than anticipated. GBCI benefits from an operating footprint in seven economically vibrant U.S. states which supports robust organic growth. Additionally, the company has used cash flows to take a partnership approach to acquisitions which have led to the bank producing Returns on Tangible Common Equity of 14%.
QSV Select Top Detractors
Core Laboratories (CLB) was the leading detractor to performance of QSV Select during the quarter and is discussed above.
Human capital management provider Paycom (PAYC) detracted from performance during the quarter. PAYC’s revenues were down due to its conversion of clients to a new, innovative solution that lessens errors and reduces the need for additional payroll runs as a result. PAYC targets customers with 50 – 10,000 employees and is expanding its business with larger enterprise deals and a push into both Mexico and Canada. The company has approximately 5% penetration of its total addressable market which we believe it can expand through its best‐in‐class salesforce. PAYC has returns on invested capital of 24%.
QSV Select Portfolio Activity
Turnover during the quarter was minimal, but QSV made one addition to upgrade its portfolio. Using the proceeds from Masimo (MASI), which was exited at the end of Q3, Amdocs (DOX) was purchased. DOX is a forty‐year‐old provider of software and services solutions for communications, entertainment, and media industries.
Our Focus on the Long Term
2023 stands as a stark reminder that predictions of market returns are folly. Few would have anticipated that markets would rise so significantly or that world events would take the turns – often tragic – that they did. While we cannot (and do not) predict, we can prepare. The strong results of 2023 have pulled forward market returns in expectation that interest rates will be cut, that inflation will continue to fall, and that corporate earnings will grow. One or more of these may not come about. The leveraged consumers that have bullishly supported the economy, and the labor market that has supported them, may cool. Geopolitical events may present challenges.
Preparing for uncertainty leads QSV to its focus on long term investment in quality businesses, those with limited debt, high interest rate coverage and strong free cash flows. We continue to find compelling opportunities in small and mid‐cap stocks of these quality firms, at reasonable valuations, and believe they will serve our clients well as we invest alongside them.
Disclaimer:
Returns are for the respective composites of QSV Equity Investors. Gross returns are calculated net of trading fees. Net returns are calculated net of trading fees and net of the firm’s management fee. All dividends are assumed to be reinvested. The returns of the QSV Small Cap strategy are compared to the historical performance of the Russell 2000 Indices as they are a widely used benchmarks for small capitalization securities. The returns of the QSV Mid Cap strategy are compared to the historical performance of the Russell Midcap Indices as they are a widely used benchmarks for mid capitalization securities. The returns of the QSV Select strategy are compared to the historical performance of the Russell 2500 Indices as they are a widely used benchmarks for SMID capitalization securities. An investment with QSV Equity Investors should not be construed as an investment in a program that seeks to replicate, or correlate with, these indices. Market conditions vary between the QSV products and these indices. Furthermore, these indices do not include any transaction costs, management fees and other expenses, as do the QSV products. Lastly, QSV may invest in securities and positions that are not included in these indices.
No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries risk of loss.
QSV Equity Investors, LLC claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of the CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. To view a GIPS report, please visit www.qsvequity.com.
QSV Equity Investors, LLC is a registered investment advisor. For additional information about the firm and its professionals please visit the SEC’s website at www.adviserinfo.sec.gov.
Q3 2023 Commentary
QSV Equity Investors
Q3 2023 Commentary
Q3 2023 was difficult for U.S. equities as the reality that “higher for longer” truly will mean higher interest rates for longer gelled in the minds of investors. The Federal Reserve is intent on fighting inflation and seems committed to keeping rates high and conditions tight for the foreseeable future, causing concerns over the impact on the economy. Economic growth and interest rates impact smaller companies more than large, and small caps experienced a double digit drop from their July peak through the quarter-end. Three months is a brief period for investors focused on the long term, yet Q3 2023 was a quarter, given the market environment, where we expected our stock selection in the QSV strategies to perform better.
Particularly within the QSV Small Cap and Select strategies, a handful of companies disappointed. Some of these, we believe, still deserve a place in the portfolios and we have added to certain names at lower prices where the disappointment is believed to be temporary. Others we have exited in favor of higher conviction positions.
Beyond security selection, the headwinds to our portfolios from being underweight in energy were considerable this quarter. The Energy sector was up over 18% within the Russell 2000 Value index, while every other sector – save Financials at +1.04% – were in negative territory. QSV has historically been underweight in energy companies. In a period of $90 per barrel oil, many energy companies can boast high returns on invested capital; at more “normal” prices it is challenging to find energy businesses with competitive advantages, disciplined management, and the high business returns that we require.
QSV’s Small Cap and Select strategies underperformed their respective Russell value indexes during the quarter while QSV Mid Cap was in line with its index. More information including since-inception performance for each of the strategies may be found at www.qsvequity.com.
QSV Strategy Quarterly Performance
QSV Small Cap returned -5.24% and -5.31%, gross and net of fees, lagging the Russell 2000 Value Index return of -2.96% and the Russell 2000 Index return of -5.13%. The most significant positive impact was made in Consumer Discretionary companies, where QSV added value in security selection and was underweight compared to the index, and in Healthcare, where QSV was overweight and added value through security selection. An underweight and company selection in Energy companies accounted for nearly all the Small Cap portfolio’s underperformance relative to the index. Company selection in Real Estate also detracted from relative returns.
QSV Small Cap Top Contributors
Capri Holdings, Ltd. (CPRI) was the leading contributor to performance during the quarter as shares rose 46%. The purveyor of Michael Kors, Jimmy Choo and Versace agreed to be acquired by Tapestry (TPR) for $57 per share. We expect the deal with TPR to close in 2024 and exited our position placing the proceeds in companies we believe provide better opportunities.
For the second consecutive quarter, foodservice packaging company Karat Packaging (KRT) was a leading contributor to performance. Gross margins improved as KRT continued to benefit from lower input and shipping costs. Core products continue to show sales growth and the company’s Eco-friendly product sales are trending above 30%. The company initiated a quarterly dividend during the quarter, underscoring the strength of its free cash flow. KRT generates returns on invested capital of 15%.
QSV Small Cap Top Detractors
After being one of the portfolio’s greatest contributors for the year, shares of Napco Security Technologies, Inc. (NSSC) dropped on the news that it would restate the prior three quarters’ results due to understating cost of goods sold. NSSC is a global provider and manufacturer of high-tech security, and internet-connected home, video, fire alarm, access control, and door locking systems, serving commercial, industrial, residential, and government markets. Management has said the issue is resolved and will not impact results going forward. We have concerns about management’s controls that led to the need for the restatement and will continue to closely monitor the business. Prior to this restatement, we had sold
a meaningful amount of the position on strength.
