Cover Story, by Mark Robertson, Managing Partner
Posted on November 1st, 2015
This year as we do every year, we counsel investors to be vigilant for the Forbes list of the Best Small Companies for shopping ideas around the time of Halloween. This year, Forbes threw us a curveball.
Some of Our Favorite Haystacks. We went looking for qualifying small companies in places like (1) Hoover’s Handbook of Emerging Companies, (2) Best Small Company Funds — as published in last month’s fund feature, (3) the Morningstar database — gleaned by Prospector software, (4) Value Line Investment Analyzer, (5) Forbes small company features, (6) Fortune’s Fastest-Growing Companies
This year as we do every year, we counsel investors to be vigilant for the Forbes list of the Best Small Companies for shopping ideas around the time of Halloween. This year, Forbes threw us a curveball. After 36 annual listings of some promising faster growing small companies, Forbes decided there’d be no 37th annual version. Needless to say, we were disappointed. So we decided to take the Forbes criteria, fine tune it with some of the quality characteristics that we know are so important — and build our own list of 50 Best Small Companies. Based on the rewarding returns realized by many high-quality small companies over the years … we think you’ll like the collection.
The following summary has been excerpted and updated from the Forbes coverage of the best small companies last year … as we celebrate the contributions of numerous small companies over the past couple of decades.
Large cap companies trounced their smaller rivals in the stock market during the 1980s and 1990s, as investors loaded up on brand names and blue chip companies during the greatest bull market the U.S. has ever seen. The S&P 500 returned 18% annually during the two decades, while the Russell 2000 small cap index clocked in at a still impressive 14% per year. The tables turned with the Internet bubble bursting in 2000 and the financial crisis later in the decade. The S&P suffered the Lost Decade (-1.0% annually) between 2000 and 2010, while the Russell 2000 rose +2.2%. During our small company presentations during November-December 2015, we cautioned that — despite the correction and lackluster small company performance in 2014, the return forecasts were still lacking. Indeed, small companies did take it on the chin for the trailing twelve months through Halloween with the S&P checking in at +5.1% vs. the Russell 2000 at -1.0%.
Small caps present tremendous opportunities for investors with faster growth potential in many cases versus the larger stalwart blue chips.
Each year, Forbes has looked to identify up-and-coming companies that have displayed strong, consistent growth in their feature on America’s Best Small Companies. Our adaptation continues that heritage, perhaps increasing the emphasis on financial strength, consistency and quality that we know is achievable when analyzing the leadership small companies.
Selection Methodology. We largely honored the Forbes selection parameters, seeking double-digit growth and limiting the field to revenues under $1 billion — while avoiding penny stocks. For the definition of Quality, see: http://www.manifestinvesting.com/articles/201303cover
Our top 100 includes public companies with sales under $1 billion. While the Forbes ranking leaned heavily on return on equity, recent earnings performance and stock price performance, we felt that our Graham/Nicholson-based definition of quality would serve us well to identify the promising, well-managed and faster-growing companies in the field.
Technology (40.5%), Consumer Discretionary (19.2%) and Industrials (16.1%) are the most represented sectors for the 50 companies. The top spot hails from the Industrial sector and the Air Transport (Freight) industry group. The company has been featured numerous times on the Forbes Best Small Companies list and with $935 million in annual revenues, will probably be ineligible next year if growth persists. Based in Greenville, Tennessee, Forward Air (FWRD) was #73 on the list last year.
Manifest Investing 50 Best Small Companies (October 2015). As inspired by Forbes, here are the top 50 — ranked by quality — for companies with double-digit sales growth and annual revenues under $1 billion. The projected annual return is the consensus-based return forecast based on sales growth regression, profitability trend and projected average and/or fair value-based P/E ratios. Many of the companies have been part of this profile for multiple years.
Forward Air provides surface transportation and related logistics services to air freight market. The company also provides scheduled surface transportation of cargo as an alternative to air transportation; and brokerage transportation services. Its logistics and other services include expedited full truckload, intermodal/drayage, fleets, warehousing, customs brokerage and shipment consolidation, deconsolidation & handling.
Forbes Regular: Forward Air (FWRD). FWRD has been part of the Forbes Best Small Companies for the last seven years.
The company operates its business through three segments: Forward Air, Forward Air Solutions and Total Quality. The Forward Air segment provides surface transportation and related logistics services to the North American ground freight market. The Forward Air Solutions segment provides pool distribution services. The Total Quality segment provides security and temperature-controlled logistics services; and truckload and less-than-truckload brokerage transportation services. It serves air freight forwarders, integrated air cargo carriers and passenger & cargo airlines. Forward Air was founded by Scott M. Niswonger on October 23, 1981.
Companies like Cognizant Technology (CTSH) and SolarWinds (SWI) have delivered for our community of investors for many years. SolarWinds would have made this list were it not for the pending acquisition. The Software (Consulting) industry, home to CTSH also features NIC (EGOV), Syntel (SYNT), Luxoft (LXFT), Tyler Technologies (TYL) and EXLService Holdings (EXLS). This could make for an interesting industry study — seeking leadership characteristics and those special advantages that portend continued success. A couple of drone companies hover on the list at #46 IRobot (IRBT) and #47 Aerovironment (AVAV).
But most of all, with an average sales growth forecast of 14.7% with a quality ranking of 87.4, these 50 Best represent a target-rich environment to seek promising small companies to study.
We selected (18) companies that we felt were not only the highest quality companies but also offered outsized long-term return forecast potential. Keep in mind that while we’re identifying quality candidates — much like an industry study — we seek the leaders when it comes to fundamentals. Price and return forecast are a secondary consideration only after we’ve identified the best-of-the-best.
Best Small Companies (2014): Performance Dashboard. 50% of the companies selected as the creme de la creme of the Forbes Best Small Companies beat the market (Wilshire 5000, +10.7%) delivering a collective total return of +19.0%!
That said, #3 (in 2014) EPAM Systems (EPAM) was prominently featured by Forbes a year ago and we included it among our “well-positioned” 18 companies that are shown in the accompanying dashboard. Well … 16 are shown — because long time Forbes and community favorite Bio-Reference Labs (BRLI) was acquired by Opko Health during 2015 and Cyberonics (CYBX) followed suit in October 2015. Both BRLI and CYBX (now “Cash”) are among the market beaters for the trailing 12 months.
Any company with a cash value of $110.70 or more is beating the market (VTSMX benchmark) based on $100 invested a year ago. This dashboard is public and is available via: https://www.manifestinvesting.com/dashboards/public/forbes-best-small-2014
The total return over the trailing year checks in at 19.0% — soundly outpacing the Wilshire 5000 (10.7%), S&P 500 (5.1%) and the Russell 2000 (-1.0%).
Quality matters. It’s significant that our group delivered during a period when “everyone” seems to be complaining — whining, even — that the only portfolios delivering returns over the last year or so must include Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (GOOG/GOOGL). Topping the Russell 2000 by such a wide margin underscores and affirms our approach to selectivity.
Alas, 3D Systems (DDD) serves as a gut-punching reminder that small companies can be like land mines. $100 invested a year ago is now worth $22.10. The long term outlook and story is still intact, but DDD was getting a lot of attention a year ago — and it was probably reflected in the price and exuberant expectations.
The Best Small Companies have delivered powerful potential for years and we urge you to shop carefully among the leaders. Discover. Own. Succeed.