Q4 2023 reminded investors that the only thing constant is change. While the prior quarter saw markets fall due to the Federal Reserve’s commitment to keep rates higher for longer in its fight against inflation, the fourth quarter brought an “everything rally” with stocks, bonds, and crypto all rising in anticipation of interest rate cuts and a belief that a soft landing for the economy is likely. Small and mid‐cap stocks participated in the rally, notching most of their calendar year gains in the final three months of 2023. Each of the QSV strategies, focused on quality businesses that possess competitive moats, delivered strong outperformance for the calendar year relative to its respective value index. More information including since‐inception performance for each strategy may be found at www.qsvequity.com.
QSV Small Cap returned 15.03% and 14.93%, gross and net of fees, respectively, slightly lagging the Russell 2000 Value Index return of 15.26% while leading the Russell 2000 Index return of 14.03%. The most significant positive impact was made in Energy companies, where an underweight to the index aided performance, and Communication Services companies, where QSV’s overweight detracted but security selection added value. An underweight and company selection in Consumer Discretionary companies detracted from relative returns. QSV’s overweight to Healthcare helped returns, but security selection detracted.
After a significant drop in Q3 on news of its restatement of three quarters’ financial results, Napco Security Technologies (NSSC) was the leading contributor to performance during the quarter as its shares rose 54%. NSSC is a global provider and manufacturer of high‐tech security, and internet connected home, video, fire alarm, access control, and door locking systems. QSV was concerned about management’s controls that led to the need for the restatement and closely monitors the business. NSSC delivers returns on invested capital of 14% and sells at a discount to our measure of intrinsic value.
PubMatic (PUBM) was a leading contributor to performance as revenues, earnings and forward guidance all exceeded expectations. PUBM is a leading platform provider of the digital advertising technology, helping publishers that supply digital ad inventory to better manage their inventory, selling a high percentage of their inventory and maximizing revenue per ad sold. Competitive advantages include switching costs ‐ the time, effort, and money required to transfer platforms once an advertiser is set up on PUBM’s platform – and cost advantages through its investment in infrastructure and off‐shore research and development. PUBM produces returns on invested capital of 18%.
Core Laboratories (CLB) fell 26% during the quarter, detracting from performance. The company has competitive advantages in reservoir analysis and production enhancement services, serving hydrocarbon exploration and production companies as they seek to improve production levels and economics. The company also anticipates significant future growth from the application of its technologies to carbon capture and sequestration projects. A risk inherent to the business is the cyclicality of oil prices, as was seen in Q4 2023.
Ituran Location and Control Ltd. (ITRN) shares fell in response to the war in Israel where the company has operations and a sizable portion of its client base. ITRN provides stolen vehicle recovery, fleet management, and other value‐added services. Its subscription‐based model adds 80,000 to 100,000 net new customers per year, derived from after‐market sales, OEMs, and insurance companies, and currently reports over 1.8 million subscribers across Israel and Latin America. ITRN management affirmed that the company has not seen any impact to its ongoing operations in Israel. Company headquarters are in the center of the country, just outside of Tel Aviv, and not near any borders. ITRN produces returns on capital of 19% and its shares are currently at a significant discount to intrinsic value.
Trims and additions were made in five holdings during the quarter, but there were no new positions added. Shares of foodservice packaging company Karat Packaging (KRT) were sold for valuation reasons. QSV had sold portions of the KRT position two other times in 2023, taking gains in this long‐term holding.
QSV Mid Cap returned 12.32% and 12.05%, gross and net of fees for the quarter, leading the Russell Mid Cap Value Index return of 12.11% before fees while narrowly lagging the Index after fees. Mid Cap lagged the Russell Mid Cap Index return of 12.82%. Security selection in Information Technology and Financial companies helped relative performance, while selection in the Energy and Industrials sectors detracted. Underweights in Energy and Materials businesses helped relative performance, while over weights to Healthcare and Technology companies detracted from performance.
