Q:  What is your investment philosophy?

A: In the small cap arena 56% of all small-cap stocks under-perform market in a given year so you start with the odds tilted against you. Our investment process is designed to tilt those odds back into our favor.

We believe that the value of any asset is the value of the future free cash flow, as opposed to reported earnings. Studies show that when free cash and earnings diverge, stock prices follow the free cash.

The other underlying pinning of our approach is how management uses their excess cash to the benefit of the shareholders. Every single company in the portfolio pays a dividend but beyond that dividend payment, we want to see management teams using that excess cash to pay down debt, as well as buy back stock.

Q:  Why do you focus on small-cap dividend payers?

A: Small-cap dividend payers not only significantly outperform their non-dividend paying counterparts but they do it consistently. They protect you on the downside, yet you also participate on the upside. Dividend payment means much more visibility on the cash flows and that lowers the overall risk profile of these stocks.

There are a little over 1,300 dividend paying small-cap companies.

Q:  How is your team structured?

A: We have a team of eight people that manage $405 million in small cap value equity assets. Six analysts are making the buy/sell decisions; there is one quantitative analyst, and one Client Portfolio Manager, who is involved in the business development and ongoing client service.

The analysts have varying backgrounds and we have been together now for several years. Each of the analysts has specific sector responsibilities. Based on our past experience. every sector has been covered by at least two of the analysts at some point during their careers, which fosters a lot of discussion on names that are presented.

Q:  Are all your investment decisions entirely consensus-driven?

A: They are all consensus-driven. It’s the responsibility of the analysts to bring names within their coverage area to the group and then the group will challenge their assumptions. The team will make a decision whether or not the position warrants a place in the portfolio.

If, for some reason, a position has not followed this disciplined process, then our Director of Value Research, Khris Herrick, does ultimately have veto power. But he has never used it and we would not foresee him ever having to use it.

The bonus structure for the analyst group is unique. The analysts are not eligible for a bonus unless the overall portfolio outperforms the benchmark. This incentizes the team to get the best ideas into the portfolio.

Q:  How is your investment process organized?

A: We use a quantitative multi-factor screen. The importance of our screen is that it is sector specific. From our back testing we have identified those factors that are proven to be predictive in generating superior risk-adjusted returns.

Our proprietary screen is looking at earnings and cash flow quality, management behavior, timing and valuation metrics.

Our quantitative model ranks all of the stocks within a sector. Stocks are ranked from the most attractive to the least attractive. The analysts then focus their attention on stocks within the first and second deciles from the list. That’s how we get down to our working candidate list.

Q:  What are the key elements of your research process?

A: We’ll take a company from that candidate list, and we’ll put it into our proprietary free cash flow model. We will stress-test the business model to identify whether the key driver to increasing firm value is going to be driven largely by an increase in sales, or it is going to be driven by margin expansion. That helps us identify where we need to focus our research efforts.