2018 Fourth Quarter Letter
It’s a relief to finally have this miserable quarter behind us. We would have gladly ended the year on September 30. Your account specific results are on the enclosed “Performance Report”. For comparison, during 2018 the Russell 2000 Value Index dropped 12.9%, the Russell 2000 Index declined 11.0%, while the larger capitalization S&P 500 fell 4.4%. (For index descriptions, please see the Client Login section of our website.)
In our careers we have not seen an economic backdrop as favorable as it appears from the reported data and our conversations with CEOs while the markets experienced as much pressure as they did in the fourth quarter. The CEO of one portfolio company stated, “while the United States is trying to talk itself into a recession. We are not seeing it.” It seems that either sentiment will improve and the portfolio will rebound sharply, or the economy will fall into recession. Our belief is that economic growth will slow a bit (not mightily) from the high 2018 rate and investors’ mindsets will correspondingly improve.
An illustration of the embedded value that exists in market downturns is Electro Scientific. We purchased the company early in the quarter and only a couple weeks later it was acquired by MKS Instruments for nearly double our entry price. Although we don’t expect this success to repeat regularly, it does highlight how severely investors treated some companies relative to their true value. Fluent was also purchased after we visited management and correctly concluded an acceleration of growth was near. Motorcar Parts of America has new contract wins and is broadening their product line in response to customers’ requests. The company was added to the portfolio with the belief investors are not properly gauging the importance of the contract wins and strategic actions management is undertaking.
During the quarter Myriad Genetics’s stock price continued marching up. The forecasted upside did not compare to other companies we wanted to own; therefore, it was sold and the funds redeployed. Super Micro Computer was sold when a story surfaced with 17 sources indicating some of its boards may have a hidden surveillance chip unknowingly embedded by a Chinese defense organization during the manufacturing process in China. Although the accuracy of the story was questioned, we exited with concerns the allegations could impact customer confidence in the company and sales growth.
It’s been years since we’ve seen this much upside across the portfolio relative to our forecasted two-year price targets. It seems inevitable that when the market settles down the smaller companies we own with lower debt, higher returns on capital and great leaders should see a meaningful rebound. This has been the outcome in the past. We eagerly await a possible repeat. As always, if the circumstances surrounding your account change such that you believe we should review the suitability of your assets managed by Tieton Capital, please contact us immediately. Thank you for your patience.