Q3 2024 Commentary
Last quarter we lamented that investors have paid little attention to the pond QSV fishes in, small and mid-cap stocks. After considerable waiting, small and mid-cap stocks outperformed the stocks of their larger brethren in Q3 2024, although it was hardly a straight line up and to the right during the quarter. Smaller companies’ stocks began a rally in July that was punctuated by selloffs in early August and early September. Their climb persisted higher to the end of the quarter supported by an interest rate cut by the Federal Reserve and investor confidence that inflation was under control. QSV participated well during the quarter, with our Small Cap and Select strategies outperforming their respective benchmarks while our Mid Cap lagged its index.
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 10.30% and 10.21%, gross and net of fees, respectively, leading the Russell 2000 Value Index return of 10.15% and the Russell 2000 Index return of 9.27%. An underweight to Energy companies aided performance. Security selection and an overweight in Industrials also helped performance. Security selection and an overweight to Technology businesses detracted from returns.
QSV Small Cap Top Contributors
Doximity, Inc. (DOCS) shares rose over 55% supported by strong revenue and earnings, both of which surpassed analysts’ expectations. DOCS also provided optimistic Q2 and fiscal year 2025 guidance, projecting higher revenue than analysts’ expectations. DOCS offers a suite of tools that support an online community for physicians, nurse practitioners and physicians’ assistants, enabling them to coordinate patient care, conduct patient visits and manage their careers, DOCS’ Q1 earnings call highlighted a net revenue retention rate of 114% and 21% growth from its top 20 clients. The company has returns on invested capital of 16%.
Hawkins Inc. (HWKN) rose more than 40%, 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 continues to benefit from capital deployment and fast growth in its largest segment, the high margin water treatment business, which is expected to drive higher earnings and free cash flow growth. HWKN produces returns on invested capital of 13%.
QSV Small Cap Top Detractors
Simulations Plus Inc. (SLP) was the leading detractor from performance for the quarter as shares dropped on a mixed demand environment and lower margins. SLP is a leading provider of software and services used by major pharmaceutical, biotech, and regulatory agencies to make better informed, data-driven decisions. We see the potential for improved demand and long-term value creation due to the company’s high switching costs, intellectual assets, and a 93% renewal rate by its customers. SLP produces operating margins of 26% on average and its shares are well below our estimate of intrinsic value.
Helen of Troy (HELE) shares declined during the quarter as management lowered guidance. The consumer products company owns strong discretionary brands that are organized into its Home & Outdoor and Beauty & Wellness segments. Entering the quarter, we incorrectly believed that lower expectations were priced into the stock. With its additional pullback during the quarter and our belief that its risks are reflected, we added to our position. We like HELE’s strong free cash flows and the restructuring plan that management has instituted to cut costs.
QSV Small Cap Portfolio Activity
Shares of Hancock Whitney Corporation (HWC) were purchased as QSV sought to increase its exposure to Financials ahead of anticipated interest rate cuts. MGP Ingredients (MGPI), a maker of premium distilled spirits and specialty wheat protein and starch food ingredients, was also added as its shares reached an attractive valuation. MGPI was previously a profitable holding of QSV Small Cap and has been steadily monitored by our team.
QSV Mid Cap returned 8.15% and 7.89%, gross and net of fees for the quarter, trailing the 10.08% return of the Russell Mid Cap Value Index and the Russell Mid Cap Index return of 9.21%. Security selection in Technology companies helped performance while an overweight to the sector detracted. Company selection and an overweight to Financials also aided performance. Selection in Industrials and Healthcare companies detracted from performance.
QSV Mid Cap Top Contributors
Shares of Jones Lang LaSalle (JLL) was the leading contributor to performance as shares rose over 31%. Revenues and earnings for JLL both exceeded industry trends and came in above expectations. The outlook for commercial real estate remains challenging but JLL offers a broad array of services, and the company is cautiously optimistic for the remainder of the year. During the quarter, JLL completed its acquisition of SKAE, enhancing its project management capabilities for data centers.