Forward Air (FWRD) shares were hit on news that they are merging with private company Omni Logistics, a provider of global freight forwarding and third-party logistics services. The merger will roughly double the scale of FWRD and will add new growth opportunities with an asset light business, yet it does present integration risks. QSV acknowledges these risks but sees opportunities for growth and cost synergies within the business. We added to our position in FWRD on weakness in its shares.
QSV Small Cap Portfolio Activity
The acquisitions of Capri Holdings (CPRI) by Tapestry and PDC Energy (PDCE) by Chevron prompted the exit of those positions during the quarter. Johnson Outdoors (JOUT), UMH Properties (UMH), and UniFirst Corporation (UNF) were sold due to business performance that did not meet our expectations and the opportunity to upgrade to better ideas. New positions were initiated in professional medical platform Doximity (DOCS), business process management company ExlService (EXLS), LabCorp spin-out Fortrea Holdings (FTRE), Hanover Insurance (THG), real estate finance company Walker & Dunlop (WD), and digital media company Ziff Davis (ZD).
QSV Mid Cap returned -4.32%, gross of fees for the quarter, leading the Russell Mid Cap Value Index return of -4.46% and the Russell Mid Cap Index return of -4.68%. The net return of -4.55% lagged the Russell Mid Cap Value Index while exceeding the Russell Mid Cap Index. Security selection in Consumer Discretionary and Industrials companies helped relative performance, while selection in Financials and Real Estate businesses detracted.
QSV Mid Cap Top Contributors
Outsourced payroll and human capital management provider Trinet Group, Inc. (TNET) was the leading contributor to performance in the quarter. Increasing use of technology, digitization of the HR function, employment growth in new industries and increasing geographic decentralization of the small and medium-sized business workforce all create favorable trends for TNET. TNET has competitive advantages relative to its peers that include its scale and the efficiencies offered through the consolidation of its operating units on a single technology platform. TNET generates returns on invested capital of 28% and shares are at a discount to our estimate of intrinsic value.
Shares of APA Corporation (APA) gained more than 20% during the quarter on rising oil prices, contributing to the results of QSV Mid Cap. APA produces oil and gas with operations in the U.S., Egypt and the United Kingdom, and exploration activities offshore in Suriname. APA generates strong free cash flows and is committed to returning 60% to its shareholders, primarily through share repurchases, dividends and paying down its debt.
QSV Mid Cap Top Detractors
Masimo Corporation (MASI) fell on poor financial results and lowered future guidance. Results were impacted by issues that included lower hospital volumes, elevated channel inventory levels, and hospital labor inflation that is impacting capital equipment demand. MASI is a medical technology company which develops, manufactures, and markets non-invasive vital sign monitoring devices and offers consumer audio products. The integration of its acquisition of Sound Audio has continued to present challenges to the business and we exited the position in favor of higher conviction businesses.
Etsy Inc. (ETSY) detracted from performance during the quarter. Etsy markets differentiated products through its “House of Brands” which includes Esty.com, Reverb, and Depop. Competitive advantages include the diversity of its offerings, a strong base of active buyers and sellers, and productivity tools it offers sellers. Despite these advantages, with rising fuel prices, the resumption of student loan payments, and a shift by consumers to “experiences” over goods, we believe there are better opportunities for our investors, thus we exited the position during the quarter.
QSV Mid Cap Portfolio Activity
Turnover during the quarter was higher than usual as QSV took opportunities to upgrade its portfolio. As noted above, Etsy (ETSY) and Masimo (MASI) were exited for business performance reasons. A.O. Smith (AOS), Cintas (CTAS), and Ross Stores (ROST) were sold for valuation reasons and Mid-America Apartment Communities (MAA) was sold to allocate to better ideas. New positions were initiated in digital services provider Amdocs (DOX), nitrogen producer CF Industries (CF), LabCorp spin-out Fortrea Holdings (FTRE), GPS-enabled hardware and software provider Garmin (GRMN), Match Group (MTCH), elevator and escalator manufacturer OTIS Worldwide (OTIS), and Waters (WAT), a provider of liquid chromatography and mass spectrometry products.
QSV Select returned -6.25% and -6.45%, gross and net of fees, lagging the returns of -3.66% and -4.78%, respectively for the Russell 2500 Value and the Russell 2500 Indexes. Select is a high conviction strategy that takes QSV’s best ideas from our Small Cap and Mid Cap strategies. An underweight and company selection in Consumer Discretionary companies helped performance as did QSV’s absence in the poorly performing Utilities sector. Company selection detracted from performance in the Financials sector as did our underweight and underperformance in Energy businesses.
QSV Select Top Contributors
Brady Corporation (BRC) was the leading contributor to performance during the quarter as the company beat consensus earnings estimates and raised its guidance for the full year. The company manufactures and sells identification and workplace safety products through its Identification Solutions and Workplace Safety segments. BRC has niche advantages in safety, identification, and compliance markets and has a diversified customer base, products, and geographic footprint. The company’s strong free cash flows have supported dividend increases for thirty-seven consecutive years, share buybacks and strategic acquisitions.
EPAM Systems, Inc. (EPAM) rose as quarterly results were better than anticipated. The company has diversified its workforce away from its previous exposure to Ukraine and the belief that demand for the company’s services may be bottoming raised investor sentiment. The global technology services company has a network of multidisciplinary teams delivering software product development and digital platform engineering services. Most of the firm’s revenues are generated from U.S. customers and its top twenty clients (representing 41% of revenue) have been with EPAM for an average of ten years. Returns on invested capital stand at 17%.
QSV Select Top Detractors
Masimo Corporation (MASI) and Napco Security Technologies, Inc. (NSSC) were the leading detractors from performance in Q3 and are discussed above.
QSV Select Portfolio Activity
QSV took opportunities to upgrade the Select portfolio during the quarter. Shares of PDC Energy (PDCE) were sold as Chevron (CVX) acquired the business. Generac Holdings (GNRC) was sold for valuation reasons. Positions were initiated in CF Industries (CF) and Fortrea Holdings (FTRE).
Our Focus on the Long Term
Investors began the last quarter on an optimistic note, while bullishness faded in September. Strength of the consumer continues to be touted as a positive for the economy (Americans Are Still Spending Like There’s No Tomorrow), as are strong employment and rising labor participation rates. Yet credit card debt is high and student loan payments are again due. Persistent inflation and higher interest rates will also weigh on the consumer as well as on corporate earnings. The Financial Times notes that 30% of the debt of Russell 2000 companies is variable rate debt (as compared to 6% for S&P 500 companies), presenting risks to lower quality, more leveraged businesses.
At this stage in the market cycle, we believe that QSV’s style of investing and our investors should do well. Late cycle investing favorsthe lower volatility stocks of quality businesses, those that have limited debt, high interest rate coverage and strong free cash flows. Selectivity is important and opportunities abound in small to mid-cap stocks that have been overlooked in the narrow market that dominated the first half of the year. Investors will also do well to check their asset allocation; the mega-cap led markets of 2023 have left many portfolios in an unbalanced state and shifts in allocations may be due.
