High ROIC + Niche Market Advantages
A Winning Recipe in Small Cap Core and SMID?
How do our experts seek to capitalize on inefficiencies in the small cap space to identify strong capital allocators that may be largely overlooked? In a short video portfolio manager Jeff Paulis, CFA, discusses his team’s bottom-up approach to investing in companies that have high Returns on Invested Capital (ROIC), strong competitive advantages, and operate in niche markets.
1. What inefficiency exists in the Small Cap Core and SMID Cap space?
We believe the market equates value creation to such metrics as earnings growth, revenue growth, and large market opportunities. Our team views Return on Invested Capital (or ROIC) and its byproduct, free cash flow, as the ultimate driver of underlying equity value, not revenue or earnings.
We believe combining a focus on high or improving ROIC with niche market companies that have defendable competitive advantages and target smaller overall markets allows companies to compound value over time by generating strong free cash flow, reinvesting that cash at high rates of return, which generates even more free cash flow, resulting in increasing equity value.
In fact, small cap companies in the Russell 2000® Index that generate the highest ROIC have historically outperformed the Russell 2000 over the long-term and created significantly more value.
The same has been true for small cap companies that have generated the greatest improvements in ROIC as they also have outperformed the Russell 2000 over time.
2. How does your investment approach capitalize on this inefficiency?
We use a disciplined ROIC research process, with the goal of discovering catalysts for ROIC change that the Street has not identified and may be overlooked by our competitors. At the same time, we spend time understanding market structures as well as the competitive environment and competitive positions of companies. We also key in on the competitive advantages of the businesses we are evaluating. At Segall Bryant & Hamill, we believe that companies participating in niche markets that also possess a strong competitive advantage are less prone to competitive challenges which is key to sustaining high ROIC levels or improving the ROIC profile of a firm.
IMPORTANT DISCLOSURE INFORMATION The opinions expressed in this video are solely the opinions of Segall Bryant & Hamill. You should not treat any opinion in this video as specific inducement to make a particular investment or follow a particular strategy, but only as an expression of the manager’s opinions. The opinions expressed in this video are based upon information the manager considers reliable, but completeness or accuracy is not warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can be guaranteed. Any and all information perceived from this video does not constitute financial, legal, tax, or other professional advice and is not intended as a substitute for consultation with a qualified professional. The manager’s opinions and statements are subject to change without notice and Segall Bryant & Hamill is not obligated to update or correct any information in this video. For illustrative purposes only. Segall Bryant & Hamill does not provide accounting, legal or tax advice. This information has been prepared solely for informational purposes and is not intended to provide or should not be relied upon for accounting, legal, tax or investment advice.