Kristen Sheffield, CFA, CIPM (00:12)
Hello everyone. My name is Kristen Sheffield. I'm an equity portfolio specialist at SJF, and today I'm joined for our conversation by co-portfolio managers of our Select strategy, Austin Hawley and Rick Snowdon. Thanks for joining me today.
Austin Hawley, CFA (00:27)
Thanks Kristen.
Kristen Sheffield, CFA, CIPM (00:29)
Let's jump right in. It has been a relatively volatile past month or so for equity markets, which as long-term intrinsic value investors, we've often talked about volatility as opportunity. However, the level of policy and macro uncertainty that's been introduced in such a short period seems to have potential for, this time could be different. So I'm curious, Austin, how would you characterize the volatility we've seen over the past several weeks and what are some of the key items you all have been focusing on?
Austin Hawley, CFA (01:04)
Yeah, great. So I would definitely agree that the level of uncertainty that we are seeing today feels very different from some past downturns, certainly different than kind of a standard business cycle downturn where we'd see a decline in cyclical activity. I feel like it's different also from the big crises we've had over the last 20 years. I mean, even thinking about the financial crisis as well as the pandemic, in both of those cases we had a near shutdown of the economy that really blurred our visibility over the interim period of time. But I think most of us felt like we would emerge from those crises with similar rules and customs to what we had before. And today we have to consider some things that I took for granted my whole career. We have to think about things like global trade, like our commitment to being a leader in the global community as the United States.
And these are things that could greatly impact what our economy looks like, not just over a cyclical period, one cycle, but for decades to come. The future could look, in my opinion, very different than what the last few decades have looked like. So today we are just confronting this issue head on and we have to consider a number of scenarios as we evaluate the portfolio, but also individual companies that maybe we didn't spend a whole lot of time on in the past because they just didn't seem like high probability events. And so maybe it's helpful, just think about one stock in our portfolio. Think about Cimpress. Cimpress is a small cap company that produces mass customized print products. So think about promotional materials for a small company. Cimpress would provide those mass customized products to small companies with kind of 10 employees or so. Cimpress has a really complex global manufacturing footprint and also supply chain where they import product from China and a number of other countries and they have manufacturing facilities in the United States, but also in Canada as well as Mexico.
So when you think about the tariffs that have been proposed, they have some very direct impacts in terms of their costs and we've had to evaluate over the last month or two the impact, the direct impact on their costs from these tariffs. We also know that those direct costs won't be the full story. They almost certainly have some pricing power in certain product categories that we have to consider and evaluate as we think about the net impacts on their business. We also know they have the ability to relocate some manufacturing capacity into the United States if they felt like they needed to do that. But we don't know the exact cost of doing that. We also don't know the timing, how long management will wait to evaluate what the ultimate impact of these tariffs are. And then finally we have this hugely uncertain demand environment because the tariffs are likely going to impact their customer demand.
So this is a small cap company with this extraordinarily complex set of variables that all of a sudden have all been thrown up in the air at once and we're trying to evaluate for the business. Now, the good news for investors in public stocks is that Mr. Market typically doesn't sit on his hands during these periods of uncertainty. In many cases he completely freaks out. And we have these huge moves in stocks that provide us with some more opportunity to evaluate all these complex variables, but we don't have to be super precise in terms of our estimate. We just have to be, know enough to box in that range of intrinsic value and then hope that Mr. Market gives us some opportunities at extraordinarily low prices to capitalize. And that's exactly the type of calculations Rick and I have been doing over the last month or two is trying to conservatively evaluate some of these variables that are new. And we are very uncertain and think about how they will impact various businesses and then just see what Mr. Market throws up to us. And in a number of cases, we've had stocks move 20%, 30% in very short periods of time, and if we have enough information, we can potentially capitalize on situations like that.
Kristen Sheffield, CFA, CIPM (06:03)
That's very helpful and it segues nicely into the next thing I want to talk about. You talk about Mr. Market potentially giving you opportunity. And I know with select in particular during past periods of significant market dislocation, we've seen increased turnover as we take advantage of those disruptions to position the portfolio to have the most attractive bottom up opportunities. So have those presented themselves over the past several weeks? Is that one of those periods and any highlights in terms of maybe where some of those new opportunities have come from?
Rick Snowdon, CFA (06:40)
Yeah, I'll take that Kristen. So yeah, you're absolutely right. Times like these do tend to create opportunities that result in some portfolio repositioning. Looking back over the past, say three months, we've eliminated four names and purchased three. Not sure there's much of a theme to those. Other than that volatility made some things more attractive than others on a relative basis. I'd certainly personally prefer not to have experienced some of what has occurred over the past few months. But in general, economic uncertainty and volatility like Austin's talking about with Mr. Market, do tend to create significant portfolio opportunities. Specifically though, to your question, we eliminated Amazon, Enovis, Bank of America and the hospital operator, HCA. Names we added were Capital One, Salesforce and Antero Resources. Across the board the additions were names we had looked at for a while and recently became more attractive to us when their prices declined. Three of the names, and on the exit side, three of the names we exited had held in fairly well from a price standpoint, which made them and from a fundamental standpoint, which made them good sources of funds for the things that we did purchase.