Disclaimer:
Returns are for the respective composites of QSV Equity Investors. Gross returns are calculated net of trading fees. Net returns are calculated net of trading fees and net of the firm’s management fee. All dividends are assumed to be reinvested. The returns of the QSV Small Cap strategy are compared to the historical performance of the Russell 2000 Indices as they are a widely used benchmarks for small capitalization securities. The returns of the QSV Mid Cap strategy are compared to the historical performance of the Russell Midcap Indices as they are a widely used benchmarks for mid capitalization securities. The returns of the QSV Select strategy are compared to the historical performance of the Russell 2500 Indices as they are a widely used benchmarks for SMID capitalization securities. An investment with QSV Equity Investors should not be construed as an investment in a program that seeks to replicate, or correlate with, these indices. Market conditions vary between the QSV products and these indices. Furthermore, these indices do not include any transaction costs, management fees and other expenses, as do the QSV products. Lastly, QSV may invest in securities and positions that are not included in these indices.
No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries risk of loss.
QSV Equity Investors, LLC claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of the CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. To view a GIPS report, please visit www.qsvequity.com.
QSV Equity Investors, LLC is a registered investment advisor. For additional information about the firm and its professionals please visit the SEC’s website at www.adviserinfo.sec.gov.
QSV Q2 2023 Commentary
QSV Equity Investors
Q2 2023 Commentary
Stocks climbed a wall of worries in the first half of 2023 that included a banking crisis, higher interest rates and inflation, the debt ceiling debate, and geopolitical concerns. Looking specifically at the “Magnificent Seven” large cap technology stocks, returns of those shares did not climb, but vaulted the wall, leaving other segments of the market in the distance. Bullishness in June lifted shares of lower quality businesses creating headwinds to the quality biased QSV strategies in Q2 2023. Using the Russell Stability indexes as proxies for high and low quality, the Russell Defensive indexes containing businesses with higher Returns on Assets, lower leverage, and lower volatility underperformed low quality businesses, as measured by the Russell Dynamic indexes, across the market cap spectrum for the quarter. QSV’s Small Cap and Mid Cap strategies outperformed their respective Russell value indexes during the quarter while QSV Select slightly underperformed. More information including since-inception performance for each of the strategies may be found at www.qsvequity.com.
QSV Strategy Quarterly Performance
QSV Small Cap returned 3.31% and 3.22%, gross and net of fees, leading the Russell 2000 Value Index return of 3.18% while trailing the Russell 2000 Index return of 5.21%. The most significant positive impact was made in Healthcare, where QSV added value in security selection and was overweight compared to the index, and in Financials, where QSV was underweight and added value through security selection relative to the index. Security selection in Information Technology and Industrials detracted from performance.
QSV Small Cap Top Contributors
Generac Holdings Inc. (GNRC) was the leading contributor to performance during the quarter. Demand for home standby generators is strong and headwinds from high inventory levels in the company’s supply chain are abating. GNRC benefits from a scale advantage in the home generator market with a market share four times greater than their next competitor. The company produces returns on invested capital of 15% and is actively deploying free cash flow from its legacy generator business into its newer clean energy business. QSV trimmed its position in GNRC as the price appreciated.
Karat Packaging (KRT) contributed to performance as shares rose nearly 40%. The foodservice packaging company benefitted from lower input and shipping costs for its products and from increased sales supported by greater distribution capacity in its Midwestern region. KRT produces returns on invested capital of 13% and uses its free cash flow for tuck in acquisitions and capacity expansion.
QSV Small Cap Top Detractors
Shutterstock (SSTK) was the leading detractor to performance for the quarter. Shares fell due to concerns that the stock imagery business of SSTK will be disrupted by Artificial Intelligence generative imagery. While this is a risk to monitor, SSTK is developing its own AI capabilities and is leading its peers with this initiative. SSTK purchased GIPHY from META during the quarter, increasing its total addressable market by adding the world’s largest collection of GIFs and stickers. SSTK produces returns on invested capital of 15%
Glacier Bancorp (GBCI) fell during the quarter as investors reacted to the bank’s lower net interest margins and higher deposit costs. While these results are disappointing, they were not unexpected given the current market environment. We see GBCI as a strong banking franchise with prudent expense management and a thirty-year history of making acquisitions to fuel growth in its business. GBCI produces returns on tangible equity of 16% and has net interest margins more than 3%.
QSV Small Cap Portfolio Activity
Following strong stock performance, Choice Hotels (CHH), Core Laboratories (CLB), Lemaitre Vascular (LMAT), Morningstar (MORN), and Watts Water Technologies (WTS) were sold for valuation reasons. Methode Electronics (MEI) was sold due to concerns over its ability to effectively integrate its acquisition of Northern Lights. World Wrestling Entertainment (WWE) was sold as it approached its acquisition by Endeavor. New positions were initiated in AudioCodes (AUDC), a provider of voice over IP and data networking solutions, Capri Holdings (CPRI), the holding company for retail brands Michael Kors, Jimmy Choo and Versace, consulting services firm ICF International (ICFI), Malibu Boats (MBUU), and Scotts Miracle Gro (SMG). QSV Mid Cap returned 4.09% and 3.84%, gross and net of fees, for the quarter, leading the Russell Mid Cap Value Index return of 3.86% and lagging the Russell Mid Cap Index return of 4.76%. Security selection and an overweight relative to the index in Industrials helped performance as did security selection and an underweight in Utilities. Company selection in Financials and an underweight and security selection in Consumer Discretionary names detracted.
QSV Mid Cap Top Contributors
Management consulting firm Booz Allen Hamilton (BAH) was the leading contributor to performance in the quarter. BAH has scale advantages as a provider of cybersecurity, data analytics, augmented reality, and artificial intelligence projects for the Department of Defense, that, like all U.S. government contracts, are subject to elevated levels of scrutiny that serve as barriers to entry for competitors. The company’s standing as the leader in artificial intelligence solutions to the U.S. government helped propel its share price during the quarter. Shares of vehicle salvage auctioneer Copart (CPRT) gained more than 20% during the quarter. The rate at which insurers choose to total vehicles following accidents has increased due to elevated repair costs, providing CPRT better access to salvaged vehicles for resale. Sales volumes and price per unit sold were up and margins increased during the quarter. CPRT produces returns on invested capital of 26% and net operating margins of 31%. QSV trimmed its position in CPRT during the quarter for valuation reasons.
