Peter Hodson, chief investment officer at i2i Capital Management
FOCUS: North American mid-caps
Top Picks: Shift4 Payments, Cellebrite DI, Construction Partners
MARKET OUTLOOK:
Everyone is talking about high valuations in the market, which frankly makes us less concerned. The “worry” means a healthy dose of skepticism and can create opportunity.
There is certainly lots of noise out there. But the two things that really count are interest rates and corporate earnings. Interest rates have already started to move lower as inflation cools. Corporate earnings are solid, with reporting companies in the S&P 500 Index so far showing 8.8 per cent growth in the third quarter. The fourth quarter is usually good for markets. We may see a more-favourable mergers and acquisitions environment next year, which, along with lower interest rates, should be very good for the small/mid cap market.
Valuations remain very attractive in the small/mid sector. Typically, smaller companies get a premium in the market, because they are growing, and have the ability to grow, much faster than large companies. But this premium has shrunk in the past three years, and historically is not far from record low levels reached less than a year ago. Despite faster growth and low valuations, the Russell 2000 Index is up 13 per cent this year, versus 23 per cent for the S&P 500 Index. One day, small caps should have a good rally, and conditions are good for such an occurrence.
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TOP PICKS:
SHIFT4 PAYMENTS (FOUR NYSE)
SHIFT4 offers payment processing solutions, to many different industries, but has a good niche in restaurants and hospitality. We would consider it a decent takeover target, and it has already been approached twice, once last year by Global Payments and earlier this year by an undisclosed company. The industry is competitive but FOUR has shown good growth, with about 30 per cent expected growth next year. Market cap is $9 billion, price to earnings 26 times.
CELLEBRITE DI (CLBT NASD)
Cellebrite offers a digital intelligence platform that allows users to collect, analyze, review, interpret and manage digital information, primarily for legally sanctioned investigations. Customers include police, military, government and other agencies. It has quickly adopted artificial intelligence to assist customers with data analytics. It has partnerships with Amazon Web Services and Axon Enterprises. One example of their services: It took the company only 40 minutes to access the data/emails in the phone of the first would-be Trump assassin. For corporate clients and others, it now offers remote data analytics. It is a very sticky business and with security concerns paramount we think it is a growing business with a developing moat. The stock is 41 times earnings but growth should be in the 30 per cent range. It also has $400 million cash. Market cap $3.6 billion.
CONSTRUCTION PARTNERS (ROAD NASD)
We are getting back to basic industries here and away from tech. ROAD provides construction and infrastructure services to public and private projects. Think: highways, bridges, airports, and commercial sites. ROAD made a large acquisition this year of Texas-based Lone Star Paving. The deal size was about 20 per cent of ROAD’s market cap but gives it an accelerated growth profile and the company recently raised its guidance. The stock is not cheap, but we note earnings per share has gone from 35 cents in 2022 to an expected $1.98 per share next year. It should benefit from the trend to onshoring and government infrastructure spending. It has a bit of debt, but the stock is showing strong momentum and there has been some insider buying. Market cap is $5 billion.
| DISCLOSURE | PERSONAL | FAMILY | PORTFOLIO/FUND |
|---|---|---|---|
| FOUR NYSE | N | N | Y |
| CLBT NASD | N | N | Y |
| ROAD NASD | N | N | Y |