Pursuing profits from mispricings of European small cap stocks.
We believe there is unrecognized value in European small cap stocks, due to a structural lack of research, which is only becoming more acute due to increasing regulation.
UNRECOGNIZED VALUE AND POTENTIAL ALPHA
The unrecognized value may lead to substantial undervaluation or overvaluation. We believe this creates an opportunity for “double alpha,” or potential profits for both long and short positions. We believe we are among the few practitioners dedicated to investing long and short in European small cap stocks.
The last equity frontier?
The typical small cap stock in Europe may be covered by two analysts, compared to eight for US small caps. Large cap stocks worldwide may be covered by 15 to 20 or so analysts. This lack of research, we believe, creates an opportunity for research-driven portfolio management.
Management, Cash, and Catalysts
The investing process for the strategy has three key elements:
Management We meet company managements regularly, and in person, since the team running the company has a disproportionate effect on a company’s fortunes, better or worse.
Cash Flow We analyze and assess company cash flows carefully, since companies live or die by the cash they do or do not generate. Good companies generate excess cash and reinvest it wisely. Poor companies struggle as cash dissipates.
COMPANIES WE SEEK: “COMPOUNDERS” AND “MISUNDERSTOOD”
Our process generally leads us to identify two types of companies:
Compounders are companies that take the cash they generate and reinvest it at high returns into future growth. On the long side, we look for companies that consistently surpass market expectations with their ability to grow. On the short side we look for compounders “gone wrong.”
Misunderstood companies cover a range of experiences. On the long side, such companies may be difficult to analyze, have made past mistakes, or have been through an industry downturn, all of which may obscure their intrinsic strengths. Misunderstood shorts also cover a range of experiences. Investors may have an overly optimistic view of company fundamentals, a company may be a “value trap,” or management may be undermining company prospects.
OUR PROCESS IN ACTION
Implementation of the strategy requires a disciplined, three-step process. We dedicate ourselves to this repeatable process over time on behalf of our investors:
We meet with companies and management numerous times before initiating positions and while we hold a position. This requires an intensive travel schedule throughout Europe for our portfolio management team.
We rigorously assess companies’ financial prospects with a particular focus on cash generation.
Before we initiate a position, we ask what will drive the market to realize a mispricing.