QSV Mid Cap Top Detractors
MarketAxess Holdings (MKTX) fell on concerns over slightly lower trading volumes that resulted from uncertainty in the banking sector and seasonal patterns. MKTX is the leading platform for trading fixed income securities, where it continues to take market share due to the growing adoption of electronic execution. It is expected that higher yields will drive greater allocations of assets to fixed income and increased participation by retail & institutional investors. Greater adoption by these buyers and by the company’s network of dealers improves liquidity and the effectiveness of the platform for its clients. MKTX produces returns on invested capital of 28% and its shares are at a discount to QSV’s measure of
intrinsic value.
Etsy Inc. (ETSY) declined during the quarter over concerns that consumers’ spending was shifting from goods to services and that the company would be challenged to profitably add customers. Etsy markets differentiated products through its “House of Brands,” which include Esty.com, Reverb, a musical instrument marketplace, Depop, a resale marketplace, and Elo7, a Brazilian marketplace for handmade goods. ETSY joined 7.5 million active sellers with 95.1 buyers as of December 2022. Customer acquisition costs are elevated from COVID era levels, but we see the diversity of its offerings, the strong base of active buyers and sellers, and the productivity tools it offers sellers as competitive advantages. ETSY shares sell at a meaningful discount to our measure of intrinsic value.
QSV Mid Cap Portfolio Activity
QSV took opportunities to upgrade its portfolio during the quarter. New positions were started a previous QSV holding, Jack Henry & Associates (JKHY), a provider of bank technology and payment processing services, and equity exchange Nasdaq Inc. (NDAQ). QSV Select returned 4.03% and 3.80%, gross and net of fees, lagging the returns of 4.37% for the Russell 2500 Value Index and the return of 5.22% for the Russell 2500 Index. Select is a high conviction strategy that takes QSV’s best ideas from our Small Cap and Mid Cap strategies. Company selection in Communication Services and Consumer Staples contributed to performance, while selection in Financials and Real Estate detracted.
QSV Select Top Contributors
Generac Holdings Inc. (GNRC) was the leading contributor to performance during the quarter
and is discussed above. Management consulting firm Booz Allen Hamilton (BAH) was a leading contributor to performance and
is also discussed above.
QSV Select Top Detractors
After being a top contributor to performance of the Select strategy in Q1, shares of electronic trading platform MarketAxess Holdings (MKTX) detracted from performance in Q2. MKTX is discussed above.
Glacier Bancorp (GBCI) fell during the quarter and is also discussed above.
QSV Select Portfolio Activity
QSV took opportunities to upgrade the Select portfolio during the quarter. Shares of Church & Dwight (CHD), Pubmatic (PUBM), and WD-40 (WDFC) were sold for valuation reasons and to purchase higher conviction companies. Positions were initiated in EPAM Systems, Inc. (EPAM), Jack Henry & Associates (JKHY), and Paycom Software (PAYC).
Our Focus on the Long Term
Optimism has returned to the markets and to consumer sentiment, and somewhat rightfully so. 401(k) and brokerage account balances have improved measurably from the end of 2022. This optimism has supported stronger consumer spending on services and is reflected in the performance of certain stocks, with cruise line operators Carnival, Norwegian and Royal Caribbean standing out as the top three S&P 500 performers in Q2. For those still seeking out areas for concern (and not believing that it is different this time) risks exist. Core inflation, the measure excluding food and energy, remains well above target and is declining at a glacial pace. The Federal Reserve and its peer central banks have not yet gotten the desired results from a string of rate hikes. Chairman Powell’s comments that we have “a long way to go” in getting back to 2% policy rates signal more rate increases to come. Elevated borrowing costs are likely to eat into corporate profits and we believe this puts the current valuations of lower quality, more leveraged small and mid-cap companies at risk. Opportunities exist for equity investors, and we counsel an emphasis on quality businesses with limited debt, high interest rate coverage and strong free cash flows. As always, this remains our focus for delivering long-term results for our clients as we invest alongside them.
Disclaimer:
Returns are for the respective composites of QSV Equity Investors. Gross returns are calculated net of trading fees. Net returns are calculated net of trading fees and net of the firm’s management fee. All dividends are assumed to be reinvested. The returns of the QSV Small Cap strategy are compared to the historical performance of the Russell 2000 Indices as they are a widely used benchmarks for small capitalization securities. The returns of the QSV Mid Cap strategy are compared to the historical performance of the Russell Midcap Indices as they are a widely used benchmarks for mid capitalization securities. The returns of the QSV Select strategy are compared to the historical performance of the Russell 2500 Indices as they are a widely used benchmarks for SMID capitalization securities. An investment with QSV Equity Investors should not be construed as an investment in a program that seeks to replicate, or correlate with, these indices. Market conditions vary between the QSV products and these indices. Furthermore, these indices do not include any transaction costs, management fees and other expenses, as do the QSV products. Lastly, QSV may invest in securities and positions that are not included in these indices.
No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries risk of loss.
QSV Equity Investors, LLC claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of the CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. To view a GIPS report, please visit www.qsvequity.com.
QSV Equity Investors, LLC is a registered investment advisor. For additional information about the firm and its professionals please visit the SEC’s website at www.adviserinfo.sec.gov.
QSV Q1 2023 Commentary
QSV Equity Investors (formerly Ballast Equity Management)
Q1 2023 Commentary
Equity markets finished the quarter with positive returns, while the path to those gains was a rocky one. January was marked by robust performance, with shares of lower-quality, higher beta companies showing significant gains. Markets were dampened in February with news that inflation, while cooling, persists and employment remains strong. March followed with the big story of the quarter, the “don’t say bailout” banking crisis, and the ninth in a string of interest rate increases from the Federal Reserve. Each of the QSV strategies produced returns ahead of their respective Russell value and core indexes during the quarter supported by positive stock selection. More information including since-inception performance for each of the strategies may be found at www.qsvequity.com.
QSV Strategy Quarterly Performance
QSV Small Cap returned 3.40% and 3.31%, gross and net of fees, leading both the Russell 2000 Value Index return of (.66)% and the Russell 2000 Index return of 2.74%. The most significant positive impact was made in Financials, where QSV added value in security selection and was underweight compared to the index, and in Communication Services, where QSV was overweight and outperformed the index. Our underweight and underperformance compared to the Consumer Discretionary sector detracted from performance.
QSV Small Cap Top Contributors
NAPCO Security Technologies (NSSC) was the leading contributor to performance during the quarter. Shares rose over 36% on better-than-expected revenues for the quarter and positive trends toward more recurring revenues. NAPCO manufactures security products for intrusion, fire, access control, and door locking systems. The company’s revenue primarily comes from commercial customers and products are sold through NAPCO’s ecosystem of 10,000 dealers and 2,000 integrators. Shares of media company World Wrestling Entertainment (WWE) were up more than 33% as expectations of a sale of the business rose. WWE has a strong brand within a niche audience, especially for its popular Raw and SmackDown content. Most revenues for WWE come from North America, but we believe there is an opportunity for growth outside the U.S. It was announced on April 3 that Endeavor Group (EDR) will form a new company, combining the UFC and WWE brands.
