Small Cap Profits Flow at Hood River

04/16/2016 10:00 am EST

Focus: HEALTHCARE

David Swank of Hood River Capital Management looks for value by seeking inefficiencies in the small cap market. Here, he discusses the strategy behind his top-reated small cap fund, along with a trio of favorite stocks focused on diverse markets with the healthcare sector.

Steve Halpern:  Our special guest today is David Swank, principal at Hood River Capital Management and co-manager of the Hood River Small Cap Growth Fund (HRSRX).  How are you doing today, David?

David Swank:  I’m doing well, thanks Steve.

Steve Halpern:  Thanks for joining us.  To begin, could you tell our listeners a little about the background of Hood River.

David Swank:  Absolutely.  At Hood River, we’re focused on small-cap stock because we think that’s an inefficient area of the market where good investors can find underappreciated companies.  

We have a strong track record stretching back to 2002, and we’re 100% employee-owned, and all of the portfolio managers have significant investments in the fund, so we think that our incentives are well-aligned with the shareholders.  

We’re really focused on doing original fundamental research.  Our team is led by 3 portfolio managers who each have 20 +years of experience successfully investing in small-cap stocks, so anyone of us we think could manage our own fund individually, but we like working together and think it makes for a stronger fund.

Steve Halpern:  Now, your small cap growth fund ranks in the top 7% of its peers for the past five years, according to Morningstar -- and you won the 2015 Lipper Award for three-year performance among 148 funds in the small cap growth category.  Could you tell us specifically about your Small Cap Growth Fund and what you believe accounts for this consistent outperformance.

David Swank:  Sure.  Obviously, we’re very proud of our strong absolute performance, but we’re especially proud of our risk adjusted performance.  

Historically, our market exposure has been slightly less than that of the small-cap growth market overall, but we’ve still managed to nicely outperform the market even in a big up, like what you’ve seen since the 2009 trough.  

The way we’ve done it is by picking stocks one by one on a bottom-up basis based on our research, so we like the small-cap market because it’s not as picked over as the larger-cap areas, so there are more hidden gems to uncover.  

For instance, Apple (AAPL), which is obviously a very large cap stock, is covered by 50-some brokerage firms, but plenty small cap companies are covered by anywhere from zero to five brokerage firms, so that means there are more misperceptions that we can discover via good research.

Steve Halpern:  So, would you actually find in some circumstances that you’re the only person covering a stock?

David Swank:  Well, certainly, there are other investors out there. But as far as analysts who are publishing notes on it, there are certainly instances in our portfolio where there are either no analysts covering a stock or, more frequently, it might be only a few publishing sporadically and not really doing a very good job covering that company.

Steve Halpern:  So, in a way, it comes down to your success as stock pickers.

David Swank:  Absolutely.

Steve Halpern:  Now, would you share your outlook for the stock market overall looking out over the rest of the year and explain how small caps fit within this outlook.

David Swank:  Sure.  So, at Hood River, we’re not market timers.  We’re always close to fully invested in the market.  

We think there aren’t many successful market timers around because the overall market is so highly scrutinized by basically countless investors, and it’s pretty efficient, but we feel confident in our ability to add value on individual stocks that aren’t as highly scrutinized.  

With that said, right now, the small-cap market is trading at a fairly normal valuation and margins are not stretched in small-caps like they are in the larger-cap areas.  

On that basis, we feel pretty comfortable right now with a lot of macro basis.  Most importantly, on a bottom-up basis, we continue to find companies that we’re excited to own.

Steve Halpern:  Turning to some individual stocks now that highlight your process as small-cap growth, you highlighted three stocks that are in diverse sectors of the healthcare market, and one of those is PRA Health Sciences (PRAH).  What’s the attraction here?

David Swank:  Sure.  PRA is a contract research company or a CRO that manages clinical trials for pharma and biotech companies.  It has a strong management team with deep experience in the industry.

PRA right now is benefiting from a recent surge in biotech financing that’s being used to pay for clinical trials, and also I believe that their excellent service levels are currently driving market share dealings.  

I think that in 2017, they should be able to earn about $3 a share or more and trade at about 20 times that which would be $60 as a share price.

Steve Halpern:   You also like the veterinary services firm, VCA (WOOF).  Could you share your thoughts here?

David Swank:  Sure, so BCA operates veterinary hospitals and clinical labs throughout the country.  They’re really benefiting from consumers coming back to the vet as labor markets are stabilizing and folks are feeling more comfortable with the economy.  

Also, I think that VCA is starting to get traction with their pet wellness program.  As volumes improve, VCA should also see improving margins.  I think that they can earn about 350 in 2017 and trade at 20 times that or $70.

Steve Halpern: Now, you also like the outlook for AMN Healthcare Services (AHS).  What’s the story here.

David Swank:  Right, AMN is a temporary staffing company that’s focused on healthcare professionals, such as doctors and travel nurses.  They’re seeing surging demand right now as patient volumes have improved at hospitals.

And at the same time, hospitals are suffering from an aging workforce that’s cutting back hours or retiring, so hospitals are trying to source additional nurses and doctors to support their growth.  

AMN should be able to grow revenues at probably mid-teens rate for kind of the intermediate term.  They should see margins grow as well.  I think that that can lead to 2017 EPS of at least $2.60 and is trading 16 times that, that would suggest a $42 fair value for the stock.

Steve Halpern:  Again, our guest today is David Swank, manager of the top-related Hood River Small Cap Growth Fund.  Thank you so much for your time today.

David Swank: Thank you, Steve. 

By David Swank, Co-Manager of Hood River Capital Management

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