Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines and looks deeper into
Speaker 1: the processes, challenges, and philosophies and security selection. I'm David Cohne,
Speaker 1: i lead mutual fund and active research at Bloomberg Intelligence.
Speaker 1: Today my co host is Michael Casper, sector and small
Speaker 1: cap strategists at Bloomberg Intelligence. Mike, thank you for joining
Speaker 1: me today.
Speaker 2: Thank you, David.
Speaker 1: So, last week you wrote a research note titled What's
Speaker 1: priced into small Caps? After stocks Route? Do you give
Speaker 1: us a brief overview of how small cap stocks have
Speaker 1: been performing this month and what could happen if economic
Speaker 1: data softens.
Speaker 2: Yeah. So it's obviously been a big downturn for the
Speaker 2: Russell two thousand this month, but what we're really seeing
Speaker 2: and what we try to get at, is it's priced
Speaker 2: into the market, and what we're seeing in our models,
Speaker 2: our fair value model, is that a credit crunch of
Speaker 2: some sort was priced into the Russell two thousand. It
Speaker 2: seems just putting in consensus numbers for the two tens
Speaker 2: next twelve month sales growth and the change in the
Speaker 2: FED balance sheet kind of zeroing that out with the
Speaker 2: end of taper coming later this year, you get to
Speaker 2: about a five point eight percent high yeal to OS
Speaker 2: spread that was baked into the Russell two thousand at
Speaker 2: its low in August. So that to give you some perspective,
Speaker 2: that gets you to a one point two seven times
Speaker 2: multiple on price to sales multiple in the Russell two thousand,
Speaker 2: So significant credit, you know, crunch priced in something it
Speaker 2: can to you know, the end of the SBB crisis, right,
Speaker 2: So twenty twenty three back to those highs if you
Speaker 2: think about it. But on the revenue side, not a
Speaker 2: lot even changes if macro softens, right, So macro expectations
Speaker 2: we we commonly use economist forecasts in our model, those
Speaker 2: were already pretty weak, and if you just zero out
Speaker 2: GDP growth, for example, zero out new orders growth, you're
Speaker 2: still only at about a point five percent revenue contraction
Speaker 2: over the year ahead, and that's significantly lower than what
Speaker 2: consensus expecting for the next twelve months. So there's not
Speaker 2: a lot of weakness that can be additionally priced, at
Speaker 2: least on the revenue side, and kind of any upside
Speaker 2: that we get from revenues could be a significant driver
Speaker 2: of the Russell two thousand going forward. The one thing
Speaker 2: I'll mention everybody asked me about recession case and what
Speaker 2: that might look like for the Russell two thousand. We
Speaker 2: took the average recession experience and modeled how that affects
Speaker 2: each of the component variables in our fait value model.
Speaker 2: Putting that into the model, you get about a nineteen
Speaker 2: percent drop in sales growth, a drop in the multiple
Speaker 2: to one point one five times, and you end up
Speaker 2: around the October twenty twenty three low on the Russell
Speaker 2: two thousand. So at that point in time, the way
Speaker 2: I'm framing it at least is that significant economic weakness
Speaker 2: was already paced into the Russell two thousand. So I
Speaker 2: think things are, you know, pretty well solidified on the downside.
Speaker 2: It's just how do we get to some of the
Speaker 2: more upside for the Russell two thousand.
Speaker 1: Okay, Well, speaking of the Russell two thousand and small caps,
Speaker 1: i'd like to welcome Michael Coyin, manager of the Voye
Speaker 1: Small Cap Growth Fund. Mike, thank you so much for
Speaker 1: joining us.
Speaker 3: Thanks for having me.
Speaker 1: Well, before we get into your fund, i'd like to
Speaker 1: ask how portfolio managers got their start, So if you
Speaker 1: could just kind of give us an overview of how
Speaker 1: you got started in investing.
Speaker 3: Yeah, sounds great. I started investing on the by side
Speaker 3: a couple of years out of college after doing an
Speaker 3: investment banking extint on Wall Street. Started at a private
Speaker 3: equity mezzanine fund in Boston with a particular focus on
Speaker 3: growth coupled with cash flow generation. Fast forward a couple
Speaker 3: of years, I started working at Columbia Management on the
Speaker 3: small cap growth team, and the Voya small Cap Growth
Speaker 3: Team now is a derivation of that existing team. So
Speaker 3: we've been working on that team longer than I care
Speaker 3: to admit, twenty two years, but consistent investment of philosophy
Speaker 3: and process being applied over that entire timeframe, which is
Speaker 3: good because the experience I had at the private equity
Speaker 3: shop I worked at really was a good dovetail into
Speaker 3: what we do here from a fundamental analysis standpoint.
