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.


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.

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