Equity exchange and market-services provider NASDAQ (NDAQ) also contributed to performance during the quarter as its shares rose 21.56%. In June, the company announced its acquisition of Adenza, a provider of risk management and regulatory software for the financial industry. The acquisition strengthens the position of NDAQ within the global financial system and speeds its transition to a greater emphasis on recurring revenue business.
QSV Mid Cap Top Detractors
Independent exploration and production company APA Corporation (APA) was the leading detractor to performance during the quarter as its shares fell 16% as the company reported mixed results. APA produced better-than-expected earnings and total production and reported a return of approximately 60% of free cash flows back to shareholders. However, APA offered production guidance for the coming quarter that was below expectations due to lower demand and anticipated higher capital expenditures.
Contract research organization ICON PLC (ICON) detracted from performance during the quarter as the company reported revenues and earnings that were below expectations. To the positive, the ICON’s backlog increased year over year and it provided earnings guidance that is above previous guidance. Management noted that the biotech sector is facing short-term challenges due to a tightening funding environment and restructuring and budget cuts from large pharma clients. ICON earns returns on invested capital of 8% and its shares are trading at a significant discount to our estimate of its intrinsic value.
QSV Mid Cap Portfolio Activity
QSV added Medpace Holdings Inc. (MEDP), a leading clinical contract research organization (CRO) focused on Phase I-IV clinical development, to its Mid Cap portfolio during the quarter. Other trims and additions to existing positions were made based upon valuation and our convictions in the fundamentals of the businesses.
QSV Select returned 10.72% and 10.45%, gross and net of fees, beating the returns of the Russell 2500 Value and Russell 2500 Indexes of 9.63% and 8.75%, 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
Doximity Inc. (DOX) was the leading contributor to performance during the quarter and is discussed above.
Cohen & Steers Inc. (CNS) rose over 33%, contributing to outperformance during the quarter. The company reported an increase in assets under management in June, attributed to market appreciation, despite net outflows, and reported quarterly earnings and revenues that were above estimates. CNS specializes in liquid real assets such as REITs and offersinstitutional accounts, open-end funds, and closed-end funds. The company has net cash, strong margins and returns on invested capital of 36%, which support a healthy dividend, share buybacks and repayment of debt.
QSV Select Top Detractors
Napco Security Technologies (NSSC) shares fell 21.86% during the quarter on news of slowing growth and insider selling. 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 18% while selling at a meaningful discount to our measure of intrinsic value.
Clinical contract research organization Medpace Holdings Inc. (MEDP) also detracted from performance as revenues and new bookings were below expectations. We continue to like MEDP because it operates in a large $45b market where its customers often do not have the required development expertise and infrastructure in-house, and the tools and testing are highly scripted in law, regulation, and practice. MEDP exhibits low capital intensity, resulting in ROICs of 25% on average.
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. One new position was initiated in a previous portfolio holding, MGP Ingredients (MGPI), a maker of premium distilled spirits and specialty wheat protein and starch food ingredients.
Our Focus on the Long Term
Most expect interest rate cuts by the Federal Reserve to continue, which should benefit smaller companies that require borrowing and, in many cases, offer better potential growth. Like the two-handed economist, we must consider that “on the other hand” there are cracks in the economy, geopolitical concerns, the Longshoremen’s strike that could spark inflation, and a contentious election cycle to grind through. Valuations continue to be more compelling in small and mid-cap businesses, and the possibility that something negative occurs – a pause in rate cuts, a recession, or some other shock – is priced into these stocks more than those of large companies. Investors should be selective and demand balance sheet strength, high returns on invested capital, and strong free cash flows as a substantial portion of smaller companies continue to be unprofitable. We suspect that year-end asset allocation reviews will reveal an overweight to large caps that have outperformed year to date and for the trailing years and believe the answer is quality small and mid-caps purchased at reasonable prices.
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.
