The Case for Small- and SMID-Cap Value

Video Transcript

Mark Goodman, CFA
Portfolio Manager
U.S. Value Equity Team

Matt Fleming, CFA, Partner
Head of the U.S. Value Equity Team, Portfolio Manager

Greg Czarnecki
Portfolio Specialist, Research Coordinator
U.S. Value Equity Team

Matt: I think value is a really exciting asset class to consider for a portfolio right now. If you look back over the last few years, the market has gotten increasingly narrowly focused on growth and, in particular, momentum. So, what you’ve had is a concentration of strategies. And so, therefore, more money is chasing fewer opportunities, so the return opportunity is less. At the same time, you’ve got some really terrific companies that are trading at historically low valuations.

Mark: Small- and SMID-value segments of the market are inherently more inefficient. There’s less analyst coverage. Looking at these companies, there are areas that are ideal for active management, where we as a team can dig in, leveraging our experience and scar tissue, investing in that space to add value.

Matt: We think small and SMID offer really the best of the opportunities for value for a couple reasons. One is that these companies really are unique, and there is an advantage to knowing them, having invested through the cycle, really getting to dive in and look at the fundamentals. We think that really can add a lot of alpha generation through stock selection. Secondly, if you look over the last three to five years, the bifurcation in valuation between the larger cohort of stocks and the smaller cohort of stocks is absolutely extreme. The larger set of companies, typically trading over $10 billion, in some cases, are trading at five times the valuation of that lower segment, and that really offers some compelling opportunities.

Matt: Our investing approach to small and SMID stocks is to find quality companies that we think are temporarily trading at or below the valuation levels of inferior companies. And the reason usually is that the market is focused too narrowly on a specific data point or extrapolating a temporary transition and thinking it is a secular change, whereas we really view that as a temporary opportunity for us to take advantage of that dislocation.

Greg: We describe our approach as the combination of quality and value, in which we’re seeking to purchase high-quality companies that trade at a discount to their inferior peers and also their intrinsic values. When we think about quality, first and foremost, we think about what the earnings and cash flows of these companies can be 18 months into the future, and we combine that with a strong balance sheet and a strong management team focused on capital allocation. In terms of valuation, we’re really trying to triangulate three things. First and foremost is how a company trades relative to its own historic trading range. Second, how a company trades relative to private market values, and then third, how a company trades relative to a comparable peer group. We combine this quality and valuation approach in a team-based assessment in which we build the portfolio one stock at a time, really leveraging our team’s career sector expertise.

Mark: We can add value for our clients by taking a longer-term view and a superior assessment of earnings quality on a normalized basis.

Disclosure

The views and opinions expressed herein are those of the speaker(s) as of the date of publication, are subject to change without notice as economic and market conditions dictate, and may not reflect the views and opinions of other investment teams within William Blair. Factual information has been obtained from sources we believe to be reliable, but its accuracy, completeness, or interpretation cannot be guaranteed. This material may include estimates, outlooks, projections, and other forward-looking statements. Due to a variety of factors, actual events may differ significantly from those presented. This video has been provided for informational purposes only and should not be considered as investment advice or a recommendation of any particular strategy or investment product, or as an offer to buy or sell any securities or related financial instruments in any jurisdiction. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions. Investing involves risks, including the possible loss of principal. Past performance is not indicative of future results.