WEBVTT - Calamos’ Nelson on Finding Fundamental Momentum 0:00:14.790 --> 0:00:17.750 Welcome to Inside Active, a podcast about active managers that 0:00:17.790 --> 0:00:22.009 goes beyond soundbites and headlines and looks deeper into the processes, challenges, 0:00:22.090 --> 0:00:25.270 and philosophies in security selection. I'm David Cohn. I lead 0:00:25.329 --> 0:00:28.410 mutual fund and active research at Bloomberg Intelligence. Some of 0:00:28.430 --> 0:00:32.460 the market's biggest companies started out much smaller, but investing 0:00:32.500 --> 0:00:35.420 in small and mid-cap growth companies isn't simply about trying 0:00:35.460 --> 0:00:38.220 to find the next company. They'll become a household name. 0:00:38.860 --> 0:00:41.740 These businesses can be earlier in their growth trajectories with 0:00:41.800 --> 0:00:46.129 less established track records and greater uncertainty about what their 0:00:46.150 --> 0:00:50.470 business may ultimately become. That can create opportunities for active managers, 0:00:50.750 --> 0:00:53.130 but that also puts a premium on determining which companies 0:00:53.170 --> 0:00:56.390 can sustain their growth and, just as importantly, what the 0:00:56.430 --> 0:00:59.560 market already expects from them. So today, I wanted to 0:00:59.620 --> 0:01:03.220 explore how an active manager approaches that challenge, how potential 0:01:03.240 --> 0:01:07.440 investments are identified in research, how sustainable growth is separated 0:01:07.480 --> 0:01:12.210 from short-term momentum, and how expectations and valuation factor into 0:01:12.250 --> 0:01:15.470 security selection and how those individual ideas come together in 0:01:15.510 --> 0:01:18.890 a portfolio. Joining me to discuss that is Brandon Nelson, 0:01:19.569 --> 0:01:24.209 Senior Vice President and Portfolio Manager at Calamos Investments, including 0:01:24.310 --> 0:01:29.339 the Calamos-Tapani Small Cap Growth Mutual Fund, ticker CTSIX, and 0:01:29.360 --> 0:01:33.819 the Calamos-Tapani Active SMID Growth Strategy, which just actually converted 0:01:33.880 --> 0:01:36.280 from a mutual fund to an ETF this week with 0:01:36.300 --> 0:01:39.949 the ticker CTAG, or C-T-A-G, and is actually the first 0:01:40.110 --> 0:01:44.750 active mutual fund ETF conversion on the Texas Stock Exchange. Brandon, 0:01:44.770 --> 0:01:45.449 thanks for joining me. 0:01:46.090 --> 0:01:47.020 Yeah, thanks for having me. 0:01:48.300 --> 0:01:52.059 So, you know, your investment philosophy is kind of described 0:01:52.080 --> 0:01:55.059 as fundamental momentum. What does that mean to you? And 0:01:55.720 --> 0:01:59.410 what does a company with fundamental momentum look like? Right. 0:01:59.550 --> 0:02:02.370 It's really got two components to it. So the first 0:02:02.410 --> 0:02:07.560 component is sustainable growth. So companies that aren't just growing 0:02:07.640 --> 0:02:10.600 for a quarter or two, but have the sort of 0:02:10.660 --> 0:02:13.440 profile that they can sustain growth for many quarters and 0:02:13.480 --> 0:02:17.420 hopefully many years. That's part one of fundamental momentum. And 0:02:17.460 --> 0:02:21.660 part two is very importantly, companies that know how to 0:02:22.139 --> 0:02:26.520 manage expectations. So we're looking for underestimated growth as well. 0:02:26.600 --> 0:02:31.400 We want to invest in management teams that know what 0:02:31.440 --> 0:02:33.740 it's like to be in the public limelight. And it's 0:02:33.919 --> 0:02:36.930 very important to be able to Do what you say 0:02:36.950 --> 0:02:41.840 you're going to do. And we find that managing expectations 0:02:42.180 --> 0:02:45.500 is sometimes just as important as running the business and 0:02:45.540 --> 0:02:48.780 the operational side of things. So fast growth and underestimated 0:02:48.840 --> 0:02:52.139 growth equals fundamental momentum. Okay. 0:02:52.540 --> 0:02:53.880 And out of those two, what do you think is 0:02:53.919 --> 0:02:56.440 harder to identify and kind of what gives you the 0:02:56.500 --> 0:02:59.690 confidence that you're right when the market might be wrong? 