Norrep Funds CEO Alex Sasso, in an interview with SmallCapPower, explains why he thinks small-cap stocks are “the beautiful asset class,” and describes the factors he considers before investing in a small-cap company. He also reveals his top stock picks, including one with a 31% Return on Equity.
Alex Sasso interview transcript
Female Narrator: The SmallCapPower CEO Interview.
Mark Thorburn:In managing the Norrep Group of Funds, Hesperian Capital Management applies proven and repeatable investment methodology that leads to favorable outcomes in inefficient markets. Hesperian focuses its resources on making active management count by specializing in markets that exhibit inefficiency as a result of being underfollowed, undervalued, or simply misunderstood. In August 2014, SmallCapPower met with CEO Alex Sasso, where we asked him to tell us more about his company.
Alex Sasso: Well, thank you for giving me the opportunity to speak with your viewers. My name is Alex Sasso, and I’m with the Norrep Group of Funds. At the Norrep Group of Funds, I’m a member of the Canadian small-cap equity team. We have a few different products that we manage. As a firm, we have 14 different products that we manage, and those products that we manage specialize in inefficient asset classes. Because within the inefficient asset classes, we’re able to find companies that are able to grow faster than the other companies in the marketplace, but don’t necessarily trade at multiples that are greater than their competitors’.
Mark Thorburn: Can you tell us about your investment track record since you joined the firm?
Alex Sasso: The Norrep Fund, which is our longest-serving product, has been around for about 14 years, greater than 14 years, and we’ve been able to generate just shy of a 20% annualized rate of return. Unfortunately, that product is closed to new investors. What we do have is a sister product called the Norrep II Fund. And the Norrep II Fund is managed identically, but we have it in our tax-efficient corporate class structure. That fund has been around since 2002 and has generated just shy of a 15% rate of return. The only difference between the two is the start date.
Another fund that we manage is the Norrep Income Growth Fund.It’s an equity-balanced fund that pays a meaningful distribution to unit-holders monthly, but maintains equity upside in some of the companies that we invest in. The Income Growth Fund is top of its category in terms of performance, and we’ve been managing it for eight years, generating a 13.4% compound annual growth rate. The final product that we manage is our Microcap Fund. It’s called the Norrep Entrepreneur’s Fund. It’s been around since 2010, and over that time period, it has generated just north of a 20% rate of return annually.
Mark Thorburn: In a recent article that you wrote, you referred to small-cap stocks as “the beautiful asset class.” What did you mean by this?
Alex Sasso: Well, it was a play on the recent FIFA World Cup soccer tournament, and within that tournament, you had a bunch of teams where elite athletes were better together as team than they were individually. We can manufacture a portfolio that does the same thing, where the portfolio is better as a group of businesses than each one of those businesses individually. And the reason is is because different businesses perform at different parts of the business cycle. Plus it helps provide some downside protection. And in the article, I talk a lot about how there are a few other asset classes that can provide the wealth creation opportunities that small-caps can. And there’s a recent article by UBS that talks about how small-caps have outperformed over the past 25 years regardless of the continent. It’s not start-date-biased, and it’s not end-date-biased.
And in this article, they spend a lot of time talking about how you get better performance, yet only marginally higher volatility. So, you’re getting a better rate of return in the asset class with roughly the same amount of standard deviation, same amount of risk. So, we recommend to our clients that they should have a meaningful part of their portfolios in the small-cap asset class, and that’s why I refer to it as the “beautiful asset class.” Here, in Canada, we have the BMO Small Cap Index, which is the benchmark index, and that index has been around since 1969. And it has provided a meaningful 10% rate of return per annum over that time period. There are few other asset classes that can provide that kind of wealth creation opportunity for clients.
Mark Thorburn: Why do you think small-cap stocks have outperformed larger cap equities over the long term?
Alex Sasso: Plenty of studies have shown that the outperformance comes from faster revenue and earnings growth. And there are a few reasons for this. One is you have the law of large and the law of small numbers. It’s much easier to grow a hundred million dollar company to a 200 million dollar company than it is for you to grow a 10 billion dollar large-cap company into a 20 billion large-cap company. Other reasons are that small-caps tend to be more entrepreneurial. Those entrepreneurs tend to own a significant portion of that company. And then another reason would be that small-caps tend to be the takeover targets, much more so than large-cap companies.
Mark Thorburn: Which factors do you consider before investing in a small-cap stock?
Alex Sasso: Well, there are lots. We spend a lot of time mathematical modeling a bunch of different attributes for the companies that we’re interested in. When these models start to look really good in our work, we drop everything and do the fundamental homework. That’s the bulk of the homework. Here, we spend a lot of time with management. We spend a lot of time going over the business plan, what the margins are today, what the margins are going to be in the future, what their competitive advantage is. And then we take this information and, almost more importantly, we go to their competitors, and then we try to compare what their competitors are saying versus what the management team of the company we’re interested in is saying.
When we get excited about a company, we tend to take a meaningful position in that company. And when we make that decision, we have to figure out what company we’re going to pull out of the portfolio to put that company in the portfolio. Now, a year from now, we really want to have added significant value to our unit-holders by putting in the right companies in our portfolio.
Mark Thorburn: Can you mention any small-cap stocks that you like for our viewers?
Alex Sasso: Sure. At this point of the business cycle, we really like the industrial cyclicals. I’ll give you highlights of a couple of companies that we own in the fund. We also like the financials, and we like the technology companies. And by technology companies, I don’t mean technology companies that don’t have material earnings or material revenues. All of our companies tend to have significant revenues, revenue growth, and earnings and earnings growth.
Back to the industrial cyclicals. A name that we like and we own is a company called IntertapePolymer Group Inc. (TSX: ITP). And what does Intertape Polymer do? Well, it’s a relatively simple business and they do just that, tapes. They do pressure-sensitive tapes, water-activated tapes, amongst a bunch of other things. But that is a good chunk of their business. They’re taking market share in North America; they’re consolidating a bunch of their smaller plants into what I call a super-plant, a super-size plant, in South Carolina. That alone will add a significant amount of earnings to the bottom line in 2015. Stock trades at 13 times trailing earnings for a 31% Return on Equity, which is a measure of a profitability of a company, it’s how much they’re adding to the book value each and every year. And it’s really, really difficult to find these kind of attributes amongst a company that’s growing in the large-cap space. In the small cap space, we can find a significant number of these companies.
Another company we really like is Linamar Corporation (TSX: LNR). Linamar is an auto parts manufacturer that is still benefiting from the financial crisis of 2008. The reason is in 2008, many of their competitors went bankrupt or became financially handicapped, where Linamar had a strong balance sheet, was growing its top line, was growing its bottom line, and was asked by many of their customers to go to different geographies to set up plants where their customers were setting up plants. Today, the company has a record backlog, has record margins, and only trades at 16 times trailing earnings with a 19% Return on Equity. Again, very difficult to find these kinds of attractive attributes in a company that’s growing as quickly as Linamar is growing amongst the larger-cap universe.
Another company we like is Badger Daylighting Ltd. (TSX: BAD). And Badger Daylighting provides hydrovac excavation services, so they remove the earth around sensitive cable, natural gas piping, amongst other services. We really like this company because they’ve been able to grow their top line significantly.They’re expanding into the U.S. And a leading indicator of the success of this company is how many of these vehicles that they’re producing per month. Well, that number just hit a record high, so we think that that provides significant visibility into the next 12 months. It should be noted that we have a position in all three of these companies that we mentioned today.
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