Speaker 1: Well, that's actually kind of brings me to my next
Speaker 1: question is, could you kind of give us an overview
Speaker 1: of your investment process or philosophy. I know you mentioned
Speaker 1: cash flow.
Speaker 3: Yeah, so our investment of philosophy is fairly simple. We
Speaker 3: look for companies that grow at a fifteen percent top
Speaker 3: and bottom line rate. At a minimum, and then look
Speaker 3: at what we consider sustainable valuations. And sustainable valuations I'll
Speaker 3: get into in a bit here. I know that we'll
Speaker 3: discuss that during the process, but ultimately we want to
Speaker 3: see a twenty percent upside to our price target when
Speaker 3: we buy a stock in the portfolio. When I think
Speaker 3: about the process itself, it really comes down to fundamental analysis.
Speaker 3: We look at the market that a company addresses, it's
Speaker 3: market share. We look at competitive modes. Are they able
Speaker 3: to pass along price increases they're getting to their customers
Speaker 3: so they can see expanding margins over time. We do
Speaker 3: have a particular emphasis on operating cash flow as opposed
Speaker 3: to free cash flow because we are small cap growth investors.
Speaker 3: We want to see our companies reinvest back into the
Speaker 3: flywheel that does allow them to grow as long as
Speaker 3: that flywheel produces acceptable rates of return, which is an
Speaker 3: excessive what their cost of capital is. So it's really
Speaker 3: not rocket science on the philosophy or process, but it's
Speaker 3: a lot of hard work and that's really what we've
Speaker 3: done over the two years I've been doing it. The
Speaker 3: process in philosophy actually predates me by seven years, so
Speaker 3: it's been applied for almost thirty years.
Speaker 2: So we know how Russell defines their growth in to
Speaker 2: see is SMP defines it a little bit differently. You know,
Speaker 2: how do you define and search for growth companies? Do
Speaker 2: you have any favorite metrics that you like to use
Speaker 2: when you're you're looking for companies.
Speaker 3: We certainly touched on a few of them already. You know,
Speaker 3: growth growth first. You know, you want to see companies
Speaker 3: that grow at an acceptable rate, whether that's organic growth
Speaker 3: or inorganic growth. We do like seeing organic growth over
Speaker 3: inorganic growth, but a lot of times companies do a
Speaker 3: very good job of showing both and producing strong growth
Speaker 3: metrics by acquisitions as well. The other thing we look at,
Speaker 3: as I mentioned before, operating cash flow, And then we
Speaker 3: certainly want to see a balance sheet that is healthy
Speaker 3: and allows them the flexibility to go pursue ustment strategies
Speaker 3: that they want to pursue and doesn't hinder them. So
Speaker 3: we'd have some leverage metrics we look at as kind
Speaker 3: of an exclusionary metric for companies that we screen for.
Speaker 2: And how do you think about valuations? Do you have
Speaker 2: any favorite metrics you mentioned operating cash flow, You might
Speaker 2: use a free cash flow yield or something like that.
Speaker 2: Do you have any favorite valuation metrics that you use?
Speaker 3: So operating cash flow is really a proxy to determine
Speaker 3: the quality of earnings. Companies use adjusted net income, which
Speaker 3: is adjusted from gap. You have to validate those adjustments,
Speaker 3: and then we compare that adjusted net income to operating
Speaker 3: cash flow and would like to see operating cash flow
Speaker 3: in excess of that adjusted net income to validate that.
Speaker 3: It's a metric we want to use going forward. The
Speaker 3: reason we do that is, as you know, management teams
Speaker 3: like to adjust for a lot of things that I
Speaker 3: don't want to adjust for and give them credit for
Speaker 3: because they want to see their stock price higher, and
Speaker 3: that's the main metric. So dovetailing into that and saying,
Speaker 3: answering your question, what are my favorite valuation metrics, we
Speaker 3: certainly look at p I don't love a revenue multiples,
Speaker 3: although some people use them, so I pay attention to them.
