The strategy uses a “Growth At A Reasonable Profile” approach, which basically means we are not speculative. Just like you’ve come to expect from us in the large cap space, our focus is on quality first. But in the small cap space, we are just as open to growth and momentum stocks as we are value stocks. A “reasonable profile” means the business must be established and already profitable, earning returns above its cost of capital. Beyond these simple parameters, we look for companies that are leaders in their industries, expanding rapidly (2-3x the market), and consistently beating expectations for growth.
Our strategy is well diversified, with a max position size of 6% and broad representation across sectors. We believe in long term value creation based on a disciplined capital allocation process. A handful of lucky concentrated bets is not the path to achieving long-term goals. We target companies with market caps between $500 million and $3 billion and have a below average portfolio turnover profile.
Balancing Fundamentals & Technicals
Fundamentals come first. Always. But we also incorporate technical analysis into our investment process, to provide key downside/support levels and also to provide confirmation of buy/sell signals. Small-cap stocks can be volatile and technical analysis provides information into position sizing, entry and exit decisions and can trigger due diligence reviews.
We’d like to use two of our portfolio holdings (CTRL, a current holding, and SAM, a recent sell) to demonstrate our balanced investment approach:
Control4 (CTRL) is a “smart home” solution provider that has provided us with a 60% return since inception but that we believe is still significantly undervalued. It is a very profitable business and is growing 12-16%. With a market cap of just $660 million, we believe it is an ideal takeover candidate.
Boston Beer (SAM) is a more widely known example. SAM was the original pioneer in the craft beer industry and enjoyed strong investor support until 2015. The stock fell out of favor when the craft beer craze spread wildly across the US, with new brewers coming out of the woodwork. SAM showed up on our screens as fundamentally cheap back in 2016. But we watched the stock for nearly a year, waiting for it to break out of its technical downtrend, thus “confirming” the buying opportunity and avoiding a “bear value trap”. We took profits 10 months later, when it was no longer fundamentally attractive.
Why Choose Van Hulzen’s Small Cap strategy?
We believe there continues to be a nice opportunity to create value in the small cap space. With mostly US sales and nice tax cut tailwinds, we believe this category will continue to out-perform large caps and global stocks. Small caps should also be largely immune to trade war issues.
We also believe our rigorous approach to stock selection and strong track record of alpha generation make us an attractive allocation for clients. It’s not hard to find small cap managers who are willing to speculate, but we believe quality always wins in the end.
It is worth mentioning that US small-cap is notorious for having good managers who are “closed” to new investors and average / weak managers who are open to new investors. This has always been the case with small-cap equities. Our strategy will also have limits on what can be managed. It is not a problem now, but every small-cap manager must face the decision of when to close the strategy to protect the integrity of the portfolio.