Evaluating ROI

In determining a company’s projected return on investment (ROI), Hubbard pays particular attention to the revenue potential and scalability of its products and the stickiness of its customers.

“The more value you’re delivering to your customers, the stickier the customers. If a company is delivering a lot of value to its customers, the customer is unlikely to switch even if a competitor offers a lower price,” Hubbard said for his strategy.

For example, one of the Fund’s recent holdings, Varonis Systems Inc., (VRNS) provides data security services specifically for unsecured data. In the current days of artificial intelligence using copilots, Varonis helps companies protect internal data from AI copilot searches. This is in addition to helping companies decide who has access to what data on the company computers, and when they can access it. “Varonis created a new service and software platform in the Cloud, allowing companies to offload the management of data security to Varonis, which monitors the alerts and provides action when needed,” Hubbard said. “It’s super efficient for companies. That type of application becomes very sticky because it saves companies a massive amount of man hours and manual labor.”

While Hubbard and his team stay on top of macro factors, such as economic cycles, they don’t try to predict market movements. “We try to understand where we are in the cycle. Are we at the beginning, at the end or are we somewhere in the middle? We know that the dynamics of any one of those cycles will present headwinds to some companies and tailwinds to others.”

To pare the field to the most attractive small-cap growth funds, Hubbard and his team run a range of screens to try to uncover companies with the potential to excel when the economy shifts gears.

“The goal,” said Hubbard, “is not to make a big macro bet on, for instance, interest rates or unemployment. But we try to use those situations to find some quality companies that are out of favor and add them to the portfolio. We know we may be early on those, but we use risk management on the back end to make sure we’re not making an outsized or implicit bet based on these macro factors.”

One promising name the Fund picked up while the stock was out of favor was Celsius (CELH), an energy drink producer. “They compete with Monster in that market,” said Hubbard, “But they’ve created a much healthier energy drink that doesn’t have sugar, artificial flavors or artificial sweeteners. They’ve grown significantly over the last several years, they’ve ramped up distribution and they’re getting their products into new stores and channels. Now they’re rolling their product out to college campuses, hospitality, hotels, restaurants.

“It’s a classic growth story—great products, large TAM and value to the customer. Then, just last year, they signed a distribution agreement with Pepsi,” added Hubbard. “So now they’re getting exponentially larger distribution, more stores, more shelf space, and better placement. All those things have a multiplier effect on the trajectory of the company’s growth.”

Time to sell—happy or not

The ongoing need to selectively prune the portfolio to make room for new prospects generally boils down to what the Fund team terms the “happy sale or the unhappy sale.”

The former includes companies that become so successful they outgrow the team’s expectations and are fairly or excessively valued.

The latter are simply stocks that, for one reason or another, failed to live up to the original thesis the Fund team mapped out.

In making both buy and sell decisions, the three most important factors Hubbard considers are operating performance, valuation and sentiment. “Our goal is to find stocks with a 50% upside over the next two to three years.

“When we invest in a company,” Hubbard added, “we have an investment thesis that lays out how we think a company’s competitive advantage, market opportunities and ROI will manifest itself in the financial statements. That’s the operating performance.”

To assess the second piece, valuation, the Fund team runs screens, tracks historical trends, monitors free cash flow and reviews a wide range of other factors to determine an appropriate target price for the stock.

“Then the third piece is sentiment,” said Hubbard. “The way we think about sentiment is ‘What do we believe or what do we think we know about this company that the market doesn’t fully appreciate?’ And ‘Is the market starting to understand our original thesis?’”

On a regular basis, the Fund team analyzes the progress companies are making on those three factors to see how their thesis is playing out. If one or more of those factors are failing to live up to their expectations, the Fund could unload or lighten their position. That’s the unhappy sale.

“But if operating performance is high, valuation is high and we don’t have anything that truly differentiates our view from market,” noted Hubbard, “that’s an easy reduction. That would be a happy sale.”