Speaker 3: EBITDA would fit into the same category. I do like
Speaker 3: using earnings because it factors in all expenses. When you
Speaker 3: start looking at EBITDA and or revenue, it really does
Speaker 3: a factor in all the expenses. Interests and taxes are
Speaker 3: real expenses. As you know. So that's really why we
Speaker 3: try to at least balance our valuation perspective through a
Speaker 3: number of different metrics.
Speaker 1: Well, you know, speaking of valuations, you had earlier mentioned
Speaker 1: sustainable valuations, how do you determine those?
Speaker 3: So sustainable valuations we look at as a proxy for
Speaker 3: what the companies traded at in the past. First of all,
Speaker 3: we have to validate the fundamentals that have dictated that
Speaker 3: valuation framework in the past are still relevant. But assuming
Speaker 3: they are, we like to buy a stock in the
Speaker 3: lower two thirds of its valuation range. And the reason
Speaker 3: for that is if you buy a stock and its
Speaker 3: peak valuation or close to its peak valuation, you're not
Speaker 3: only betting on the earnings growth that you've predicted, you
Speaker 3: are assuming that it's going to hold that high end
Speaker 3: of that valuation range. And those are two tough assumptions
Speaker 3: to make. In conjunction with one another, you have two
Speaker 3: ways to lose. You have valuation compression. You lose on
Speaker 3: valuation compression, or you can miss on earnings misses. You
Speaker 3: want to mitigate the downside by really buying them at
Speaker 3: a fair price. And if a stock's not at a
Speaker 3: fair price, we put it on our watch list, and
Speaker 3: I've had stocks on my watch list for five days,
Speaker 3: five months, and in some cases five years. So it's
Speaker 3: just one of those things that you have to realize
Speaker 3: buying a stock correctly is an important part of the
Speaker 3: investment process.
Speaker 2: And what sectors do you find the most interesting right now?
Speaker 2: Do you have any specific sector loads?
Speaker 3: Yeah, you know, I think there's there's a lot of
Speaker 3: interesting things going off on the market right now. You know,
Speaker 3: we have had been overweight semiconductors for the first half
Speaker 3: of the year. I think there's still some interesting, interesting
Speaker 3: investment opportunities there, but we've been fading that group a
Speaker 3: little bit and really been dusting off software. Software has
Speaker 3: been an underperforming industry over the first six months of
Speaker 3: the year and years, and what we're seeing is companies
Speaker 3: reassessing their expectations and now they seem more levels set.
Speaker 3: But as you talked about hard landing or recessionary risks,
Speaker 3: that's certainly only valid if we have a soft landing scenario,
Speaker 3: So you know, we're we're being mindful of that. You know,
Speaker 3: with the FED being prospectively likely to lower rates, we're
Speaker 3: also looking some interest rate sensitive areas such as capital equipment,
Speaker 3: such as home building building products. Some financials have some
Speaker 3: tailwinds on that front. Some consumer names have some tailwins
Speaker 3: on that front, but I think that'll take a little
Speaker 3: longer to work its way out, specifically low end consumers.
Speaker 1: You mentioned some technology industries. I know the strategy is
Speaker 1: bottom up, but do you look at macro factors at
Speaker 1: all or is it mainly just looking at the best
Speaker 1: opportunity or the best opportunities happen to be in a
Speaker 1: particular industry or sector.
Speaker 3: We do not. We don't play macro economists when we're
Speaker 3: constructing the portfolio. We really let it flow from the
Speaker 3: bottom up. But that's not to say we don't consider
Speaker 3: or pay attention to macro factors. I think you have
Speaker 3: to be insane to not at least pay attention to
Speaker 3: what's going on around you when you're investing, especially in
Speaker 3: small cap. But at the same time, it's not dictating
Speaker 3: solely what we're doing, uh, because ultimately we're here to
Speaker 3: pick stocks and outperform the market, and we feel like
Speaker 3: we can do that with a nice healthy balance of
Speaker 3: fundamental analysis, UH, good risk war judgment as well as
Speaker 3: macro considerations.
Speaker 2: And I already opined on what I think caused last
Speaker 2: week's sell off a little bit. But what's your opinion
Speaker 2: on it? Do you think it meaningfully changes anything?
