Security-Selection Outlook Assessed
Despite the secular bull market, opportunities still abound for stock picking, according to Eric Marshall, president and head of research at Dallas-based Hodges Capital Management, which manages $3 billion.
“This is a great time to be an active portfolio manager, because even though the market has moved up over the last few years, there’s still not a lot of money coming into domestic, actively managed mutual funds,” Marshall told Markets Media.
As recently as last month there were negative outflows out of U.S. equity funds, he noted. Bond markets were still taking money in. International funds were taking money in. “With all the passive investing that has occurred in ETFs over the last few years, there’s less people out there doing the active portfolio management like we’re doing where we’re going out doing rigorous bottoms-up investing,” he said.
The inefficiencies that normally exist in small cap stocks have been exaggerated by more and more passive investing in ETFs. “Right now more, than at any time in the 18 years I’ve been doing this, it’s more rewarding to go out and do that deep-dive, fundamental analysis on individual stocks.”
Marshall, who also serves as co-portfolio manager of the Hodges Small Cap Fund, the largest of the company’s seven mutual funds, has developed Hodges Capital Management’s research department over the last 10 years into a strong team of analysts who conduct on-site visits and scrutinize company data.
“We’re very much based on a fundamental, bottoms-up, stock-picking approach,” he said. “We have an investment team of 10 people that consists of 3 senior portfolio managers and 7 analysts that just go out and do bottoms-up research across multiple industry sectors.”
Last year, the team made over 2,700 contacts across more than 1,000 different publicly-traded companies–having phone conversations, visiting the companies and studying what’s going on in their underlying businesses.
“We’re looking at what are the barriers to entry, what’s going on with pricing trends in their business, do they have bargaining power with their customers, suppliers and what’s going on competitively with all the industry participants,” said Marshall. “We’ll also spend time looking at the quality of management and build an investment thesis on the basis of what is the secular growth opportunity in that small cap company, and what is the underlying value of either their assets or their cash flow. “
Marshall concurred with Fed chair Janet Yellen’s comments that stocks are relatively cheap in comparison with other asset classes. “We’re still very constructive on stocks,” he said. “Even though multiples have expanded across the market, we still see stocks as much more attractive than bonds, real estate or commodities. The S&P 500 forward P/E ratio of 17 translates into a yield of 6% on stocks versus 2% on the ten-year Treasury.
“That risk premium of 400 basis points is still historically high,” Marshall said. “If you go back over the last 80 years it’s usually 50 to 200 basis points. So when people talk about whether this is a stock market bubble, I would answer no.”
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