0:03:00.080 --> 0:03:04.300 I think of the two underestimated growth is more difficult 0:03:04.580 --> 0:03:09.610 to find. Yeah. I think it's easier to identify, you know, 0:03:10.010 --> 0:03:13.770 open-ended fast growth situations, but it's a whole nother thing 0:03:13.830 --> 0:03:17.389 to execute on that and to, you know, again, do 0:03:17.430 --> 0:03:19.700 what you say you're going to do. And that I 0:03:19.720 --> 0:03:24.060 think is really, that's where our research comes into play. 0:03:24.100 --> 0:03:26.000 And we, we meet with a lot of management teams 0:03:26.040 --> 0:03:28.190 and we try to, sort of get inside their head 0:03:28.250 --> 0:03:31.180 and try to understand what's important to them so that 0:03:31.660 --> 0:03:36.420 we're looking for favorable setups where that sustainable growth profile 0:03:36.460 --> 0:03:39.900 is there, but also where management teams seem to have 0:03:39.940 --> 0:03:43.740 a sensitivity to managing expectations. And it's really when you 0:03:43.760 --> 0:03:46.280 get those two things together, that's where kind of the 0:03:46.320 --> 0:03:51.150 magic happens. The market really likes those characteristics, fast growth 0:03:51.170 --> 0:03:55.010 and underestimated growth. And it'll pay a premium for companies 0:03:55.030 --> 0:03:57.870 that have that profile. So we're all about trying to 0:03:57.910 --> 0:04:02.350 find companies that are in the early stages of demonstrating 0:04:02.390 --> 0:04:06.530 that profile and then riding that wave of them getting 0:04:06.670 --> 0:04:12.520 re-rated from maybe, let's say, a 14 times PE ratio 0:04:12.560 --> 0:04:16.400 when that process started. Fast forward seven, eight, nine quarters, 0:04:16.800 --> 0:04:19.640 and maybe you're trading at a PE ratio of 35 times. 0:04:19.900 --> 0:04:22.020 And that's where you really find the big winners. 0:04:22.800 --> 0:04:26.130 Okay. You know, I've always heard a great company doesn't 0:04:26.150 --> 0:04:28.330 always turn out to be a great stock. How do 0:04:28.370 --> 0:04:31.980 you distinguish between the two when you're evaluating a potential company? 0:04:32.440 --> 0:04:36.360 Yeah, I agree with that completely. Yeah, sometimes great companies 0:04:36.960 --> 0:04:42.860 are slow growing, not exceeding expectations. That doesn't mean you're 0:04:42.880 --> 0:04:47.020 a bad company if you're not showing fundamental momentum. But 0:04:47.140 --> 0:04:50.480 what we think drives stock prices the most, and at 0:04:50.520 --> 0:04:52.219 the end of the day, that's really what we care 0:04:52.260 --> 0:04:56.120 about as portfolio managers, is really what I said before. 0:04:56.180 --> 0:05:00.990 It's that fundamental momentum profile. And it's that fast growth 0:05:01.089 --> 0:05:04.990 and underestimated growth profile. And if you don't have it, 0:05:05.190 --> 0:05:07.150 you still might be a great company, but you're just 0:05:07.210 --> 0:05:09.950 not great for our portfolios. And you might be kind 0:05:09.970 --> 0:05:14.010 of a mediocre stock if you're not showing those characteristics. 0:05:14.710 --> 0:05:18.339 Okay. You know, you've been managing or investing in small 0:05:18.420 --> 0:05:21.420 and in SMID cap growth companies for a while. I 0:05:21.440 --> 0:05:24.210 don't want to age you, so I won't guess the year. 0:05:24.250 --> 0:05:31.130 But you've used essentially the similar philosophy throughout that period. 0:05:31.490 --> 0:05:33.599 What have you learned over that time about where the 0:05:33.620 --> 0:05:35.560 market is most likely to misprice growth? 0:05:37.740 --> 0:05:41.789 I think the most important maybe lesson I've learned in 0:05:41.910 --> 0:05:43.849 investing all those years, I don't know if it really 0:05:43.910 --> 0:05:47.650 answers your question directly about mispriced growth, but I think the, 0:05:48.270 --> 0:05:51.940 one of the first things I learned about investing, especially 0:05:51.980 --> 0:05:56.680 with this sort of investment process is sell discipline is 0:05:56.760 --> 0:06:00.790 really important and falling in love with your stocks is 0:06:02.020 --> 0:06:05.110 can be the kiss of death. And it's so easy 0:06:05.140 --> 0:06:08.290 to do. Just as humans, we have this tendency to 0:06:09.170 --> 0:06:12.969 get emotionally attached to stocks and we sort of lose 0:06:13.050 --> 0:06:16.289 our objectivity and we make bad decisions as a result. 