1Q 2018 Quarterly Letter – Higher Volatility Provides Opportunity

Despite politician shenanigans, we are optimistic about our investment portfolios.  President Trump’s imposed steel tariffs concerned investors that a he may instigate a bigger trade war with China. While we are inclined to view his actions as more bark than bite, we are comforted by the fact that we own mostly smaller domestic companies as opposed to larger multinational companies that would be directly impacted by a trade war. Ironically, these trade concerns tempered our worry about too much investor optimism. Back in January, Investors Intelligence reported a concerning 30-year record of five bullish investors for every one that was bearish. Now the bull/bear ratio has fallen back to its healthy historical average. Negative headlines aside, the current reality of strong economic growth and lower taxes have analysts projecting 18% growth for 2018 in S&P 500 earnings per share (EPS), the key driver of stock prices. Volatility increased in the first quarter to levels not seen since 2011. While others fear it, we view the return of market volatility as welcome news. As opportunistic investors, we can earn additional returns by buying temporarily out-of-favor investments after negative headlines and selling companies when they reach fair value. In addition, in down markets, companies with our ideal attributes like higher quality management teams, low debt levels, and lower valuations have tended to perform admirably.

Return to Higher Volatility Should Provide More Opportunity

S&P 500 Avg Daily Trading Range Average Since 1983 = 1.3%

Our largest overweight investment area continues to be in community banks. Even though we’ve taken some healthy profits in some core bank holdings, we continue to find valuable bank franchises in niche markets like Knoxville, TN, York County, PA, and Springfield, MO with outstanding management teams who have lots of “skin in the game” in the form of high stock ownership. While the average community bank between $1-$5 billion in asset size now trades at 1.79x tangible book value, the average valuation of our top 20 bank holdings is 1.4x book, a 21% discount.  From a macro perspective, the bank sector has historically experienced the highest positive correlation to rising interest rates, a particularly appealing attribute given our view that rates should continue to rise. In addition, banks are one of the largest beneficiaries of tax reform which is the key driver of the anticipated 28% EPS growth In 2018. Due to the drastic rise of low-cost passive index funds and the underperformance of high cost hedge funds, we are seeing less industry resources devoted to fundamental research on individual companies. We see Wall Street firms, which historically employed armies of analysts, drastically reducing research analyst jobs and shifting away from smaller companies as they can’t generate enough commissions to support their organizations. Overall, the number of companies in the small-cap benchmark Russell 2000 that receive no formal attention from Wall Street research firms has jumped 30% over the last 3 years, according to a Reuters analysis. We believe less attention to specific companies will create more inefficiently priced stocks and gives us the opportunity to concentrate investments in companies which have outstanding management teams, low-debt balance sheets, strong competitive positions and trade at attractive valuations.  In closing, I’m pleased to report that our “Value Select” equity strategy was ranked #14 out of 474 funds for 3-year investment performance in the U.S. Value category by Lipper investment rankings. While past performance is not indicative of future performance, we feel our experienced team, value-oriented investment approach, and vast investment opportunity set gives us the opportunity to achieve superior investment returns for our clients in the coming years.

Disclosures

This post is for informational purposes only and does not constitute a complete description of our investment advisory services. This post is in no way a recommendation of any security or a solicitation or offer to sell investment advisory services. This newsletter should not be construed as advice to buy or sell any particular security. This post is not definitive investment advice and should not be relied on as such. It does not take into account any investors’ particular investment objectives, tax status, or investment horizon. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. Any forward-looking statements speak only as of the date they are made, and Eidelman Virant Capital assumes no duty to and does not undertake to update forward-looking statements. Certain investments mentioned in this post may not have been held by clients of, or recommended by, Eidelman Virant Capital. Past performance is not indicative of future results. 

Read the Full Letter: Q1 2018 Quarterly Letter