Speaker 3: Well, it's interesting market psychology. I always say, you know,
Speaker 3: the my job is part art and part science, and
Speaker 3: I think the art part of it is very under
Speaker 3: appreciated and that the art part only comes with experience.
Speaker 3: But when you think about what's happened over the last
Speaker 3: six weeks, Uh, you had some data come out in
Speaker 3: early July, uh, you know, software CPI data and the
Speaker 3: FED signal that they are ready to cut, so that
Speaker 3: that proverbial you know, bad news was good news. Fast
Speaker 3: forward a couple of weeks. You had a weaker PMI data,
Speaker 3: and you had weaker jobs data come out really the
Speaker 3: last week of July, first week of August, and bad
Speaker 3: news became bad news all of a sudden because the
Speaker 3: risk of recessionary the recessionary economic backdrops increased precipitously. So
Speaker 3: I think the you know, and I think there was
Speaker 3: an overreaction in the market that was exasperated by something
Speaker 3: that was completely irrelevant to US fundamentals, in that the
Speaker 3: Japanese the Bank of Japan raised interest rates by twenty
Speaker 3: five basis points and expressed a willingness to do so
Speaker 3: more through the balance of the years. So that really
Speaker 3: caused an unwind of the the yen carry trade, and
Speaker 3: so I think that really threw gasoline on the fire
Speaker 3: relative to the selloff. You saw a lot of risk
Speaker 3: based that sets sell off. So you talked about small
Speaker 3: cap really underperforming month to date, and I think that's
Speaker 3: part of what happened.
Speaker 2: And do you have any opinion on where the Russell
Speaker 2: two thousand might be going from here? I know a
Speaker 2: lot of the growth drivers got removed back in the
Speaker 2: Juneery constitution, but any color you have on that.
Speaker 3: Well, I've really I liked hearing what you said about
Speaker 3: your historical perspective on the October lows, the October twenty
Speaker 3: twenty three lows, and I do agree with you. At
Speaker 3: that point in time, we were adding to names and adding
Speaker 3: to companies that had higher growth profiles because in higher
Speaker 3: growth being companies that had twenty forty percent type of
Speaker 3: top line growth because they were priced at a discount.
Speaker 3: That time is pasted. I don't think we're at those
Speaker 3: levels now, but we're certainly selling off. You know, there's
Speaker 3: two factors that are going to determine where we go.
Speaker 3: Are we going to go into a soft landing scenario
Speaker 3: or a hard landing scenario landing scenario. I think small
Speaker 3: caps have a pocket of underperformance ahead of us, and
Speaker 3: that will be a challenge until you know, we reach
Speaker 3: the determination that we're in that environment and then they'll
Speaker 3: start out performing in a soft landing environment. I think
Speaker 3: we're already in the outperformance timeframe now with obviously what
Speaker 3: we've seen recently as a hiccup to that.
Speaker 1: One thing you mentioned earlier, and the kind I think
Speaker 1: it ties into the discussion is you know, risk and
Speaker 1: reward and how that factors in? How do you evaluate
Speaker 1: risk and reward or you know, should I say what
Speaker 1: keeps you up at night?
Speaker 3: Risk and reward? You know? Again, this goes back to
Speaker 3: that art and science part of the job. But the
Speaker 3: science part of it, which is probably what you're more
Speaker 3: interested in, and I'll get into the art part here
Speaker 3: in a second, is really evaluating what a stock can
Speaker 3: do and the fundamentals of a company can do in
Speaker 3: a variety of scenarios. It's really a probability matrix. If
Speaker 3: you will, you can do a two point probability matrix
Speaker 3: or have one hundred point probability matrix. I don't have
Speaker 3: the time to do one hundred point probability matrix, so
Speaker 3: we tend to do a three point probability matrix. A
Speaker 3: base case, barecase, a gold case, not dissimilar from a
Speaker 3: lot of other folks. And what's the backdrop there, and
Speaker 3: what's the multiple structure that that's going to yield, And
Speaker 3: so we look at an upside downside scenario. Now, when
Speaker 3: we're in the middle of making evaluations on companies that
Speaker 3: are trading in the marketplace, what we use as as
Speaker 3: a instructive tool is watching how stocks react to different news,
Speaker 3: and that's the art part of this job. It's really
Speaker 3: the price discovery process. If you see a company miss
Speaker 3: and guide down the stocks flat or up. A lot
Speaker 3: of times bad news is priced in, at least for
Speaker 3: the near term, and so that's something to take a
Speaker 3: mental note of because if you like that company, it's
Speaker 3: probably not a bad time to start buying it, and
Speaker 3: understanding the market already has really tepid expectations there and
Speaker 3: if they can produce any sort of upside that's likely
Speaker 3: going to be good for the stock price.