Monolithic Power Systems (MPWR) was the leading contributor to performance in the quarter as the company delivered strong earnings growth. 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%.
Shares of Bank OZK (OZK) gained more than 35% during the quarter, supported by strong business performance including loan growth in its Real Estate Specialties Group that was greater than expected. OZK management noted that they will focus less on share buybacks in 2024 versus 2023 due to their expectations for further loan growth. OZK has a long history of exemplary credit, best‐in‐class profitability, and strong management. The bank produces Returns on Tangible Equity of 18% and its shares are trading at 1.1 times tangible book value.
Core Laboratories (CLB) was the leading detractor to QSV Mid Cap performance and is discussed above. Oil and natural gas producer APA Corporation (APA) detracted from performance during the quarter. While both revenues and earnings beat analysts’ expectations for the quarter, APA shares declined along with commodity prices. APA produces strong free cash flows and is committed to returning 60% to shareholders in the form of buybacks and share repurchases. Following the end of the quarter, APA announced its acquisition of Callon Petroleum (CPE) in an all stock deal, furthering the trend of M&A to build scale in the exploration and production industry. The combined company should see meaningful synergies through reduced overhead, interest expenses and operating synergies.
There were no total sales or purchases of positions during the quarter. QSV did add to its position in the payroll and human capital management platform Paycom (PAYC) on weakness in its share price.
QSV Select returned 13.98% and 13.74%, gross and net of fees, leading the 13.76% returns of the Russell 2500 Value before fees, while slightly lagging the Index after fees. QSV Select outperformed the 13.35% return of the Russell 2500 Index. Select is a high conviction strategy that takes QSV’s best ideas from our Small Cap and Mid Cap strategies. Security selection helped performance in Financial, Information Technology and Real Estate holdings, while detracting from performance in Industrials, Energy and Consumer Discretionary businesses. An underweight in Energy holdings aided performance.
Napco Security Technologies (NSSC) was the leading contributor to performance during the quarter and is discussed above.
Glacier Bancorp (GBCI) rose as quarterly results were better than anticipated. GBCI benefits from an operating footprint in seven economically vibrant U.S. states which supports robust organic growth. Additionally, the company has used cash flows to take a partnership approach to acquisitions which have led to the bank producing Returns on Tangible Common Equity of 14%.
Core Laboratories (CLB) was the leading detractor to performance of QSV Select during the quarter and is discussed above.
Human capital management provider Paycom (PAYC) detracted from performance during the quarter. PAYC’s revenues were down due to its conversion of clients to a new, innovative solution that lessens errors and reduces the need for additional payroll runs as a result. PAYC targets customers with 50 – 10,000 employees and is expanding its business with larger enterprise deals and a push into both Mexico and Canada. The company has approximately 5% penetration of its total addressable market which we believe it can expand through its best‐in‐class salesforce. PAYC has returns on invested capital of 24%.
Turnover during the quarter was minimal, but QSV made one addition to upgrade its portfolio. Using the proceeds from Masimo (MASI), which was exited at the end of Q3, Amdocs (DOX) was purchased. DOX is a forty‐year‐old provider of software and services solutions for communications, entertainment, and media industries.
2023 stands as a stark reminder that predictions of market returns are folly. Few would have anticipated that markets would rise so significantly or that world events would take the turns – often tragic – that they did. While we cannot (and do not) predict, we can prepare. The strong results of 2023 have pulled forward market returns in expectation that interest rates will be cut, that inflation will continue to fall, and that corporate earnings will grow. One or more of these may not come about. The leveraged consumers that have bullishly supported the economy, and the labor market that has supported them, may cool. Geopolitical events may present challenges.
Preparing for uncertainty leads QSV to its focus on long term investment in quality businesses, those with limited debt, high interest rate coverage and strong free cash flows. We continue to find compelling opportunities in small and mid‐cap stocks of these quality firms, at reasonable valuations, and believe they will serve our clients well as we invest alongside them.
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.
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