NCM Investments Logo

December 15, 2022

Commentary: NCM Small Companies Class

On December 15, 2022, Portfolio Manager Alex Sasso provided an overview of the wealth creation opportunities in the small cap space and the unique positioning of the NCM Small Companies Class portfolio.


Hi everybody, it's Alex Sasso. Today is December 15th, 2022, and I'm the manager of the NCM Small Companies fund. I've been the manager of the fund for a long time. And since this is the first webcast, we're going to be talking about our small cap product, I thought I’d spend a little bit more time talking about the virtues of the asset class itself.

The fund was launched officially back in 2002. It's got a strong long term track record, but basically what it does is it provides exposure to Canadian small and mid-cap businesses through a proven and repeatable investment methodology that we've honed over many decades and are continually tweaking and modernizing for today's world.

The product really features specialized expertise. It's not a general equity product. You really do need a specialized expertise and in-house research that's really required for successful investing in this space, as there are a lot of other attributes of this asset class that need to be taken into consideration when taking a portfolio position.

So for me, and with the experience that I have, I find that Canadian small caps often provide the best combination of value and growth. You can find some rapidly growing companies that have yet to be discovered by the marketplace, and yet don't trade like they're rapidly growing large cap companies. And what I like is that the management teams are typically better aligned with investors because they usually have significant shareholdings in the business they've been managing in a long time and they really know the space and the customers. For me, that is a big competitive advantage relative to some of the very large cap companies that compete against some of these small cap companies.

And you know, history has shown that you can get very long periods of outperformance with small caps, and there are periods of very long periods of underperformance. And we've recently experienced some long periods of underperformance. I believe that we're coming to the end of that period for a whole bunch of different reasons, which we can save for future webcasts.

They tend to be inefficiently priced. As I mentioned earlier, you have less people watching it and watching these companies. And for me as an investor that provides opportunities to buy some of these companies at less than what we call intrinsic value. So therein lies the wealth creation features of this specific product. Essentially, the law of small numbers really apply. It's easier to turn a $100 million revenue company into a $200 million of revenue company, and seeing the value that that creates relative to a large cap where you have, you know, billions and billions of dollars of revenues and try to get those companies to double their revenues.

The other thing I like is you can really be much more selective in the exposure that you want as a portfolio manager. Large caps tend to have multiple product lines in the market and a whole bunch of different geographies and areas. We could be much more specific on the small cap side, and there are significantly more small cap companies than large caps. So the simple set that I get to choose from is significantly higher.

They tend to be takeover targets and those provide what I call return accelerators because those takeover targets tend to be at a nice premium to, often they’re at a nice premium to market value, and it could provide a quick return boost to the product. Now, in terms of the product itself, we currently have 36 positions and our top ten is over 40% of the fund. It's actually 42% of the fund.

The metrics of the portfolio look spectacular. In fact, this is other than 2008 and very few other times in my career I’ve seen metrics this attractive. Our trailing price to earnings is a very impressive 12 times. To give you a sense of how attractive that is, the BMO Small Cap Index is 17 times and the S&P TSX is roughly 14 times currently.

The estimated P/E, which we also pay attention to for the fund is ten times. So you're buying a group of businesses trading at relatively low in the business cycle. Valuation metrics again, both relative to the two, to the small cap benchmarks and to the TSX as well. And even though these things trade at a discount to the market, their profitability is at a premium to the market.

So you take a look at the return on equity. It's a measure that we look at when studying the profitability of some of these companies and the expected ROE for the fund is 19 and that's significantly better than both those benchmarks that I mentioned earlier. The return on capital is 16%, again, significantly better than both the TSX and the BMO small cap benchmark, which is the benchmark we use on, and what the industry uses on the small cap side.

Our earnings surprises are better, our estimate revisions are better. So that's very impressive. And that means that the companies that we're investing in tend to be what the analysts are expecting them to produce in terms of earnings or cash flow.

And the last metric I'll mention, and it's one of the best predictors of future stock price movements is free cash flow. It's also very important for the health of the business and the free cash flow yield of the portfolio is 8% currently. And note that these numbers are at the end of November and I don't think that they've changed significantly since then. But the free cash flow is 8%. And to give you an idea, the BMO is at three and a half percent and the TSX is at 5%.

So again, what you're getting is you get in a portfolio, a group of businesses that are growing faster, trade at less expensive valuations are more profitable and generate a lot more free cash flow. So thank you very much for your time today. Hopefully this was helpful. Future updates will be much more specific in terms of the changes that we're making to the portfolio.

Thank you.


The information in this video is current as of December 15, 2022 but is subject to change. The contents of this video (including facts, opinions, descriptions of or references to, products or securities) are for informational purposes only and are not intended to provide financial, legal, accounting or tax advice and should not be relied upon in that regard. The communication may contain forward-looking statements which are not guarantees of future performance. Forward-looking statements involved inherent risk and uncertainties, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. All opinions in forward-looking statements are subject to change without notice and are provided in good faith. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.



Alex Sasso, CFA

Chief Executive Officer and Portfolio Manager of NCM Small Companies Class and NCM Income Growth Class.