Speaker 2: What are you seeing from earning season and fundamentals. Are
Speaker 2: there any major takeaways that you have.
Speaker 3: I think the major takeaway is that cyclicality is being
Speaker 3: is certainly being demonstrated in earnings. I mean, they're the
Speaker 3: cyclical companies are are certainly feeling the economic slowdown, the
Speaker 3: interest rate tightening that the Fed's done. You know, since
Speaker 3: kind of that twenty twenty three timeframe is certainly or
Speaker 3: twenty two time frame really is certainly taking hold. And
Speaker 3: so what you're what we're seeing there is a challenged
Speaker 3: backdrop for many companies that are dependent on access to capital.
Speaker 3: And so when when we see that and the FED
Speaker 3: is too tight in which in my opinion, they're a
Speaker 3: little bit too tight right now. They need to start loosening.
Speaker 3: Are we behind the curve potentially? I don't think they're
Speaker 3: too far behind the curve here, so I think they
Speaker 3: can catch up, but I think I think they need
Speaker 3: to start moving in September.
Speaker 1: I'd like to ask managers some reflective questions in your opinion,
Speaker 1: you know, what do you think or how has small
Speaker 1: cap investing changed since you started in the business.
Speaker 3: You know, it's an interesting question. I think the private
Speaker 3: equity arena being able to be so well funded over
Speaker 3: the last twenty two years since I've been doing small
Speaker 3: gap specifically, they've been able to fund companies far longer
Speaker 3: than they've previously been willing to fund them. And so
Speaker 3: in some cases that you know, good companies have bypassed.
Speaker 3: My definition of small gap is that doesn't happen frequently,
Speaker 3: but it happens. That's probably the biggest difference. You obviously
Speaker 3: have a lot of different types of investors. You have
Speaker 3: high frequency traders, you have AI driven investment investment managers. However,
Speaker 3: the core fundamental evaluation backdrop of investing is still relevant,
Speaker 3: and our investment philosophy and process has produced between four
Speaker 3: hundred and four hundred and fifty basis points of outperformance
Speaker 3: over a twenty nine year timeframe. So it's still relevant,
Speaker 3: and it's still useful to have somebody with their hands
Speaker 3: on the steering wheel instead of putting it into a
Speaker 3: computer and just letting it run. So I'm talking to
Speaker 3: my own book here, but that's my opinion.
Speaker 1: So you mentioned with private equity, are you seeing I
Speaker 1: guess less opportunities with companies not going as you know,
Speaker 1: public as often as they used to.
Speaker 3: I would say on the on the margin. You might
Speaker 3: see one or two companies that fit the description of
Speaker 3: what I'm saying, but instead of a company coming public
Speaker 3: at five hundred million, they may come public at one
Speaker 3: point five to two billion. Still small cap. The definition
Speaker 3: of small cap has certainly gone up from a cap perspective,
Speaker 3: but so has large cap. I mean, we have a
Speaker 3: handful of three trillion dollar market cap companies, or did
Speaker 3: at one point in time, and you look at small
Speaker 3: cap or our range of small cap is really kind
Speaker 3: of that five hundred million to call it seven billion
Speaker 3: on an entry point basis. And you know, our ability
Speaker 3: to buy a stock is really determined by liquidity. One
Speaker 3: of the big things we look at from a risk
Speaker 3: perspective is liquidity. We want to make sure that we
Speaker 3: can trade in and out of a stock in an
Speaker 3: acceptable period of time.
Speaker 1: Okay, well, this is great. I really appreciate you coming on,
Speaker 1: Mike and Mike. Thank you so much for joining me today.
Speaker 3: Thank you well, David and Mike, thanks for having me.
Speaker 3: Appreciate it, and we'll do it again sometime.
Speaker 1: Soon, definitely until our next episode. This is David Cone
Speaker 1: with Inside Active