0:06:17.089 --> 0:06:21.140 And we try to be unemotional and very objective. And 0:06:21.160 --> 0:06:24.280 we have this set of rules that relate to fundamental momentum. 0:06:24.820 --> 0:06:27.339 And when the companies violate those rules, you have to 0:06:27.380 --> 0:06:31.120 have an open mind and a willingness to reduce exposure 0:06:31.200 --> 0:06:34.220 to those stocks. Again, they might still be great companies, 0:06:34.720 --> 0:06:37.679 but they're possibly no longer going to be great stocks 0:06:37.920 --> 0:06:41.400 going forward. And it's important to distinguish between those two things. 0:06:41.440 --> 0:06:45.220 So biggest lesson learned is don't fall in love with 0:06:45.260 --> 0:06:48.680 your companies and have an open mind and a willingness 0:06:48.880 --> 0:06:52.880 to recognize the thesis may have changed from when you 0:06:52.900 --> 0:06:55.160 first purchased the stock and had success with the stock. 0:06:55.730 --> 0:06:58.589 And you have to just acknowledge that and know that, 0:06:59.650 --> 0:07:02.230 you know, going forward, it may not be wise to 0:07:02.270 --> 0:07:03.770 keep that investment in the portfolio. 0:07:03.790 --> 0:07:06.469 Okay. No, it makes a lot of sense. And, you know, 0:07:06.510 --> 0:07:08.390 we've kind of gone over the philosophy a little bit 0:07:08.450 --> 0:07:10.050 and set the stage. But, you know, one of the 0:07:10.070 --> 0:07:11.850 things I'd love to do on this podcast is kind 0:07:11.890 --> 0:07:14.300 of get into the whole process. So if you could 0:07:14.310 --> 0:07:17.360 kind of take us through your investment process from the beginning, 0:07:17.420 --> 0:07:20.800 you know, with thousands of small companies you could potentially 0:07:20.840 --> 0:07:22.760 invest in, you know, how do you narrow that new 0:07:22.940 --> 0:07:26.600 universe down to companies that deserve deeper research? Yeah. Yeah. 0:07:26.680 --> 0:07:28.780 And I'm glad you mentioned that because I think there's 0:07:28.820 --> 0:07:33.110 a perception that there really aren't many stocks available to 0:07:33.130 --> 0:07:36.110 choose from. You know, private equity has really become a 0:07:36.150 --> 0:07:41.050 big asset class over the years and it's legit, not 0:07:41.210 --> 0:07:44.030 knocking it, but there seems to be this narrative that, 0:07:44.790 --> 0:07:48.590 you know, companies, they're just, there's so few stocks for 0:07:49.060 --> 0:07:50.940 folks like me to even choose from. How could you 0:07:50.980 --> 0:07:54.220 possibly come up with a portfolio of stocks that could 0:07:54.240 --> 0:07:56.660 appreciate and value. And I can tell you again, from 0:07:56.680 --> 0:08:01.720 a 30-year perspective, there's no issue from where I sit. 0:08:01.980 --> 0:08:06.210 We're finding great ideas all over the place. Maybe there's 0:08:06.270 --> 0:08:09.630 fewer stocks public today than there were 10, 20 years ago, 0:08:10.050 --> 0:08:13.070 but there are still hundreds and hundreds of publicly traded stocks. 0:08:13.110 --> 0:08:17.750 And we're not dependent on IPOs, for instance, to come 0:08:17.790 --> 0:08:20.720 up with new ideas for our portfolio. So that's just 0:08:20.760 --> 0:08:23.300 kind of a side note, I guess, on what I'll 0:08:23.340 --> 0:08:27.370 tell you about our specific process. But yeah, you know, 0:08:27.410 --> 0:08:30.790 we start with a large opportunity set, call it 1500 0:08:30.790 --> 0:08:34.370 plus stocks in the small cap and mid cap growth space. 