Clarkston works hard to exploit this inefficiency. The fact that our investment team competes with fewer rivals examining the same companies provides us with a greater opportunity to gain an information edge using our robust research process. We pore over annual reports and balance sheets of companies in our target market, diving deep into the financials of not just the business in question, but its competitors and the industry as a whole, in order to analyze all factors that drive results. A smaller business means less coverage, less pre-existing research and more information waiting to be discovered and capitalized upon. We don’t have to be the best in the most competitive markets, but we must be able to compete in the market in which we participate. Our research-intensive approach enables us to create a repeatable advantage and remain competitive in this space.
Perhaps the most valuable source of information about a business is the most direct: the management. Smaller market capitalizations enable us to acquire large positions in companies, which grants us better access to management teams. This is critical to Clarkston’s approach. Access to these teams allows us to closely evaluate management and create a better partnership with the stewards of each business. A large stake in a company provides us with an opportunity to communicate directly with management, something that would be capital prohibitive with large-cap companies, where it is unfeasible for us to purchase a significantly large holding.
The Micro-Niche Advantage
A micro-niche business, as Clarkston defines it, is a business that thrives in a smaller, mature market that tends to grow slowly and be more isolated from disruption. These markets are small enough that large corporations can’t justify the cost to entry, and venture capitalists won’t risk the price of innovation when there are more attractive opportunities for blue sky investing elsewhere. Even if these companies were to take the risk of investing in a small market, they could only realize a worthwhile return by stealing market share from existing incumbents – no easy task.
Since the playing field isn’t crowded with hundreds or thousands of competitors fighting for market share at any cost, this leaves a few incumbents ruling the micro-niche market as an oligopoly. Medical/hazardous waste, dealer management systems, healthcare transition processing – all of these are textbook micro-niche markets. They have years, sometimes decades, of operating experience, which leads to wiser choices with pricing, building/taking out capacity and entering new markets and acquisition multiples. Smaller players may try to compete at the perimeters, but they are unable to compete at scale and are often a source for future growth and M&A.
Clarkston’s unique investment approach reflects our fundamental philosophy. We seek out easy-to-understand businesses, exploit the market’s inefficiency to gain an information edge and analyze that information to identify high-quality micro-niche companies. However, all of these factors are predicated on our firm commitment to invest with a long time horizon – at least 10 years or longer.
Longer-term ownership of a business lessens the impact of slight changes in purchase price on the total return of a portfolio holding. As long-term investors, we worry less about slight changes in purchase price and more about the business’s long-term fundamentals. This is paramount for a concentrated investor.
Simply put, a long time horizon rewards our patient temperament. It endows us with strong hands to hold onto high-quality investments during challenging periods when others would be forced to sell and grants us courage to buy when the market is afraid. Add in our robust research approach, the market’s inefficiency and the micro-niche advantage, and we have found our recipe for small-cap investing.
Historical returns are not indicative of future results.
All investing is subject to risk, including the possible loss of the money you invest.
Investing in small or medium sized companies typically exhibit greater risk and higher volatility than larger, more established companies.
The Duff & Phelps Stocks, Bonds, Bills, and Inflation® (SBBI®) Yearbook includes returns, index values, and statistical analyses of U.S. large-company stocks, small company stocks, long-term corporate bonds, long-term government bonds, intermediate-term government bonds, U.S. Treasury bills, and inflation from January 1926 to present. Small-company stocks are represented by stocks making up the ninth and 10th deciles of the New York Stock Exchange (NYSE) from 1926-1981, the DFA U.S. Small Company 9-10 (for ninth and 10th deciles) Portfolio from January 1982-March 2001, and the DFA U.S. Micro Cap Portfolio from April 2001-December 2019.
The Russell 1000® Index is a market capitalization weighted index that measures the performance of the large capitalization sector of the U.S. stock market and includes the 1,000 largest stocks in the Russell 3000® Index. The Russell 2000® Index is a market capitalization weighted index that measures the performance of the small capitalization sector of the U.S. stock market and includes the 2,000 smallest stocks in the Russell 3000® Index. The Russell Top 200® Index includes approximately 200 of the largest securities in the Russell 3000® Index based on a combination of their market cap and current index membership and represents approximately 68% of the US market. The Russell 3000® Index consists of the 3,000 largest U.S. public companies. You cannot invest directly in an index. Although reinvestment of dividend and interest payments is assumed, no expenses are netted against an index’s returns. Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and/or Russell ratings or underlying data and no party may rely on any Russell Indexes and/or Russell ratings and/or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication.
Warren Buffett quote: Homespun Wisdom From the ‘Oracle Of Omaha’, Business Week (July 5, 1999).
Research and development (R&D) includes activities that companies undertake to innovate and introduce new products and services. Blue sky investments are speculative schemes that have no real value for investors. Mergers and acquisitions (M&A) is a general term used to describe the consolidation of companies or assets through various types of financial transactions, including mergers, acquisitions, consolidations, tender offers, purchase of assets and management acquisitions.
References to specific securities are for illustrative purposes only and should not be considered as investment advice or as recommendations to buy, hold or sell any securities.
This material and its contents are for informational purposes only and are current as of the date this material was created. The information herein is subject to change at any time without notice, due to numerous market and other factors. Certain statements contained in this material may be statements of belief, statements of future expectations or other forward-looking statements that are based on the current views and assumptions of Clarkston Capital Partners, LLC (“CCP”) and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. CCP assumes no obligation to update any forward-looking information contained in this material. Certain information was obtained from sources that CCP believes to be reliable; however, CCP does not guarantee the accuracy or completeness of any information obtained from any third party. CCP makes no express warranty as to the accuracy or completeness of this material.
This material has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. CCP recommends that investors independently evaluate particular investments and strategies, and encourage investors to seek the advice of a financial advisor and their own legal or tax advisors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
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