QSV Small Cap Top Detractors
Seacoast Banking Corp of Florida (SBCF) was the leading detractor to performance for the quarter as shares dropped in tandem with the banking industry. SBCF offers commercial and consumer banking, wealth management, and mortgage and insurance services in the rapidly growing Florida market. While QSV Commentary Q1 2023 shares fell along with their regional bank peers, we see SBCF as a well-capitalized business with growing net interest margins, Returns on Tangible Equity of 10% and Returns on Equity of 7%. Also in the banking industry, Horizon Bancorp (HBNC), fell during the quarter, detracting from performance. HBNC offers commercial and consumer banking, wealth management, and mortgage and insurance services to customers in Central Indiana and Michigan. Its network of branches includes those acquired from TCF Financial in 2021. While negatively affected by the quarter’s banking crisis, we see HBNC as a strong enterprise, with Returns on Tangible Equity of 18% and Returns on Equity of 13%.
QSV Small Cap Portfolio Activity
Aerojet Rocketdyne Holdings Inc. (AJRD) shares were sold early in Q1 as the company was acquired by L3Harris Technologies. QSV initiated new positions in investment banking and wealth management firm Evercore Equity (EVR), Kulicke & Soffa Industries (KLIC), a maker of capital equipment and tools for the semiconductor industry, and NexPoint Residential Trust (NXRT), an operator of multi-family properties
in the southeastern U.S. The QSV Mid Cap strategy returned 5.28% and 5.02%, gross and net of fees, for the quarter, leading both the Russell Mid Cap Value Index return of 1.32% and the Russell Mid Cap Index return of 4.06%. QSV’s security selection added value in the Energy and Consumer Staples sectors, while security selection in Financials detracted.
QSV Mid Cap Top Contributors
West Pharmaceutical Services (WST) rose by 47% during the quarter on further evidence of pricing power and margin increases across its portfolio of products. WST has competitive advantages as a key supplier to pharmaceutical, biotechnology, and generic drug businesses, with expertise in the development and manufacture of supplies for the containment and administration of injectable drugs. The company delivers Returns on Invested Capital of 22%.
Monolithic Power Systems Inc (MPWR) gained more than 40% during the quarter on optimism over the firm’s year-over-year results, diversification of its manufacturing capabilities, and long-term growth prospects. MPWR is a global provider of high-performance, semiconductor based power solutions. As a “fabless” company – one that does not manufacture the chips used in its products – MPWR has benefitted from devoting more resources to chip design rather than capital expenditures, resulting in greater free cash flows, higher margins, and Returns on Invested Capital of 24%.
QSV Mid Cap Top Detractors
Shares of exploration and production company APA Corp (APA) fell as recessionary concerns and waning oil and natural gas prices weighed on investor sentiment. We see APA as a strong operator with geographically diversified sources of production and the ability to emphasize oil or gas production as each presents itself as more advantageous. APA is committed to returning 60% of its strong free cash flow to shareholders in the form of dividends and share repurchases. Shares of management consulting firm Booz Allen Hamilton (BAH) pulled back during the quarter due to a potential Federal government shutdown and feared budget cuts. While these actions would impact QSV Commentary Q1 2023 revenues to BAH, the current backlog of projects should produce growth for the business in 2023 and beyond. Additionally, BAH has been more resilient as it focuses on large government-wide acquisition contracts (GWACs) that can be less susceptible to reductions across government agencies.
QSV Mid Cap Portfolio Activity
With the early quarter rally and later decline, QSV took opportunities to upgrade its portfolio. QSV exited Casey’s General Stores (CASY), Skyworks Solutions (SWKS), and Snap-on Inc (SNA). New positions were started in multi-family real estate investment trust Mid-America Apartment Communities (MAA) and Paycom Software (PAYC), a provider of payroll and human capital software. The QSV Select strategy returned 6.68% and 6.45%, gross and net of fees, leading the returns of 1.40% for the Russell 2500 Value Index and the return of 3.39% for the Russell 2500 Index. Select is a high conviction strategy that takes QSV’s best ideas from our Small Cap and Mid Cap strategies. An underweight and outperformance in Financials helped performance, as did an overweight and outperformance in Healthcare holdings. The leading detractor from performance was our overweight and underperformance in Industrials.
QSV Select Top Contributors
West Pharmaceutical Services (WST) was the leading contributor to performance during the quarter and is discussed above.
MarketAxess Holdings (MKTX), the leading platform for the electronic trading of corporate bonds, contributed to performance during the quarter as investors continued to move from voice-negotiated trading to electronic trading of bonds. MKTX’s dominance in corporate bonds also stands as a risk, as revenues are tied to the level of corporate bond issuance and credit spread volatility. Trends toward increasing turnover in these bonds and capabilities in trading U.S. Treasuries and municipal bonds should help boost revenues. MKTX produces Returns on Invested Capital of 28% and its shares are at a discount to QSV’s measure of intrinsic value.
QSV Select Top Detractors
Following a solid quarterly earnings report, shares of Synovus Financial Corp (SNV) fell along with the banking industry during the March banking crisis. SNV offers shareholders an opportunity to take part in the rapidly growing southeastern U.S. market. The company produces Returns on Tangible Equity of 20% and Returns on Equity of 16%. Shares sell at a significant discount to QSV’s measure of intrinsic value.
Booz Allen Hamilton (BAH) shares also detracted from performance. BAH is discussed above.
QSV Select Portfolio Activity
Turnover was limited during the quarter. As in the QSV Mid Cap strategy, we exited shares of premium tool provider Snap-on Inc (SNA) for valuation reasons.
Our Focus on the Long Term
The banking crisis puts the Federal Reserve in a tenuous spot as it considers added rate increases in the battle against inflation. Pressure on banks’ balance sheets caused by both the stresses on existing borrowers and the need to raise rates credited on deposits will lead to tightened lending standards and diminished lending. This, in turn, will put the brakes on growth and contribute to the risks of a recession. QSV cannot predict with any greater accuracy than the next person whether a recession occurs, but we do know that challenging times such as these generally favor quality businesses that can self-fund growth through free cash flows and less reliance on debt markets. Investors sought quality in a compact list of mega-cap tech companies in early 2023; we believe more compelling opportunities exist in small and midcap companies for investors able to dig out those with durable competitive advantages and reasonable valuations.