0:08:35.190 --> 0:08:38.060 We have, you know, this tier one criteria. I mentioned 0:08:38.100 --> 0:08:41.760 this fundamental momentum criteria. We're really picky about the stocks 0:08:42.100 --> 0:08:46.380 we're choosing, you know, really only maybe about 10% of 0:08:46.420 --> 0:08:51.059 that universe of stocks. checks the boxes for what potentially 0:08:51.080 --> 0:08:53.800 could go in the portfolio. And it's from that sort 0:08:53.820 --> 0:08:57.709 of subset of, call it 150 to 200 stocks, where 0:08:57.750 --> 0:09:00.370 we really sort of roll up our sleeves and do 0:09:00.750 --> 0:09:03.710 much more in-depth research, myself and my teammates, to come 0:09:03.770 --> 0:09:07.050 up with a portfolio of 80 to 120 stocks. And 0:09:07.070 --> 0:09:12.070 so it's the fundamental momentum characteristics I mentioned, fast growth, 0:09:12.270 --> 0:09:15.090 underestimated growth, We also want to make sure the market 0:09:15.170 --> 0:09:18.219 is embracing the idea too. So we do pay attention 0:09:18.270 --> 0:09:21.540 to sort of the stocks, how the stock is being 0:09:21.600 --> 0:09:24.380 received in the marketplace. And we want to make sure 0:09:24.420 --> 0:09:27.380 the market is in a place where it's embracing that 0:09:27.480 --> 0:09:31.939 fundamental momentum that we're identifying. And it's really where you 0:09:31.960 --> 0:09:36.470 get the fundamental momentum marrying up with a market that's 0:09:36.520 --> 0:09:39.670 willing to embrace the idea. That's when you find the 0:09:39.710 --> 0:09:43.209 big winners. And so we're very much honed in on 0:09:43.900 --> 0:09:46.600 trying to find all those stars to sort of align. 0:09:47.140 --> 0:09:50.339 And we're good at finding big winners. And very importantly, 0:09:50.480 --> 0:09:53.940 we're good at letting them run. That's a big mistake 0:09:53.980 --> 0:09:57.230 investors make is they sell their winners too soon. And 0:09:57.270 --> 0:09:59.770 on the flip side, they keep their losers too long. 0:10:00.110 --> 0:10:03.489 Bad investment, you're hanging on to it, just hoping to 0:10:03.510 --> 0:10:05.720 get back to even someday. We look at it the 0:10:05.750 --> 0:10:10.220 other way. We say, wrong stock, wrong time. We run 0:10:10.240 --> 0:10:12.860 into trouble too, just like everybody else. But the way 0:10:12.900 --> 0:10:16.179 we handle it is sort of cut losses quickly, let 0:10:16.220 --> 0:10:18.240 it be a scratch or a bruise on the portfolio, 0:10:18.280 --> 0:10:20.569 but don't let it ruin the whole year. and double 0:10:20.590 --> 0:10:24.320 down and triple down on the exposure on a losing situation. 0:10:24.400 --> 0:10:28.280 So find big winners, let them run and cut your 0:10:28.320 --> 0:10:31.260 losers quickly. That's really the name of the game. And 0:10:31.480 --> 0:10:34.480 that's how we approach investing, you know, day to day. 0:10:34.640 --> 0:10:36.510 I'm covering a lot of ground with you just on, 0:10:36.520 --> 0:10:39.870 you know, investment process. Some of that is investment process 0:10:39.910 --> 0:10:43.089 and some of that is almost a investment philosophy, but 0:10:43.270 --> 0:10:45.869 it all kind of comes in together and intertwines on 0:10:45.910 --> 0:10:49.130 a day to day basis. So hopefully that helps explain. No, definitely. 0:10:49.150 --> 0:10:52.459 It, You alluded to management earlier, and I'm going to 0:10:52.600 --> 0:10:54.700 ask you about that next. But, you know, is there 0:10:54.940 --> 0:10:57.440 once these companies have your attention, you know, what exactly 0:10:57.480 --> 0:10:59.040 are you looking at to kind of give you those 0:10:59.220 --> 0:11:01.339 answers that you might not get just from looking at 0:11:01.420 --> 0:11:02.240 financial statements? 0:11:03.110 --> 0:11:05.790 Yeah, as it relates to management teams, especially in the 0:11:05.830 --> 0:11:08.890 small cap space, you know, management teams are a really 0:11:08.929 --> 0:11:11.510 big deal. They tend to move the needle a lot 0:11:11.710 --> 0:11:13.809 in terms of how the stock is actually going to 0:11:13.850 --> 0:11:17.760 ultimately perform. And it really relates, I'd say the most 0:11:18.000 --> 0:11:22.140 to that idea of underestimated growth, you know, management teams, 0:11:22.240 --> 0:11:24.600 there's some management teams and I've seen it all over 0:11:24.620 --> 0:11:29.260 the years where on one extreme, they'll say, you know, 0:11:29.540 --> 0:11:34.060 we have, we don't really care what the market looks at. 0:11:34.120 --> 0:11:37.080 We don't, we don't care if our growth is underestimated 0:11:37.120 --> 0:11:38.400 or not. We're just going to do what we're going 0:11:38.420 --> 0:11:40.920 to do. And if it's better than people think, so 0:11:40.970 --> 0:11:43.449 be it. If it's worse than people expect, so be it. 