Q3 2024 Commentary
Last quarter we lamented that investors have paid little attention to the pond QSV fishes in, small and mid-cap stocks. After considerable waiting, small and mid-cap stocks outperformed the stocks of their larger brethren in Q3 2024, although it was hardly a straight line up and to the right during the quarter. Smaller companies’ stocks began a rally in July that was punctuated by selloffs in early August and early September. Their climb persisted higher to the end of the quarter supported by an interest rate cut by the Federal Reserve and investor confidence that inflation was under control. QSV participated well during the quarter, with our Small Cap and Select strategies outperforming their respective benchmarks while our Mid Cap lagged its index.
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 10.30% and 10.21%, gross and net of fees, respectively, leading the Russell 2000 Value Index return of 10.15% and the Russell 2000 Index return of 9.27%. An underweight to Energy companies aided performance. Security selection and an overweight in Industrials also helped performance. Security selection and an overweight to Technology businesses detracted from returns.
QSV Small Cap Top Contributors
Doximity, Inc. (DOCS) shares rose over 55% supported by strong revenue and earnings, both of which surpassed analysts’ expectations. DOCS also provided optimistic Q2 and fiscal year 2025 guidance, projecting higher revenue than analysts’ expectations. DOCS offers a suite of tools that support an online community for physicians, nurse practitioners and physicians’ assistants, enabling them to coordinate patient care, conduct patient visits and manage their careers, DOCS’ Q1 earnings call highlighted a net revenue retention rate of 114% and 21% growth from its top 20 clients. The company has returns on invested capital of 16%.
Hawkins Inc. (HWKN) rose more than 40%, 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 continues to benefit from capital deployment and fast growth in its largest segment, the high margin water treatment business, which is expected to drive higher earnings and free cash flow growth. HWKN produces returns on invested capital of 13%.
QSV Small Cap Top Detractors
Simulations Plus Inc. (SLP) was the leading detractor from performance for the quarter as shares dropped on a mixed demand environment and lower margins. SLP is a leading provider of software and services used by major pharmaceutical, biotech, and regulatory agencies to make better informed, data-driven decisions. We see the potential for improved demand and long-term value creation due to the company’s high switching costs, intellectual assets, and a 93% renewal rate by its customers. SLP produces operating margins of 26% on average and its shares are well below our estimate of intrinsic value.
Helen of Troy (HELE) shares declined during the quarter as management lowered guidance. The consumer products company owns strong discretionary brands that are organized into its Home & Outdoor and Beauty & Wellness segments. Entering the quarter, we incorrectly believed that lower expectations were priced into the stock. With its additional pullback during the quarter and our belief that its risks are reflected, we added to our position. We like HELE’s strong free cash flows and the restructuring plan that management has instituted to cut costs.
QSV Small Cap Portfolio Activity
Shares of Hancock Whitney Corporation (HWC) were purchased as QSV sought to increase its exposure to Financials ahead of anticipated interest rate cuts. MGP Ingredients (MGPI), a maker of premium distilled spirits and specialty wheat protein and starch food ingredients, was also added as its shares reached an attractive valuation. MGPI was previously a profitable holding of QSV Small Cap and has been steadily monitored by our team.
QSV Mid Cap returned 8.15% and 7.89%, gross and net of fees for the quarter, trailing the 10.08% return of the Russell Mid Cap Value Index and the Russell Mid Cap Index return of 9.21%. Security selection in Technology companies helped performance while an overweight to the sector detracted. Company selection and an overweight to Financials also aided performance. Selection in Industrials and Healthcare companies detracted from performance.
QSV Mid Cap Top Contributors
Shares of Jones Lang LaSalle (JLL) was the leading contributor to performance as shares rose over 31%. Revenues and earnings for JLL both exceeded industry trends and came in above expectations. The outlook for commercial real estate remains challenging but JLL offers a broad array of services, and the company is cautiously optimistic for the remainder of the year. During the quarter, JLL completed its acquisition of SKAE, enhancing its project management capabilities for data centers.
