Our continuing review of the quarter-end portfolios of the Investment Gurus brings us to David Nierenberg of D3Family Funds, a less well-known investment manager amount the heavy-weights such as Warren Buffett, George Soros, John Paulson. However, we found his investment approach interesting. In short, D3 team are long term, actively engaged investors in a concentrated portfolio of public, growth-at-the-right-price (GARP), micro-cap companies. They may manage hedge funds so if you have half a million dollars to invest, you may give them a call.
In the firm’s website, we find this write-up on the firm’s investment strategy:
D3 focuses on micro-caps for four reasons. First, although the large cap segment of the market obtains and processes information so efficiently that it is hard to beat large cap indices, micro-caps remain an island of informational imperfection where insightful stock picking can produce sustained superior performance. This is possible because most micro-caps are not well followed by securities analysts, if at all. Trading volumes in, and investment banking for, micro-caps are not lucrative enough to command Wall Street’s attention. Therefore, a diligent micro-cap investor may develop sufficient insight to outperform the market in a meaningful and persistent way.
The second reason for D3’s micro-cap focus is that academic analysis shows that small company stocks on average outperform large stocks by one percentage point per year. This may result from the informational imperfections just discussed or perhaps because it may be easier for small businesses to grow faster, off smaller bases, than large ones.
The third reason we focus on micro-caps is for better access to senior management and boards of directors. Because we believe that a thorough evaluation of people, process, and governance is as important as quantitative financial and competitive analysis, we insist on interviewing management and directors before investing. When one manages only $450 million (the current size of the D3funds), allocated among 10 core investments, it is difficult to gain private access to senior executives of large cap companies; a $45 million investment by D3 is simply too small to call on their time. But the CEO, CFO, or board chair of a micro-cap, by contrast, are accessible because D3 typically would be among their largest investors. On average D3 owns approximately 10% of each portfolio company today.
Fourth, D3 focuses on micro-caps because our typical investment usually makes us large enough to defend or advance shareholder interests. The fund can catalyze the sale of an underperforming company; instigate changes in management, strategy or governance; or fight attempts to shortchange shareholders. Using general partner David Nierenberg’s training as a lawyer, and his experiences as a management consultant, venture capitalist, and corporate director, and the experiences of our two other general partners, the fund has constructively engaged with portfolio companies on many occasions. While we do not seek to engage all the time, we do not shirk persuasion, disagreement, or even occasional confrontation. But we strongly prefer friendly, constructive persuasion, acting as long term partners with capable executives and boards.
Within the micro-cap segment, D3 is a growth-at-the-right-price (GARP) investor. This means that D3 invests in growth companies, but only when they trade at low valuations. An example might be a 15-20% grower, with extra cash on its balance sheet, bought at a forward net price-earnings ratio of only eight because the company missed a quarter or because investors disliked or misunderstood its industry. Studies have demonstrated that value investing outperforms growth investing by three to four percentage points per year. Being a GARP investor enables us to position our portfolio opportunistically along the growth-value spectrum, wherever we find the optimal balance between reward and risk.
D3’s portfolio is deliberately concentrated for two reasons, both relating to “return on time.” First, it takes considerable time to learn enough about a company, its people, and its industry to develop and maintain a proprietary level of “insight information” relative to other market participants. Second, when we seek to influence our portfolio companies, our efforts usually consume substantial time. (This illustrates why most professional investors, who have far more investments than we do, cannot influence their companies.) A good model for the optimal size of the D3 portfolio therefore might be that of a professional director: one may know and do enough to be effective on 10 boards, but certainly not 30.
Although the firm stated that they would sometimes become confrontational, there is nothing is the media that indicates that David Nierenberg is an active investor like Carl Icahn who is ready to pick a fight just about any day.
There is no information in the public domain on their performance track record either. Based on the asset amount the firm filed with SEC over the years, the firm seems to be still recovering from the 2008-2009 market slump, but we do not know how much of that is due to performance and how much of that is due to investor withdrawn.