0:11:43.550 --> 0:11:45.970 We don't care. Like that's, red flags all over the 0:11:45.990 --> 0:11:51.030 place for us if we're hearing that. If instead they're like, okay, 0:11:51.070 --> 0:11:56.150 we've got a conservative philosophical approach, we've given guidance, but 0:11:56.270 --> 0:11:59.770 we've not included a new product that we're rolling out 0:11:59.809 --> 0:12:01.930 next year because we don't know how good that product 0:12:01.990 --> 0:12:04.310 is going to be and therefore just out of conservatism, 0:12:04.350 --> 0:12:07.550 let's just not include it. And so they're very cognizant 0:12:07.890 --> 0:12:11.050 of sort of this idea of managing expectations and making 0:12:11.080 --> 0:12:15.179 sure they don't fall short of whatever the expectations are 0:12:15.260 --> 0:12:19.940 that are out there. So that's where the management team, 0:12:19.960 --> 0:12:23.240 I think, probably shows itself the most in the importance 0:12:23.300 --> 0:12:26.540 of management teams. And that ripples through to the sell 0:12:26.570 --> 0:12:29.510 side analyst estimates too. Let's face it, a lot of 0:12:29.530 --> 0:12:34.330 these analysts that are publishing research are using management's sort 0:12:34.350 --> 0:12:38.170 of guidance to determine where their models should end up being. 0:12:38.210 --> 0:12:41.480 And so there's this sort of domino effect of, You know, 0:12:41.520 --> 0:12:47.020 management teams that are conservative and have sensitivity to managing expectations, 0:12:47.750 --> 0:12:50.569 they tend to be, you know, just very important on 0:12:50.630 --> 0:12:53.190 a lot of levels, I guess, in terms of, you know, 0:12:53.210 --> 0:12:54.890 checking the box of fundamental momentum. 0:12:55.730 --> 0:12:58.450 With the, you know, underestimated growth, how do you measure 0:12:58.470 --> 0:13:02.010 what the market already expects from a company? And, you know, 0:13:02.240 --> 0:13:04.720 how large, I guess, is the gap between your expectations 0:13:05.140 --> 0:13:08.179 and the market needs or what the market expects, you know, 0:13:08.260 --> 0:13:09.640 for it to actually become interesting? 0:13:10.010 --> 0:13:15.530 No, that's a good point because if it's just a 0:13:15.590 --> 0:13:18.989 minor upside situation, let's say the company is expected to 0:13:19.030 --> 0:13:23.170 grow 10% and we think they're really going to do 11%, 0:13:23.170 --> 0:13:26.960 I don't know if that's enough to get us excited. 0:13:28.140 --> 0:13:31.520 But if it's 10% growth expected, but we think they're 0:13:31.540 --> 0:13:36.679 going to do 23%, okay, now that's much more meaningful. 0:13:37.059 --> 0:13:39.540 And I'm talking like over the course of a year. 0:13:41.150 --> 0:13:45.819 that's likely to result in that valuation multiple expansion that 0:13:45.860 --> 0:13:49.640 I mentioned earlier, where if the company's growing fast and 0:13:49.679 --> 0:13:54.740 exceeding expectations meaningfully, that's going to have a direct result 0:13:54.800 --> 0:13:58.839 in terms of the magnitude of that re-rating that the 0:13:58.880 --> 0:14:02.640 stock is likely to see. So it is important. We 0:14:02.660 --> 0:14:05.679 look for fast growth, but we also look for underestimated growth. 0:14:05.740 --> 0:14:08.720 And just to really bring the point home, You know, 0:14:08.980 --> 0:14:13.600 we would actually pass on a faster growth situation where 0:14:13.620 --> 0:14:16.980 there's minimal upside. So I would not buy a stock 0:14:17.240 --> 0:14:22.690 that's growing where the company's growing 40%, but they're likely 0:14:22.730 --> 0:14:27.250 to do, you know, actually put up 37% growth. I 0:14:27.270 --> 0:14:29.729 would pass on that stock. I'd rather buy a stock 0:14:29.770 --> 0:14:33.750 where growth is expected to be 18% and they're going 0:14:33.950 --> 0:14:36.520 to do 25% growth, lower growth rates in that example. 