When you think of lucrative ventures in dorm rooms, tech start-ups like it
Or so Dell comes to mind. But fund managers Brian Smoluch and David Swank began dreaming of investing in college roommates nearly three decades ago. Now, they are navigating the turbulent world of small-cap stocks, looking for companies that are rapidly growing but overlooked by other investors.
Former students of the University of Virginia are co-principals and portfolio managers
Hood River Small-Cap Growth
Fund (ticker: HRSRX). He graduated from college in 1994, and when his professional paths initially took him in different directions, he “always wanted to do something together,” says Smoluch.
The opportunity came when Smoluch’s partners in Roxbury Capital Management retired in 2008 and stepped into the role of Swank. “Our investment styles have grown together,” Swank says. Both are now 50 years old.
The pair co-founded Roxbury Spinoff Hood River Capital Management in 2013, but the Growth Fund’s Corporate Shares (HRSMX) are far behind. Since the beginning of 2003, since the Smolucch helm, it has beaten both its small-cap growth class and index as defined.
For the last three, five, 10 and 15 years. Morningstar gives it a five-star rating.
Smoluch and Swank are able to do well by exploiting inefficiencies in this secret corner of the market. This means that independent research, meetings with management teams, often limit themselves to profitable, low-value companies when it comes time to sell.
These tactics show that even though small-cap stocks fell sharply above the broader market this year, there are still attractive opportunities. The Russell 2000 index is down about 25% this year, compared to the 21% drop for the broader S&P 500 index. But when the market rebounds, small-caps are likely to dominate.
The fund is down nearly 31% in 2022, partially offset by a decline in consumer-owned stocks
(CZR) recently joined its Top 10 holdings. Over the past year, it still exceeds its Morningstar Small Growth Index.
An edited version of our conversation follows.
Barons: What did you talk about in college? Have you ever thought you’d end up here?
Brian Smoluch: We have always been interested in researching companies and are extremely competitive. In our fourth year at UVA, we have roomed together and talked a lot about starting a stocks and investment firm, so we were excited to do it for work.
What drew you to small-caps?
Smollach: We like small-caps because it’s inefficient. Big company like that
[AAPL] 50 to 55 analysts may include it; One of our companies may have only five or 10.
How do you narrow down the field and choose which one to buy?
Smollach: We talk to about 400 companies every quarter. This allows you to get a pulse of what is happening in business in real time across a multitude of different industries. With small-caps, you have better access to management teams. Usually we can get a CEO or not [chief financial officer] On the phone within 24 to 48 hours.
We are a top-10 or top-20 shareholder, so they are open to having discussions with us. We are talking to that company, some competitors and we will be able to put together a mosaic of how it works in real time.
What do you see before you invest?
Smollach: We want to buy companies with well-managed teams that are stealing a stake in a well-growing space. And we are buying at a good valuation. Most of our companies are profitable and are growing.
We are looking at it based on price-to-earnings or price-to-cash flow, and we want those valuations to be good in the interim or over time. When estimates for our companies are too high and the stock is going to decrease, we trim those positions. There is a strict sales discipline to control risk.
If our bottom-up work suggests an underlying rough patch, negative future sales earnings revisions, or overestimation, we will sell it and then reconsider it.
Do you find it difficult to sell shares that earn you a lot of money?
Smollach: Selling a winner can be very difficult, but you have to be disciplined and sell high value stocks or those stocks will haunt you later. The reason we are doing really well in 2021 is because we have sold our most valuable homemade winners in 2020.
Do you now have a repentant investment?
Smollach: We talked
[MDB]-It’s a big company-passed several years ago several times and due to valuation. Even after this year’s pull-back, the stock has tripled from where we were looking.
Rare year and competition was 2019 when you lowered the index. What happened?
Smollach: In 2019, we followed our benchmark index by about four percentage points, most of which came from health care in the second half of the year. Going back to that period, we realized that assessments were not more attractive because we had less weight biotechnology. Biotechnology then started a speculative race, which led to some poor performance.
Today, however, small-cap biotech stocks are down from mid-2019. In hindsight, from a long-term perspective, our assessment of those valuations looks much sharper and sticking to our valuation discipline has ultimately helped our long-term performance.
Tell me about your bad investment and what you learned from it.
Smollach: One of the worst investments we made in 2002 was at HPL Technologies, a yield-optimization software for semiconductor companies. Unfortunately, the CEO created invoices that exceeded revenues, and when it went public, the stock was effectively hit. Experience emphasized the importance of engaging yourself with trusted management teams.
What are you telling customers when small-caps are too low?
Smollach: We have a lot of sophisticated investors and they usually allocate a small percentage of their portfolio to the asset class. But they know that small-caps are highly inefficient and they have 20 years of data across all types of markets to show our ability to have better risk control. We are also diverse.
David Swank: That’s why investors are in small-cap, searching for undiscovered names that the market doesn’t appreciate adequately. Revenues over the last two decades, in its entirety, have come from bottom-up stock options, not sector calls.
Speaking of doing well,
[LNTH] Over 100% this year. Do you still like it?
Swank: Lantheus sells diagnostic agents for heart disease, oncology and radiopharmaceuticals. The true story is that it has been inverted in the near and long term by its imaging agent Pylarify. Pylarify has a longer half-life, delivers crisp images and has more scalable output compared to competition.
At the end of last year, analysts were looking for Pylarify to sell for under $ 100 million [of product] In 2022; Now it looks like over $ 400 million. Although the stock is up, it is increasing earnings and trading only at consensus earnings of 19 times next year. I think there is still a significant increase in sales and earnings estimates for next year.
Option Care Health
[OPCH] Another health service name you have.
Swank: It is the largest independent provider of home infusion services; About 70% of its revenue comes from chronic conditions. It is benefiting from institutions and home transfers, pushed by both cost and patient preference.
It should be able to grow earnings in the middle of adolescence. Right now it is trading around 21 times my 2023 revenue estimate; I think there will be more to it than just good returns. It can also make some tuck-in acquisitions that can be immediately collected.
You are adding to your position in the Energy-Drink Maker
Smollach: It is now earning more than 200%, which is exceptional and has a market share of approximately 4%;
[MNST], To give some perspective, is about 37% stake. We think there is plenty of room for Celsius to grow. I wouldn’t be shocked if the 20% share comes.
SeaWorld is one of your top holdings. How does it develop?
Smollach: SeaWorld has used Covid to its advantage by optimizing how the park operates from a labor perspective. Its net income per person — how much each person produces in the garden — has risen significantly. Pre-Kovid, it was about $ 62. In the most recent quarter, it was trading at around $ 79. With the fact that admission is slightly above the 2019 level, this is a significant gain.
Do you find it fascinating about Caesars Entertainment?
Swank: There are a lot of good basics going on and it’s cheaper compared to its prospects. Business is ripping in Las Vegas and other areas are probably not far behind. Caesars is also developing a sale by selling some noncore assets, making the shares more attractive to a broader group of investors.
Thank you, Brian and David.
Write Teresa Rivas at [email protected]