Disclaimer:
Returns are for the respective composites of QSV Equity Investors. Gross returns are calculated net of trading fees. Net returns are calculated net of trading fees and net of the firm’s management fee. All dividends are assumed to be reinvested. The returns of the QSV Small Cap strategy are compared to the historical performance of the Russell 2000 Indices as they are a widely used benchmarks for small capitalization securities. The returns of the QSV Mid Cap strategy are compared to the historical performance of the Russell Midcap Indices as they are a widely used benchmarks for mid capitalization securities. The returns of the QSV Select strategy are compared to the historical performance of the Russell 2500 Indices as they are a widely used benchmarks for SMID capitalization securities. An investment with QSV Equity Investors should not be construed as an investment in a program that seeks to replicate, or correlate with, these indices. Market conditions vary between the QSV products and these indices. Furthermore, these indices do not include any transaction costs, management fees and other expenses, as do the QSV products. Lastly, QSV may invest in securities and positions that are not included in these indices.
No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries risk of loss.
QSV Equity Investors, LLC claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of the CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. To view a GIPS report, please visit www.qsvequity.com.
QSV Equity Investors, LLC is a registered investment advisor. For additional information about the firm and its professionals please visit the SEC’s website at www.adviserinfo.sec.gov.
Rebrand, AUM Milestone Propelling QSV Equity Investors Forward
Rebrand, AUM Milestone Propelling QSV Equity Investors Forward
Rebrand AUM Milestone Propelling QSV Equity Investors Forward – Full Reprint
Things are moving forward for QSV Equity Investors, which recently eclipsed the $100 million mark in assets under management. The domestic small- and mid-cap focused equity firm officially rebranded from Ballast Equity Management on March 21, with its new name a nod to the focus on the factors that drive the team’s investment process – quality, sustainability and value. “We’re striving to deliver stability for our investors, low standard deviation, however, you want to measure it, a low volatility strategy. We do that by buying quality companies at reasonable valuations,” Partner and Head of Business Development Dave Mertens said. The decision was also influenced by the firm’s awareness of the persisting overlap the Ballast name had with other firms in the space as the team discussed rebranding for the better part of the last year, according to Mertens. “Asset managers in general have taken the name of every rock, tree, river and mountain. There’s many names that have been taken and it’s hard to find something that’s new and original,” he added. QSV was co-founded in 2016 by CEO Jeff Kautz and CIO Randy Hughes, who worked together at Janus Henderson Investors subsidiary Perkins Investment Management before launching Ballast, forming the mid-cap strategy that year prior to introducing small-cap and small- to mid-cap strategies in 2017. “[Kautz and Hughes] really felt that they needed to kind of get their legs under them and really build a proof statement or a track record of a certain length before we went out to the public,” Mertens said. That focus may have caused the pair to lose touch with some of the contacts they had built up in their time at Perkins and made laying a foundation the primary directive for Mertens upon joining in 2019. “We were getting out and making calls to some of the [investors] that had done business with Jeff and Randy earlier at Perkins,” Mertens said. “We were getting the data in the databases and getting basic blocking and tackling in place.” The firm maintains a Naperville, Ill.- based office, formerly in Oak Brook, Ill., that serves Kautz and Hughes. Mertens, who is based in Colorado, noted the firm hit the road initially in cities like Chicago where they had a more robust network, but that marketing did not get into full swing until early 2020 just as the COVID-19 pandemic hit. COO Josh Freedman, also based in Colorado, rounds out the current team af-ter joining in 2020 from Denver-based Elk Creek Partners. “We had worked with him together in late 90s and early 2000s, so we knew Josh well, but we knew that from his experiences at Platte River [Capital Management] and Elk Creek, he knew how to put infrastructure in place that was scalable,” Mertens said. “As he got that done in 2020 that really prepared us … to be more ready for the marketplace and the institutional marketplace.” The firm’s growth to $100 million in assets has been aided by its relationship with emerging manager-of-managers Legato Capital Management, which has resulted in investments in the firm’s domestic smallcap value product by the five New York City Retirement Systems, FIN Searches data shows. The small-cap strategy, which the Informa PSN database shows has outperformed the Russell 2000 Value Index over the one-, three- and five-year periods ending Dec. 31, comprises the bulk of QSV’s assets under management with roughly $83 million, according to Mertens, who noted the firm has built from friends and family to a now majority of institutional investors. The firm, while “benchmark aware,” is focused on its bottom-up process of finding the best businesses, according to Mertens, who noted QSV will generally have position sizes of 1% to 4% and sector weights or no more than 200% or less than 50%. “The outliers, in terms of sectors, are due to our quality bias and our demand for high returns on invested capital. Historically, we have been very low or absent in energy and utilities. As you can imagine that low weight in energy was a headwind last year, but generally we’ve just not seen those companies produce high returns on invested capital,” Mertens said. Conversely, the firm tends to overweight areas like technology, healthcare, consumer staples and businesses that produce high returns on invested capital, he added, noting that the technology weight in what the firm calls “chicken tech” represents a differentiator from the typical small- or mid-cap value manager. “These are not high tech, high growth companies so much as software and services providers that are more steady return on invested capital plays,” Mertens said. QSV anticipates its capacity will top out at roughly $2 billion for the small-cap strategy, $2.5 billion in the smid-cap strategy, and $7 billion in the mid-cap strategy, according to Mertens. He noted that closing at a manageable size is a primary consideration for the team, which learned the lesson of managing too much money in a capacity constrained strategy when the Perkins small-cap strategy was reopened after the firm’s merger with Janus Henderson. “They learned from that experience that size is the enemy of performance, and it really did hinder their performance considerably, trying to manage too much money,” Mertens said. QSV does plan to scale the firm in line with asset growth but in the meantime is content with its current setup. “As the firm grows and as we’re able to we certainly want to add in the investment team eventually,” Mertens said. “What we have now, in terms of human capital, is certainly enough to get the job done and we are scalable.”
Disclaimer: No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries the risk of loss. QSV Equity Investors is a registered investment advisor. For additional information about the firm and its professionals please visit the SEC’s website at www.adviserinfo.sec.gov
This article was reprinted with the permission of Emerging Manager Monthly
The Trouble with Point Estimates
The Trouble with Point Estimates
QSV_The Trouble with Point Estimates
NEW BRAND. SAME PEOPLE, PHILOSOPHY AND PROCESS.
The Ballast Equity Management team has worked together for over 25 years, refining our investment philosophy and process, and improving our craft. Our skillset is in researching, valuing, and building portfolios of small and mid-cap stocks and decidedly not in marketing or branding, thus we find ourselves with a corporate name, Ballast Equity Management, which is quite like that of another, peer, firm. As a result, we are rebranding our firm to QSV Equity Investors. QSV stands for the Quality, Stability and Value that we continually seek to deliver to our clients with each decision we make. Our people, philosophy and process will not change, only our name will.
THE TROUBLE WITH POINT ESTIMATES
After an era of low interest rates, globalization and low inflation, investors were hit in 2022 with the reality of a new regime, one marked by higher interest rates, inflation, and higher volatility. This new regime has percolated its way into corporate earnings with negative earnings surprises notable in the Communication Services, Information Technology, and Consumer Discretionary sectors. Where earnings for the market go in the near term is difficult to predict, but consensus is that these declines are likely to continue into the next quarter and, we believe, the consensus view may be too rosy for the balance of 2023. At QSV, we worry about the “E” in P/E and feel the game has gotten more challenging for investors seeking to make quick decisions based on the point estimates often used in valuing stocks.
