Balance sheets key to finding value

03/12/2018

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With interest rates expected to continue rising in 2019 and corporate leverage at high levels, Portfolio Manager Justin Tugman says investors should stay focused on company balance sheets.


What are the key themes likely to shape the markets in 2019?

As we look at the year ahead, we believe several themes that arose in 2018 will carry over to 2019, with some new issues also emerging on the horizon. First, we think trade wars and tariffs will continue to make headlines but that, ultimately, resolutions for many of these issues could come in 2019. Second, monetary policy, not just in the U.S. but around the world, could become an increasing focus: Will the Federal Reserve continue to raise interest rates? Will the European Central Bank finally become less accommodative? Third, economic growth could slow given factors outside the U.S., including the impact of a strong dollar and more difficult year-over-year comparisons for corporate earnings. Fourth, with increasing leverage on company balance sheets, credit concerns could become more worrisome. Finally, we believe the performance of value stocks compared to growth stocks will continue to improve.


Where do you see the most important opportunities and risks within your asset class?

As is often the case, in small caps there are many high-quality companies that are not widely followed but could have attractive long-term investment opportunities. At Perkins, our analysts search high and low for these undiscovered opportunities, which typically possess high levels of insider ownership, strong balance sheets, good management teams and durable franchises. Additionally, many of these stocks have little ownership by passive investment vehicles, which we find to be an attractive quality. Currently, we are finding some of these opportunities in the banking and industrials sectors, where valuations appear attractive and where we feel comfortable about the prospects for 2019. On the other hand, although small-cap health care is benefiting from strong fundamentals, we think euphoric sentiment has pushed up the valuations of these stocks to untenable levels.


How have your experiences in 2018 shifted your approach or outlook for 2019?

Historically, when companies make mistakes, it often is due to leverage that was taken on at the wrong time of the business cycle to fund either merger and acquisition (M&A) activity or stock buybacks. Often and with great fanfare, M&A deals are announced with claims that they will be wildly accretive to earnings and generate solid returns, thanks to inexpensive financing. However, the allure of cheap debt can sometimes be too great for management teams who believe the good times will last forever. In our opinion, this is where the problems begin. Certain cyclical groups punished in October’s sell-off might begin to look attractive based on valuation, but for many of these names we think the balance sheets are highly levered at the potential peak of their respective cycles. At Perkins, we always focus on the balance sheet and this could be even more critical in 2019 as the many companies that feasted on cheap debt in recent years grapple with rising interest rates.



Which themes have the potential to redirect markets in 2019? Download our one-pager summary to find out




Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Anything non-factual in nature is an opinion of the author(s), and opinions are meant as an illustration of broader themes, are not an indication of trading intent, and are subject to change at any time due to changes in market or economic conditions. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio. No forecasts can be guaranteed and there is no guarantee that the information supplied is complete or timely, nor are there any warranties with regard to the results obtained from its us.

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