0:14:37.060 --> 0:14:41.880 but underestimated growth. And so that's really, again, where kind 0:14:41.900 --> 0:14:43.940 of the magic happens. So you have to have a 0:14:43.980 --> 0:14:47.880 growth rate above a minimum for in sort of a 0:14:47.940 --> 0:14:51.180 normalized economy. We like to see at least 10% revenue growth, 0:14:51.340 --> 0:14:54.640 at least 15% earnings per share growth. Averages are much 0:14:54.680 --> 0:14:56.940 higher than that, but that's kind of what we're thinking 0:14:56.980 --> 0:15:00.060 for a minimum growth rate. And then for revision potential, 0:15:00.120 --> 0:15:04.480 I'd say at least 10% revision, positive revision potential over 0:15:04.520 --> 0:15:06.500 the course of the four or 12 months. 0:15:07.180 --> 0:15:11.310 That's interesting. How does valuation fit into the equation? I mean, 0:15:11.410 --> 0:15:13.770 can you have a company that has exactly what you're 0:15:13.790 --> 0:15:16.550 looking for, but might just be simply too expensive to own? 0:15:17.550 --> 0:15:20.630 We do pay attention to valuation, but it is not 0:15:20.820 --> 0:15:24.160 a tier one sort of consideration. We don't let valuation 0:15:24.180 --> 0:15:27.920 sort of drive the bus on our decision making. A 0:15:28.460 --> 0:15:34.750 lot of stocks that look expensive are stud performers, right? 0:15:35.090 --> 0:15:39.720 They end up being monster performers despite looking expensive. And 0:15:40.840 --> 0:15:43.260 part of the issue is, yeah, they might look expensive 0:15:43.320 --> 0:15:48.340 on the consensus estimates, but they reported way more than 0:15:48.360 --> 0:15:51.160 the consensus estimates. And so what looked to be a 0:15:51.200 --> 0:15:53.580 high valuation multiple at the time you were looking at 0:15:53.600 --> 0:15:55.920 it ended up not really being that high when you 0:15:56.060 --> 0:15:59.990 plugged in what they really ended up doing in earnings. 0:16:00.010 --> 0:16:03.050 These are stocks that get valued on forward earnings and 0:16:03.110 --> 0:16:07.620 forward EBITDA. expectations, forward sales. And so to the extent 0:16:07.640 --> 0:16:12.220 there's upside to all those metrics, there's downside to the valuation. 0:16:12.280 --> 0:16:15.140 So evaluation can be kind of tricky. Again, we pay 0:16:15.160 --> 0:16:19.750 attention to it. We get most nervous about stocks where 0:16:19.790 --> 0:16:24.350 we're sensing fatigue in the fundamental momentum profile at the 0:16:24.410 --> 0:16:28.970 same time that we're seeing elevated valuation multiples. So maybe 0:16:29.010 --> 0:16:33.030 it's already gone through that re-rating process, that positive re-rating process. 0:16:33.420 --> 0:16:36.640 And now we're starting to see some fatigue and maybe 0:16:36.660 --> 0:16:41.260 a little weakness in that fundamental momentum profile. It's time 0:16:41.300 --> 0:16:44.900 to reduce exposure when we see those characteristics all kind 0:16:44.940 --> 0:16:47.380 of come into play. So again, we use it, but 0:16:47.720 --> 0:16:51.900 we don't let it trick us. Valuation, that is, we 0:16:51.920 --> 0:16:54.560 don't let it trick us into not buying stocks that 0:16:54.600 --> 0:16:57.860 look expensive up front. At the same time, sometimes valuation 0:16:57.920 --> 0:17:00.760 tricks people into not selling their losers. They say, oh, 0:17:00.800 --> 0:17:04.560 I can't sell this stock It's so cheap. Well, maybe 0:17:04.600 --> 0:17:06.820 it's not as cheap as it looks because that company 0:17:06.840 --> 0:17:09.440 is going to miss estimates in the multiples a lot 0:17:09.480 --> 0:17:11.810 higher than it looks. So it can go the other way, too. 0:17:11.900 --> 0:17:17.070 So I think valuation just I just don't think it 0:17:17.130 --> 0:17:20.710 should be a sort of decision. I don't think it 0:17:20.750 --> 0:17:24.250 should drive by and to sell. And I don't think 0:17:24.270 --> 0:17:26.669 it should drive by or sell decisions. There we go. 0:17:27.330 --> 0:17:29.730 Okay, no, makes sense. You know, I mean, smaller companies, 0:17:29.800 --> 0:17:33.020 I think, can, you know, they obviously have tremendous growth opportunities, but, 0:17:33.160 --> 0:17:35.679 you know, some of them also can have, you know, 0:17:35.740 --> 0:17:38.580 greater business or financing risk. How do you kind of 0:17:38.640 --> 0:17:41.400 distinguish between a company that's, you know, early in, you know, 0:17:41.420 --> 0:17:44.609 say a durable growth trajectory versus one that, you know, 0:17:44.630 --> 0:17:46.469 where the numbers simply look good temporarily? 