ALL VALUATION TOOLS ARE NOT EQUAL
Point estimates, or market multiples, are widely used by investors and Price to Earnings is the most often used tool for valuing equities. P/E is simple to use, requiring just two inputs. The trailing 12-month price-to-earnings multiple, for example, divides a stock’s current share price by the last year’s earnings per share. The simplicity of this calculation also speaks to its shortcomings– multiples tend only to provide high-level snapshots of valuation at a point in time. These limitations can misguide investors; a P/E may appear low because the company is at peak earnings. Or, without considering what may happen to the “E,” or earnings, in such a simple equation, investors often can step into value traps – stocks that are cheap for good reason – when relying on multiples. Though investors can gain more insight by looking at a company’s P/E multiple over many years or by comparing it to the market and other companies in the same industry, there is another critical drawback; valuation multiples still do not account for cash and debt on the company’s balance sheet. More importantly, they do not account for a company’s potential growth or its risk profile. Because of such limitations, we at QSV may use these ratios in our initial screening process, but we rely on a more robust model to derive our ultimate intrinsic value estimates.
QSV relies on a proprietary, and more sophisticated, valuation model to identify winning companies. Our Economic Profits model enables us to take a closer look at what a prospective firm has going on under the hood. Economic Profits and Discounted Cash Flow (DCF) models are similar and should arrive at the same intrinsic value for a company. However, we believe the Economic Profits model, which considers both the cost of debt, as DCF does, as well as the cost of equity, provides additional insight. By studying the firm’s capital structure and allocation decisions, such as its debt levels, tax rates, share repurchases and dividend payouts, QSV can assess whether management’s capital allocation decisions are creating or destroying value, making this model a more comprehensive tool for valuing a firm’s stock.
FUNDAMENTALS IN FOCUS
Before the valuation process begins, QSV conducts thorough quantitative and qualitative analysis to seek out businesses with competitive “moats.” We believe that business performance, including high margins, reverts to the mean over time, but we also believe that competitive advantages enable companies to maintain higher than average performance for longer periods of time. High quality companies tend to remain high quality companies. This persistence helps us value the stocks of these companies with a higher degree of conviction.
Easy money and rising markets created wealth and nascent investment success in areas that would never have occurred to Ben Graham or Warren Buffett at the beginning of the post-financial crisis era. Passive investing made a great percentage of active managers look passé. Meme stocks made work from home traders temporarily wealthy. Thematic ETFs focused on these meme stocks, on our politicians’ personal trading, and on other “disruptive” ideas capitalized on investors’ optimism, yet often went from hot to cold with startling speed. In the current environment of greater uncertainty, higher borrowing costs, and earnings headwinds, we believe investors would be prudent to emphasize active management in quality businesses, those with durable competitive advantages, strong balance sheets and strong and growing free cash flows.
About QSV Equity Investors
QSV Equity Investors (formerly Ballast Equity Management) is an employee-owned asset management firm that invests alongside its clients in high conviction portfolios of quality small and mid-capitalization businesses. QSV manages these portfolios of publicly traded companies for individuals, family offices and institutions. Based in Oakbrook Terrace, Illinois, QSV was founded in 2016 by Jeff Kautz and Randy Hughes, investment professionals who previously held senior roles at Perkins Investment Management and have invested together for over 20 years. For more details on the specific performance and characteristics of QSV’s strategies, including a fully GIPS compliant presentation, please contact Dave Mertens at dmertens@qsvequity.com.
Q2 2024 Commentary
Q2 2024 Commentary
No one needs another investment commentary noting the divergence of Nvidia and the “Magnificent 7” stocks’ performance with that of the broader market, but it is hard to live through a quarter like Q2 2024 without that on our minds. This compact group of companies has contributed more than 60% of the returns of the index in 2024 and, when the returns of the capitalization weighted S&P 500 are compared to an equally weighted S&P 500, there is a 10% difference in favor of the cap weighted benchmark. While this dynamic plays out, investors have paid little attention to the pond QSV fishes in, small and mid-cap equities, where the returns were quite different, and negative during the quarter. Each sector of the Russell 2000 Value index delivered losses in Q2, with Utilities (supported by the prospects for data centers for the AI revolution?) only slightly in negative territory and Healthcare, where QSV finds an ample supply of quality businesses, suffering losses of more than 10%. Returns for mid-cap indexes were in similar,
negative, territory.
More information including since-inception performance for each QSV strategy may be found at www.qsvequity.com.
QSV Strategy Quarterly Performance
QSV Small Cap returned -3.76% and -3.84%, gross and net of fees, respectively, lagging the Russell 2000 Value Index return of -3.64% and the Russell 2000 Index return of -3.28%. Security selection in Healthcare helped performance, while an overweight in the sector detracted. Selection in Real Estate also aided performance. Selection in Industrials and Financials businesses detracted from returns.
QSV Small Cap Top Contributors
Napco Security Technologies Inc. (NSSC) shares rose nearly 30% supported by strong growth in revenues and gross margins in its business units. NSSC is a global provider and manufacturer of high-tech security products, including access control systems, door-locking products, intrusion and fire alarm systems and video surveillance products. The company is focused on doubling revenue within its recurring, high-margin Services business in the next 2-3 years and currently produces returns on invested capital of 17% while selling at a discount to our measure of intrinsic value.
Hawkins Inc. (HWKN), rose more than 18%, contributing to performance. HWKN is a leading provider of chemicals and ingredients sold through its industrial, water treatment and health and nutrition segments. The company has benefitted from fast growth in its high margin water treatment business which is expected to drive higher earnings and free cash flow growth as it represents a larger portion of the firm’s overall revenues. HWKN produces returns on invested capital of 13%.
QSV Small Cap Top Detractors
Shares of clinical research organization Fortrea Holdings (FTRE) dropped more than 40% during the quarter as the company fell short of analysts’ estimates of revenues and earnings and the company lowered its outlook. The company, spun out of LabCorp (LH) in 2023, benefits from offering tools and testing to the biotechnology and pharmaceutical industries that are highly scripted in law, regulation, and practice. QSV believes that it is not uncommon for a company to struggle initially post-spinoff and has confidence in the long-term outlook for FTRE. As a result, we added to our position on weakness in the share price.
Alamo Group (ALG) shares declined during the quarter as a five-week strike in one of its plants is expected to impact the quarter’s financial results. The manufacturer of agricultural and vegetation maintenance equipment settled the strike with a five-year contract that should remove the risk of labor disruption for some time. ALG operates as forty global brands in two key divisions: industrial equipment and vegetation management equipment. The company benefits from an extensive dealer network and leading market share. Sixty percent of its revenues come from state and municipal government contracts.