The fourth one though Enovis is definitely different. It's one where we decided the thesis was no longer valid after the CEO recently left. He'd been the driver of the culture and the business model, which was based on Danaher's very successful model. And just the evidence wasn't great that it was working out, but we were trying to be patient. And then when he left we said, wait a second, this really seems concerning and likely has broken the thesis. Fortunately, that doesn't happen very often, but it did in this case.
Kristen Sheffield, CFA, CIPM (08:36)
So another area I kind of wanted to dig into a bit further is the consumer. And I think even prior to some of the tariff announcements, there had been a bit of discussion surrounding stress on the consumer, certainly at the lower end, but increasingly becoming kind of broader base. And I think consumer oriented areas have seen some of the sharper selloffs throughout this year. I'm thinking of areas like autos or housing, retail. Have you all become more cautious on the consumer and how has that translated to the portfolio, if at all?
Rick Snowdon, CFA (09:16)
Yeah, so we have, and whatever level of tariffs we do end up with will clearly effectively be a tax on the consumer's ability to spend. I'd say over the past few months we've lightened up somewhat on consumer exposure, trimming GM comes to mind. But our consumer names in general though all have something else positive working for them that provides some buffer to a weaker consumer and the spending of that consumer. Starbucks is a situation that we think the turnaround opportunity is significant. Builder First Source is experiencing very creative mix shift to higher value engineering products despite the fact that housing is under significant pressure. And CarMax, I can tell you I purchased four cars for my kids over the past say 10 years. And the customer experience and quality of outcome at CarMax is night and day better than buying a used car at a traditional dealership.
Omnichannel, breadth of inventory across the network where they can supply you cars from anywhere and no haggle pricing, it's just not even close. In fact, the oldest of my kids just bought thankfully himself a replacement car and CarMax is the only place he shopped. So not to mention that in a tariff world some consumers are going to be trading down from new cars to used cars, which will be a benefit or at least a buffer for CarMax. The other consumer focused name is Lulu, and we purchased it last fall due to the self-help opportunity that existed. They'd experienced some product issues that led to elevated inventory and then discounting. We felt the brand was strong enough that this could be corrected, and they are showing promising signs of doing just that. It's also worth bearing in mind that Lulu's clientele skews to the more affluent, which should be less sensitive. I wouldn't say completely insensitive, but less sensitive to tariff related price increases.
Kristen Sheffield, CFA, CIPM (11:25)
Good endorsement of the CarMax buying model. It's like we've got, picking our spots when it comes to the consumer. And I know this last one is a bit of a tough question and maybe even more so than usual in the current environment, and we're not expecting you to have any sort of crystal ball here, but any thoughts you can share on your outlook going forward or complete your remarks?
Austin Hawley, CFA (11:52)
Well, I have some thoughts just in terms of just longer term set up and in particular where select I think might be very valuable to some investors portfolios. There's clearly still some very big uncertainties in the global economy now, despite the fact that large cap stocks have now, a month after Liberation Day, completely recovered and recaptured even more. They're actually higher than where they were prior to the tariff announcement. And investors seem very comfortable returning to those handful of large cap names that have done so well for them as the major components in the indices over the last year, but also the last several years, the last decade. And it is really striking. I mean if you look over the last three years, the cap weighted S&P 500 has outperformed the equal weighted by nearly 600 basis points a year, not cumulatively, but per year.
And just over that month, the recovery from the bottom in early April, we've seen the cap weighted indices in large cap stocks outperform by almost 250 basis points in less than one month. And so it certainly seems like investors are going right back to the playbook that has worked for them over the last decade or so. And I'll be the first to acknowledge that a number of those large companies continue to put up really strong fundamentals. I mean, companies like Microsoft that we've owned in the past are just fabulous businesses. But there is a reality that it becomes harder to compound value at the scale that you see a lot of these companies at. And there will come a time when you look at the indices and those largest companies will no longer be able to justify the huge valuation premiums relative to the market that we've seen pretty consistently over the last several years.
And at that point in time, investors will really, really want some portion of their portfolio in the vast majority of companies in the large cap universe, but also beyond that have been valued at much lower valuations. And implicitly the index investor over the last several years has been increasing their exposure to those largest companies and decreasing their exposure to the rest of the universe. And when you think about what will happen at some point when it becomes harder to justify those valuations, you're going to want more exposure to the rest of the world. All those companies outside the Mag 7, the largest market cap stocks. And I think that's exactly what select provides to our investors. We have a concentrated portfolio of 20 to 30 stocks. They tend to be stocks that are not well known that have been thrown out by the indices or other investors because they don't have a lot of sell side coverage, they're small, they don't fit nicely in an industry coverage model.
And we have carefully selected those businesses to be high quality businesses that we think can compound over time and are available at very attractive valuations. And so I'm going to wrap all that up and just say I don't know when that's going to happen. I don't know within years when that's going to happen, but I know it could be very, very significant in terms of the wealth creation prospects for clients to have some of that exposure versus not having it given where the indices stand today and how concentrated those indices have become.
Kristen Sheffield, CFA, CIPM (16:04)
I think that's a great place to wrap up and great food for thought for folks watching this. So Austin, Rick, thanks again for joining me today. I appreciate the time and insights as always.
Rick Snowdon, CFA (16:18)
Thanks Kristen.