Author: capitismedia
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.
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.