0:17:47.990 --> 0:17:50.910 Yeah, as far as like financing goes, you know, most 0:17:50.950 --> 0:17:53.450 of the stocks we invest in, a lot of them 0:17:53.510 --> 0:17:58.149 are self-funding their growth. And that's important. And for the 0:17:58.250 --> 0:18:00.790 ones that aren't able to self-fund their growth, maybe their 0:18:00.850 --> 0:18:04.210 earlier stage, they're still building out their infrastructure, let's say, 0:18:04.990 --> 0:18:07.780 they've got something special, at least the ones we invested. 0:18:07.800 --> 0:18:12.580 And investors are very willing to get capital to them 0:18:12.600 --> 0:18:14.980 in order for them to build their business. These aren't 0:18:15.020 --> 0:18:19.919 just like plain vanilla, you know, small companies and mid-sized companies. 0:18:19.940 --> 0:18:23.840 These are up and coming companies. companies that have something special, 0:18:23.880 --> 0:18:27.179 some unique good or service that they're selling. And investors 0:18:27.560 --> 0:18:31.220 are excited to give them capital to build their business. 0:18:31.280 --> 0:18:34.820 And so I find that it's not usually an issue. Well, 0:18:34.859 --> 0:18:37.320 first of all, our companies that we invest in do 0:18:37.359 --> 0:18:40.740 tend to be much more profitable than the average small 0:18:40.770 --> 0:18:44.449 cap company. So that's something I probably should have said 0:18:44.670 --> 0:18:46.229 right off the bat. And they also tend to have 0:18:46.290 --> 0:18:49.830 less financial leverage. But in cases where they need capital, 0:18:50.900 --> 0:18:53.419 They usually don't have a problem getting it because they're 0:18:53.880 --> 0:18:59.140 very exciting, sort of sexy growth stocks where investors are 0:18:59.580 --> 0:19:03.790 seeing a really positive potential return on that capital. Okay. 0:19:03.869 --> 0:19:06.629 Once you have a company that meets all of your criteria, 0:19:06.850 --> 0:19:09.750 how do you determine the position size in a portfolio? 0:19:10.070 --> 0:19:12.810 What would earn a stock a large position? 0:19:13.310 --> 0:19:16.969 Great question. It does depend on, you know, maybe the 0:19:17.030 --> 0:19:19.270 history we have with the stock. If we've owned it 0:19:19.310 --> 0:19:21.670 before and we're more familiar with it, there's a willingness 0:19:21.690 --> 0:19:24.970 to maybe make it a bigger position faster. But I'd 0:19:24.990 --> 0:19:28.740 say for most situations, you know, we'll start at maybe 0:19:28.780 --> 0:19:32.700 a 50 basis point position in the portfolio and then 0:19:33.160 --> 0:19:36.300 we'll watch it closely. We'll, you know, we have our 0:19:36.340 --> 0:19:38.729 finger on the pulse of these companies and, you know, 0:19:38.750 --> 0:19:41.910 we're paying attention to all the data points. We're scrubbing 0:19:41.970 --> 0:19:44.970 the quarterly earnings reports, and we're just going from there. 0:19:45.010 --> 0:19:48.990 At the same time, we're also monitoring the market reception 0:19:49.010 --> 0:19:52.840 to those stocks too. And we're monitoring those data points 0:19:52.900 --> 0:19:57.360 on a daily basis. And so if maybe it starts 0:19:57.420 --> 0:20:00.919 at 50 basis points and we see a great quarter 0:20:00.940 --> 0:20:05.770 of execution, let's say it's growing fast, beating expectations, there's 0:20:05.810 --> 0:20:07.930 very much a willingness to take it up to maybe 0:20:07.950 --> 0:20:11.710 a 1% or 1.3% position in the portfolio and then 0:20:11.750 --> 0:20:14.270 go from there. Hopefully it's appreciating at the same time. 0:20:14.290 --> 0:20:17.310 And so you end up seeing this sort of natural 0:20:17.390 --> 0:20:22.510 lift of weight in the portfolio as a company, as 0:20:22.550 --> 0:20:25.389 the quarters go by and the execution is there and 0:20:25.410 --> 0:20:28.510 the company is being embraced by the market, that 50 0:20:28.510 --> 0:20:34.219 basis point position evolves between the market appreciation and us 0:20:34.260 --> 0:20:37.270 buying more. Before you know it, sometimes it's, you know, 2% 0:20:37.270 --> 0:20:41.310 plus position, you know, within six months. And so that's 0:20:41.670 --> 0:20:44.170 very common for it to sort of play out that way. 0:20:44.910 --> 0:20:48.580 And then, of course, you know, very, again, cannot emphasize 0:20:48.630 --> 0:20:53.540 enough the importance of sell discipline and just, you know, 0:20:53.600 --> 0:20:56.720 monitoring the portfolio constantly. One thing I didn't mention before, 0:20:56.760 --> 0:21:00.800 which is really important, everybody probably always says, you know, 0:21:00.840 --> 0:21:03.090 they're great at buying stocks and great at selling stocks. 