Nierenberg’s portfolio is really simple. As of June 30, 2010, there were nine stocks in the portfolio, the top ones are:
No. 1: Homestore Inc. (NASDAQ:MOVE), Weightings: 18% - 28,155,339 Shares
Homestore Inc. is a destination on the Internet for real estate information, advertising products and services. Move Inc. has a market cap of $297.8 million; its shares were traded at around $1.91 with and P/S ratio of 1.3.
Nierenberg has kept the number of shares steady since December quarter of 2008.
No. 2: Electro Scientific Industries Inc. (NASDAQ:ESIO), Weightings: 15.88% - 3,811,984 Shares
Electro Scientific Industries, Inc. and its subsidiaries provides electronics manufacturers with equipment necessary to produce key components used in wireless telecommunications, computers, automotive electronics, and many other electronic products. Electro Scientific Industries Inc. has a market cap of $321 million; its shares were traded at around $11.53 with and P/S ratio of 2.2.
Nierenberg bought about five thousand shares during 2Q10.
No. 3: Natus Medical Inc. (NASDAQ:BABY), Weightings: 13.93% - 2,743,007 Shares
Natus Medical Incorporated is a provider of healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments such as hearing impairment, neurological dysfunction, epilepsy, sleep disorders, and newborn care. Natus Medical Inc. has a market cap of $334.7 million; its shares were traded at around $11.75 with a P/E ratio of 22.1 and P/S ratio of 1.9.
This is another long term holding of Nierenberg. He accumulated a bulk of his shares when the stock was in single digits.
No. 4: RadiSys Corp. (NASDAQ:RSYS), Weightings: 13.44% - 4,527,463 Shares
RadiSys Corporation is a leader in computer based building blocks used by original equipment manufacturers for products in the telecommunications and networked equipment markets. Radisys Corp. has a market cap of $210.8 million; its shares were traded at around $8.76 with a P/E ratio of 26.5 and P/S ratio of 0.7.
This is also a long term holding, but he seems to have lost quite a bit of money on this one.
No. 5: Heartland Payment Systems Inc. (NYSE:HPY), Weightings: 13.34% - 2,882,147 Shares
Heartland Payment Systems, Inc. provides bank card-based payment processing services to small- and medium- sized merchants in the United States. Heartland Payment Systems Inc. has a market cap of $525.9 million; its shares were traded at around $13.9 with a P/E ratio of 21.4 and P/S ratio of 0.3. The dividend yield of Heartland Payment Systems Inc. stocks is 0.3%. Heartland Payment Systems Inc. had an annual average earning growth of 20.1% over the past 5 years.
This a relatively new holding, and the stock has sort of made a round trip since he bought into the stock.
No. 6: Superior Energy Services Inc. (NYSE:SPN), Weightings: 9.04% - 1,552,809 Shares
SUPERIOR ENERGY SERVICES, INC. is engaged in the business of providing offshore plugging and abandonment and wireline services in the Gulf of Mexico, the development, manufacture and sale of electronic torque and pressure control equipment and thread protectors which are used in connection with oil and gas exploration, the development, manufacture and sale of oil spill containment boom and ancillary equipment and the rental of specialized oil well equipment and fishing tools. Superior Energy Services Inc. has a market cap of $1.65 billion; its shares were traded at around $20.98 with a P/E ratio of 16.5 and P/S ratio of 1.2. Superior Energy Services Inc. had an annual average earning growth of 20.1% over the past 10 years. GuruFocus rated Superior Energy Services Inc. the business predictability rank of 4-star.
This is another long term holding of Nierenberg. Back in 2007, Nierenberg had more than $100 million in this one stock. Since then, the stock price dropped and he has also sold about 40% of his shares. As a result, the stock accounts for a smaller percentage of his funds’ asset.
To view Nierenberg’s complete portfolio, click http://www.gurufocus.com/ListGuru.php?GuruName=David+Nierenberg.
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