Equity exchange and market-services provider NASDAQ (NDAQ) also contributed to performance during the quarter as its shares rose 21.56%. In June, the company announced its acquisition of Adenza, a provider of risk management and regulatory software for the financial industry. The acquisition strengthens the position of NDAQ within the global financial system and speeds its transition to a greater emphasis on recurring revenue business.
QSV Mid Cap Top Detractors
Independent exploration and production company APA Corporation (APA) was the leading detractor to performance during the quarter as its shares fell 16% as the company reported mixed results. APA produced better-than-expected earnings and total production and reported a return of approximately 60% of free cash flows back to shareholders. However, APA offered production guidance for the coming quarter that was below expectations due to lower demand and anticipated higher capital expenditures.
Contract research organization ICON PLC (ICON) detracted from performance during the quarter as the company reported revenues and earnings that were below expectations. To the positive, the ICON’s backlog increased year over year and it provided earnings guidance that is above previous guidance. Management noted that the biotech sector is facing short-term challenges due to a tightening funding environment and restructuring and budget cuts from large pharma clients. ICON earns returns on invested capital of 8% and its shares are trading at a significant discount to our estimate of its intrinsic value.
QSV Mid Cap Portfolio Activity
QSV added Medpace Holdings Inc. (MEDP), a leading clinical contract research organization (CRO) focused on Phase I-IV clinical development, to its Mid Cap portfolio during the quarter. Other trims and additions to existing positions were made based upon valuation and our convictions in the fundamentals of the businesses.
QSV Select returned 10.72% and 10.45%, gross and net of fees, beating the returns of the Russell 2500 Value and Russell 2500 Indexes of 9.63% and 8.75%, 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
Doximity Inc. (DOX) was the leading contributor to performance during the quarter and is discussed above.
Cohen & Steers Inc. (CNS) rose over 33%, contributing to outperformance during the quarter. The company reported an increase in assets under management in June, attributed to market appreciation, despite net outflows, and reported quarterly earnings and revenues that were above estimates. CNS specializes in liquid real assets such as REITs and offersinstitutional accounts, open-end funds, and closed-end funds. The company has net cash, strong margins and returns on invested capital of 36%, which support a healthy dividend, share buybacks and repayment of debt.
QSV Select Top Detractors
Napco Security Technologies (NSSC) shares fell 21.86% during the quarter on news of slowing growth and insider selling. 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 18% while selling at a meaningful discount to our measure of intrinsic value.
Clinical contract research organization Medpace Holdings Inc. (MEDP) also detracted from performance as revenues and new bookings were below expectations. We continue to like MEDP because it operates in a large $45b market where its customers often do not have the required development expertise and infrastructure in-house, and the tools and testing are highly scripted in law, regulation, and practice. MEDP exhibits low capital intensity, resulting in ROICs of 25% on average.
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. One new position was initiated in a previous portfolio holding, MGP Ingredients (MGPI), a maker of premium distilled spirits and specialty wheat protein and starch food ingredients.
Our Focus on the Long Term
Most expect interest rate cuts by the Federal Reserve to continue, which should benefit smaller companies that require borrowing and, in many cases, offer better potential growth. Like the two-handed economist, we must consider that “on the other hand” there are cracks in the economy, geopolitical concerns, the Longshoremen’s strike that could spark inflation, and a contentious election cycle to grind through. Valuations continue to be more compelling in small and mid-cap businesses, and the possibility that something negative occurs – a pause in rate cuts, a recession, or some other shock – is priced into these stocks more than those of large companies. Investors should be selective and demand balance sheet strength, high returns on invested capital, and strong free cash flows as a substantial portion of smaller companies continue to be unprofitable. We suspect that year-end asset allocation reviews will reveal an overweight to large caps that have outperformed year to date and for the trailing years and believe the answer is quality small and mid-caps purchased at reasonable prices.
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.