0:21:03.740 --> 0:21:06.820 We actually took it another level when we're talking about 0:21:06.859 --> 0:21:11.660 our sell discipline. The thesis was, or the theory was, hey, 0:21:11.680 --> 0:21:14.100 if we're so great at selling stocks, they probably should 0:21:14.580 --> 0:21:18.460 be poor performers after we sell them. Well, the data 0:21:18.480 --> 0:21:20.750 supports that. We ran all that. We've been running that 0:21:20.790 --> 0:21:24.149 data for years. And sure enough, stocks we sell out 0:21:24.170 --> 0:21:28.230 of our portfolio persist as losers in the six months 0:21:28.330 --> 0:21:30.250 after we sell it, 12 months after we sell it, 0:21:30.290 --> 0:21:31.889 and not just by a little bit. They end up 0:21:31.930 --> 0:21:35.600 being you know, meaningful losers relative to our benchmark. So 0:21:36.060 --> 0:21:38.740 there's just to add some meat to the bones, I guess, 0:21:39.180 --> 0:21:41.200 to say the sell discipline adds a lot of value. 0:21:41.550 --> 0:21:43.610 I think we're really good at buying stocks and letting 0:21:43.630 --> 0:21:46.629 them run, but I think we're exceptionally good at selling 0:21:46.670 --> 0:21:51.290 stocks and, you know, avoiding trouble or lessening trouble. 0:21:52.170 --> 0:21:55.290 I'm not hearing, you're not planning on adding a short component, 0:21:55.330 --> 0:21:56.590 are you? Like a shorting component? 0:21:56.609 --> 0:21:59.200 No, we've been asked that. We have been asked that 0:21:59.420 --> 0:22:00.619 many times over the years. 0:22:00.640 --> 0:22:00.720 Yeah. 0:22:01.380 --> 0:22:03.100 We maybe should have done that a long time ago, 0:22:03.119 --> 0:22:07.180 but no, we're long only. But yeah, it's a logical 0:22:07.220 --> 0:22:11.619 follow-up question. We probably should be shorting those stocks that 0:22:11.640 --> 0:22:14.050 we're selling because again, if they're falling later. 0:22:15.190 --> 0:22:18.290 That's pretty cool. I mean, that's obviously a different type 0:22:18.330 --> 0:22:20.870 of skill, but it's cool that it works that way. 0:22:20.890 --> 0:22:24.690 When I was going through the documentation of the two strategies, 0:22:24.710 --> 0:22:26.910 one of the things that kind of struck out or 0:22:26.930 --> 0:22:29.660 struck out for me or that I noticed was kind 0:22:29.680 --> 0:22:32.899 of in the SPID strategy, it said you expect roughly 90% 0:22:32.900 --> 0:22:35.690 of the value added to come from security selection rather 0:22:35.750 --> 0:22:39.490 than sector kind of allocations. So I guess my question is, 0:22:39.530 --> 0:22:42.710 how do you keep a bottom-up portfolio like this from 0:22:42.950 --> 0:22:46.669 unintentionally becoming a large bet on a particular sector or 0:22:46.970 --> 0:22:47.600 even a factor? 0:22:48.720 --> 0:22:52.460 It's always a mixture of sector, or sorry, selection and 0:22:52.500 --> 0:23:01.629 sector allocation. exposures and factor exposures, of course, where we 0:23:01.650 --> 0:23:03.880 spend our time is on and where we think we 0:23:03.950 --> 0:23:06.879 add the most value is on the bottom up, you know, 0:23:06.970 --> 0:23:10.260 company interactions and just having our finger on the pulse. 0:23:11.260 --> 0:23:16.280 We're intentionally trying to find stocks that aren't that sensitive 0:23:16.340 --> 0:23:19.720 to the Fed's next move or GDP being, you know, 0:23:20.119 --> 0:23:23.580 plus one or plus three percent. You know, it's just 0:23:23.800 --> 0:23:26.340 it's we want to find stocks that are really in 0:23:26.359 --> 0:23:30.050 their own bull market and you know, have that profile 0:23:30.090 --> 0:23:33.030 where they're going to grow fast. They're going to likely 0:23:33.090 --> 0:23:36.149