QSV Small Cap Portfolio Activity
Shares of Forward Air (FWRD) were sold after the company added debt for its Omni Logistics acquisition and, in our view, could not clearly define the mission for the combined business. PubMatic (PUBM) and Shutterstock (SSTK) were each sold for valuation reasons. Scotts Miracle-Gro (SMG) was sold as they continued to struggle with the exposure to the cannabis industry and the addition of debt, reducing our estimate of the company’s intrinsic value. Proceeds were invested in existing holdings as well as new holding Catalyst Pharmaceuticals(CPRX), a biopharmaceutical company focused on developing therapies for people with rare, debilitating neuromuscular and neurological diseases.
QSV Mid Cap returned -5.15% and -5.38%, gross and net of fees for the quarter, trailing the -3.40% return of the Russell Mid Cap Value Index and the Russell Mid Cap Index return of -3.35%. Security selection in Consumer Staples companies helped performance, as did company selection and an overweight to Information Technology companies. Selection in Financials detracted as did selection and an overweight to Healthcare.
QSV Mid Cap Top Contributors
Monolithic Power SystemsInc. (MPWR) was the leading contributor to performance in the quarter as the company delivered strong earnings growth and benefitted from the outlook for AI-related tailwinds. MPWR is a global provider of high-performance, semiconductor-based power solutions. As a “fabless” company – one that does not manufacture the chips used in its products – MPWR has profited from devoting more resources to chip design rather than capital expenditures, resulting in greater free cash flows, higher margins, and returns on invested capital of 22%.
Teradyne Inc. (TER), a provider of semiconductor chip testing equipment, also contributed to performance during the quarter as it beat earnings estimates and affirmed guidance. AI-related opportunities are contributing to current growth and an enhanced outlook while the company’s exposure to mobility produces headwinds due to lower demand. TER produces returns on invested capital of 26% and sells below our estimate of intrinsic value.
QSV Mid Cap Top Detractors
Fortrea Holdings (FTRE) was the leading detractor to performance during the quarter and is discussed above.
Lincoln Electric Holdings (LECO) detracted from performance during the quarter as the company saw softness in its quarterly revenues and lowered its full year earnings guidance. We see these as short-term issues for LECO, a trusted name in welding, cutting, and brazing products, with a leading global market share. While still in the commercialization phase, LECO is developing an EV charger business that represents an additional growth opportunity for the business. The company has raised its dividend for twenty-two years and produces returns on invested capital of 21%.
QSV Mid Cap Portfolio Activity
There were no total sales or purchases of positions during the quarter. QSV did add to its position in the clinical research organization Fortrea Holdings (FTRE) on weakness in its share price and made other trims and additions based upon valuation and our convictions in the fundamentals of the businesses.
QSV Select returned -4.40% and -4.62%, gross and net of fees, lagging the returns of the Russell 2500 Value and Russell 2500 Indexes of -4.31% and -4.27%, respectively. Select is a high conviction strategy that holds QSV’s best ideas from our Small Cap and Mid Cap strategies. Security selection was positive in Industrials. Selection and an overweight in Information Technology and Consumer Discretionary holdings also aided performance. Selection detracted from returns in Financials and Healthcare holdings.
QSV Select Top Contributors
Napco Security Technologies Inc. (NSSC) was the leading contributor to performance during the quarter and is discussed above.
Tyler Technologies Inc. (TYL) rose as its transition to Software as a Service, subscription revenues and earnings increased. TYL is the largest provider of enterprise software products focused solely on the public sector, with a focus on local governments where high switching costs stand as Tyler’s competitive advantage. The company has a 98% customer retention rate and incremental margins in its subscription business of over 70%. We continue to believe that TYL will benefit from increased government spending on infrastructure.
QSV Select Top Detractors
Fortrea Holdings (FTRE) was the leading detractor to performance of QSV Select during the quarter and is discussed above.
Vestis Corporation (VSTS) detracted from performance during the quarter. Formerly a division of Aramark, VSTS provides uniform services and workplace supplies to North American Customers ranging from small businesses to Fortune 500 companies. Business performance has been impacted by client retention dropping because of off-cycle price increases and sub-par results from the company’s sales team. We believe the company’s focus on improved service and sales productivity will get this performance back on track.
QSV Select Portfolio Activity
Limited trading was done in QSV Select during the quarter, with trims and additions made to address valuations and quality upgrades.
Our Focus on the Long Term
We believe that mid-year reflection is appropriate for investors including a close look at asset allocation. With the concentration of returns to-date in large cap equities, and specifically in a handful of companies, many portfolios are tilted in favor of those holdings. Unintended bets may exist where investors in both passive and active funds have stakes in the Magnificent 7 companies that have increased in size. Markets could be “different this time” but if the outperformance of the S&P 500 over the smaller companies in the Russell 2000 persists throughout 2024 it will cap a four consecutive year period of such outperformance, something that has not occurred since 1995-1998. Small and mid-cap value equities excelled in the years that followed that, while investors in large cap stocks endured the “lost decade” of returns. Compelling valuations currently exist in small and mid-cap businesses. Coupled with the possibility of lower inflation, lower interest rates, and potential tailwinds from deglobalization, we see a convincing case for allocating to quality small and mid-cap companies.
Disclaimer:
Returns are for the respective composites of QSV Equity Investors. Gross returns are calculated net of trading fees. Net returns are calculated net of trading fees and net of the firm’s management fee. All dividends are assumed to be reinvested. The returns of the QSV Small Cap strategy are compared to the historical performance of the Russell 2000 Indices as they are widely used benchmarks for small capitalization securities. The returns of the QSV Mid Cap strategy are compared to the historical performance of the Russell Midcap Indices as they are widely used benchmarks for mid capitalization securities. The returns of the QSV Select strategy are compared to the historical performance of the Russell 2500 Indices as they are widely used benchmarks for SMID capitalization securities. An investment with QSV Equity Investors should not be construed as an investment in a program that seeks to replicate, or correlate with, these indices. Market conditions vary between the QSV products and these indices. Furthermore, these indices do not include any transaction costs, management fees and other expenses, as do QSV products. Lastly, QSV may invest in securities and positions that are not included in these indices.
No client or potential client should assume that any information presented should be construed as personalized investment advice. Personalized investment advice can only be rendered after engagement of the firm for services, execution of the required documentation, and receipt of required disclosures. Investing carries risk of loss.
QSV Equity Investors, LLC claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of the CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. To view a GIPS report, please visit www.qsvequity.com.
QSV Equity Investors, LLC is a registered investment advisor. For additional information about the firm and its professionals please visit the SEC’s website at www.adviserinfo.sec.gov.