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At Heartland, part of our assessment of stocks is looking at financial soundness, including balance sheet strength. We focus on gross and net debt to EBITDA, much like a credit analyst. Our goal is to ensure that (A) companies will be able to service their debts without issue & (B) repairing debt is not the focus of the company. We prefer management teams to spend their time operating the business. For example: M&A is something we analyze very carefully.
Many small-cap stocks that get on this M&A treadmill do a deal or two. They put debt on their balance sheet, and it becomes permanent because they don't have the free cash flow generation, the business strategy, or the discipline to pay down that debt in relatively short order.
We like to invest in companies that have a manageable amount of leverage and often times we focus on companies that do have debt.
But there must be a catalyst which is evidenced by an inflection in free cash flow generation, which could lead to subsequent deleveraging.
Or a company that may have a noncore asset they desire to sell which could bring down debt in a reasonably short period of time.
We think small caps contain two big risks: financial risk and operational risk. Operational risk is hard to avoid in small caps. Generally, they lack scale, have smaller management teams, and less bandwidth in the management teams, so operational risk tends to be inherent in smaller companies.
On the other hand, financial risk is associated with levered companies. Lots of debt can cause operating risks to be very high, a combination of risks we do not like to take.
We continue to use our 10 Principles of Value Investing™, which guide our assessment process and help us determine if the stocks we are picking are financially sound.
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Past performance does not guarantee future results.
Investing involves risk, including the potential loss of principal.
There is no guarantee that a particular investment strategy will be successful.
Value investments are subject to the risk that their intrinsic value may not be recognized by the broad market.
The statements and opinions expressed in the articles or appearances are those of the presenter. Any discussion of investments and investment strategies represents the presenters' views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. Any forecasts may not prove to be true.
Economic predictions are based on estimates and are subject to change.
Heartland Advisors’ 10 Principles of Value Investing™ consist of the following criteria for selecting securities: (1) catalyst for recognition; (2) low price in relation to earnings; (3) low price in relation to cash flow; (4) low price in relation to book value; (5) financial soundness; (6) positive earnings dynamics; (7) sound business strategy; (8) capable management and insider ownership; (9) value of company; and (10) positive technical analysis.
Small-cap investment strategies, which emphasize the significant growth potential of small companies, have their own unique risks and potential for rewards and may not be suitable for all investors. Small-cap securities are generally more volatile and less liquid than those of larger companies.
Heartland’s investing glossary provides definitions for several terms used on this page.
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