Cover Story, by Mark Robertson, Managing Partner
Posted on November 1st, 2017
Our Best Small Companies chosen one year ago delivered an average total return of 31.7% with five of them more than doubling. This annual feature now has an average total return of 15.2% over the last twelve years vs. 10.3% for the Wilshire 5000. What are the companies selected for the 2018 Best Small Companies?
Three years ago, we lamented the decision by Forbes to discontinue their annual Best Small Companies list. 36 years in the running, the list provided a number of actionable opportunities over the last couple of decades for many of us. That said, while sticking to their core criteria, we may have actually improved the discovery and screening process. During 2017, our small company favorites delivered their third best return over the last decade or so and have now topped the Wilshire 5000 in nine of the last twelve tracking periods. The average return over the last three years since we were “orphaned” by Forbes stands at 24.1%, bolstering the 12-year average to 15.2% vs. 10.3% for the general stock market. We remind all investors that Small-Cap DOES NOT EQUAL Small Company. Quality Matters. Discover and shepherd enough growth.
“Investment in knowledge pays the best interest. Towering genius disdains a beaten path. It seeks regions hitherto unexplored.” — Abraham Lincoln
It’s a never-ending quest. The discovery of high-quality, rapidly-growing, companies is an urgent component of portfolio design and management.
For decades, we’ve celebrated Halloween with a powerful nudge and reminder to consistently and persistently pursue promising smaller companies to keep our portfolios percolating. They’re generally more challenging to find and understand. Information can be fleeting, elusive and in some cases, overly optimistic. But they don’t have to be roller coasters. Insist on quality and all the usual suspects that haunt excellent companies. While everybody else is out there looking for the “Next Microsoft,” feel free to discover — and share — the “Next Neogen.” Or the “Next Biomet.”
We’re not so sure about the towering genius thing, but we acknowledge the “regions hitherto” part. That said, it’s particularly rewarding with a warm and fuzzy feeling when you own a few stocks that go up +184% and +178% in a given year. Our Best Small Companies for 2017 delivered an average total return of 31.7%.
Best Small Company Performance (2006-2017). The Best Small Company tracking portfolio has now beaten the Wilshire 5000 in 9-of-12 years. The last three years have delivered 19.0%, 21.6% and 31.7% respectively. The 31.7% was achieved versus a Wilshire 5000 at 23.8% for 10/31/2016-10/31/2017. For 2006-2017, the average annualized return is 15.2% versus 10.3% for the total stock market.
The 2017 roster had five companies that more than doubled between Halloween 2016 and 2017. $100 invested in Universal Display (OLED) became $284. Align Technology (ALGN, $278), Stamps.com (STMO, $224), IPG Photonics (IPGP, $220) and Grand Canyon Education (LOPE, $205) rounded out the top five.
You can review the performance since 10/31/2016 via the tracking dashboard at: https://www.manifestinvesting.com/dashboards/public/best-small-2017
They don’t all work out so well. $100 invested in Synchronoss Technology (SNCR) is now worth $31 and $100 in Francesca’s is now worth $40. (10/31/2017)
But an overall average return of 31.7% is a powerful thing. The $1000 invested in the ten weaker performers is now worth $653.20. BUT – some context and perspective – the gains from just OLED and ALGN offset the “losses” from these 10 and you’d still have $15 left after compensating for the ten laggards. The average quality ranking of the 10 weakest performing stocks is 70.2. The quality ranking of the ten best performers is 82.6. Yes, Virginia, Quality Matters.
The (40) small companies that qualified for this years list are shown in the accompanying table. The METHODOLOGY was faithful to Forbes with a few wrinkles. Revenues were limited to $1 billion but with a little latitude and to avoid micro companies, a minimum of $50 million was used. The sales growth forecast is the strongest characteristic of truly small companies, so we mandated a minimum growth rate expectation of 10%. Asset-based businesses were not excluded but are rare qualifiers due to the realities of inherently lower growth (and often, cyclicality) for the industries.
BEST? We define BEST as an EXCELLENT QUALITY company that has a superior RETURN FORECAST – so we use MANIFEST Rank (combination of return forecast and quality) as the primary criterion.
Best Small Companies (2018). After a year that was very good for our 2017 slate, many of those companies have either gotten too large, or their return forecasts are now subdued after the price advance to make a repeat appearance. That’s the good news. More good news is that we get a bunch of undiscovered newcomers to examine.
In the #1 position, we’ve tagged Cambrex (CBM) for our Solomon Select feature (page 3) this month.
The scalability of #10 MercadoLibre (MELI) continues to be compelling as this Latin American blend of eBay and/or Amazon continues to deliver. The currency and inflation challenges are real but the field of opportunity is massive. For an investor, the time horizon is most helpful. On our radar screens since June 2010, MELI has delivered an annualized total return of 25.1% since then.
At #17 Prestige Brands (PBH) is compelling as a study. You know this company as Pedia Care, Murine, Comet and Spic & Span as well as number of things that people need and use.
If you can stomach investing in restaurants, #8 BJ’s Restaurants (BJRI) may well prosper if the recovery intensifies. Another favorite that has faltered but might be regaining footing is #25 NIC (EGOV). That mess in Texas might work out better than expected. The asset-based interloper, #15 Signature Bank (SBNY) is a crossingwallstreet.com favorite of Eddy Elfenbein’s. We’ll give SBNY a toaster for showing up.
Last but not least, we have to brag about one of our children. #40 Neogen (NEOG) was 4th on last year’s list and a Best Small Co staple since the list built back on Halloween 2006. NEOG has been added to the Value Line Standard Edition this month. With an annualized total return of 26.6% since the 2006 Best Small Company List, we think a standing ovation is udderly in order. Feel free to tower prudently in regions hitherto. Commence discovery.