“Day to day the stock market is a fashion, but over a period of time it is owning a business.”
–Roger Lipton
Following treacherous market conditions at the end of 2018, we are pleased to report that the Hodges Mutual Funds experienced improved performance in the quarter ending March 31, 2019. During the recent quarter, the market digested ongoing uncertainty surrounding a trade deal with China, tempered expectations for earnings growth this year, as well as, an inversion in the yield curve as certain long-term rates slipped below certain short-term rates. Nevertheless, the S&P 500 Index managed to rally 13.65% in the quarter coming off an extremely oversold condition. Despite an uplift in valuations during the recent quarter, domestic stock valuations still seem reasonable relative to the current interest rate environmentwith the S&P 500 Index trading at 16.3X forward earnings estimates according to FactSet, which is consistent with its five-year average of 16.4X. The inverse of the current P/E multiple is an earnings yield of 6.13%, compared to the 10-year treasury yield of 2.4% at March 31, 2019. We believe the relationship between the earnings yield on stocks and interest rates currently indicates that the potential reward for holding stocks outweighs the underlying downside risk.
Over the past few months, there has been no shortage of options as to why the market sold off so severely in the fourth quarter of 2018 only to experience a V-shape recovery in the first quarter of 2019. We believe the market simply priced in a recession or at the very least a significant slowdown in the U.S. economy, which may not be as severe as many investors had feared back in December. The reality is at some point every strong economy and business cycle experiences an eventual slow down, just as every bear market in history has been followed by a bull market. Another factor that may have exaggerated the recent swings in certain stock valuations is the lack of fundamental value investors that historically buy on such market pullbacks. With fewer fundamentally driven investors focusing on the intrinsic values of individual companies and a greater number of investors participating in passive investing, structural changes in the capital market may have contributed to over sold conditions at the end of last year. According to data from Bank of America Merrill Lynch, passive management now accounts for 45% of all assets for US stock-based funds compared to roughly 25% a decade ago. While this trend can produce its own momentum in the market, it can also create pockets of inefficacies in individual stocks that translate into opportunities for active managers, like Hodges Capital Management. As a result, we see the remainder of 2019 as a time to take advantage of compelling opportunities in individual stocks within the transports, home builders, consumer discretionary, technology, and certain healthcare stocks.
Although the investing landscape can be frustrating at times for many fundamental investors, we are not changing our core investing discipline, which is designed to seek out quality companies running great businesses with excellent management teams that are trading at reasonable prices. Moreover, we are not attempting to forecast or market time interest rates, currency fluctuations, or commodity prices. Instead, we are focused on the fundamentals of individual companies and our research team is rigorously gathering and analyzing firsthand information from a broad scope of publicly traded companies. Here are a few worthwhile observations. First, most management teams seem cautiously optimistic regarding the prospects for demand growth, pricing power, margin improvement and earnings over the next twelve months. Second, balance sheets are generally carrying more debt than a couple of years ago but seem manageable across most corporations. Lastly, we do not see the typical signs (such as a significant increase ininventoriesor overbuilding of manufacturing capacity) that would signal a coming recession in 2019. However, we do see some inflationary cost pressures in transportation and labor costs for certain industries, which are consistent with the latter stages of an economic cycle. Furthermore, we do not expect the P/E multiple for the average U.S. stock to expand meaningfully in the coming months, but instead see further gains being supported by modest earnings growth and stable multiples for most of the economically sensitive sectors of the market.
We know the remainder of 2019 will not be without its own unique challenges and we would not be surprised to see volatility return throughout the year. In the midst of increased volatility, we have historically found bargains as we rigorously look for investments in well-run businesses that control their own destiny by relying on ingenuity and well-calculated business decisions. Although the macro conditions impacting the market can seem overwhelming at times, we always fall back to the idea that the long-term performance of stock prices is determined by the future earnings and cash flows of each underlying business. In conclusion, we see this as an ideal environment for active portfolio managers to carefully select individual stocks that we believe can generate long-term value for shareholders.
Returns (% Retail Class) as of 3/31/2019
| Expense Ratios | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| QTD | 1 YR* | 3 YR* | 5 YR* | 10 YR* | SI* | Inception | Gross | Net | |
| Small Cap Fund (HDPSX) | 16.67 | -2.96 | 8.44 | 3.30 | 18.02 | 8.66 | 12/18/07 | 1.30 | |
| Russell 2000® Total Return | 14.58 | 2.05 | 12.92 | 7.05 | 15.36 | 8.03 | |||
| Hodges Fund (HDPMX) | 27.10 | -14.45 | 7.73 | 3.65 | 14.91 | 9.33 | 10/09/92 | 1.33 | 1.18** |
| S&P 500® Total Return | 13.65 | 9.50 | 13.51 | 10.91 | 15.92 | 9.82 | |||
| Small Intrinsic Value Fund (HDSVX) | 13.22 | -10.91 | 4.38 | 4.00 | -- | 4.54 | 12/26/13 | 1.38 | 1.29** |
| Russell 2000® Value Total Return | 11.93 | 0.17 | 10.86 | 5.59 | -- | 5.68 | |||
| Small-Mid Cap Fund(HDSMX) | 15.41 | -8.08 | 7.52 | 4.00 | -- | 4.95 | 12/26/13 | 1.86 | 1.40** |
| Russell 2500 Total Return | 15.82 | 4.48 | 12.56 | 7.79 | -- | 7.93 | |||
| Blue Chip Equity Fund (HDPBX) | 13.12 | 5.52 | 10.96 | 7.72 | -- | 10.61 | 09/10/09 | 1.45 | 1.30** |
| Russell 1000® Total Return | 14.00 | 9.30 | 13.52 | 10.63 | -- | 13.39 | |||
*Average Annualized
**The Advisor has contractually agreed to reduce its fees and/or pay Fund expenses until at least July 31, 2019.
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s share, when redeemed, may be worth more or less than their original cost. Current performance of the funds may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling 866-811-0224. The funds impose a 1.00% redemption fee on shares held for thirty days or less. Performance data quoted does not reflect the redemption fee. If reflected, total returns would be reduced.
Hodges Small Cap Fund (HDPSX)
The Hodges Small Cap Fund experienced a 16.67% gain in the first quarter of the 2019 compared to a gain in the Russell 2000 Index of 14.58%. Outperformance in the most recent quarter reflected a sharp recovery in many of the Fund’s technology, consumer, industrial, and material related stocks. Looking ahead, we now view the risk reward for holding small cap stocks as balanced.
The Hodges Small Cap Fund remains well diversified across industrials, transportation, financial services, technology, and consumer-related names, which we believe can contribute to the Fund's long-term performance. The Fund has recently taken profits in several stocks that appeared fairly valued relative to their underlying fundamentals and established several new positions that we view as having an attractive risk/reward profile. The total number of stocks held in the Fund at the end of the recent quarter was 54 compared to 50 at the beginning of the quarter. The top ten holdings at the end of the quarter represented 33.52% of the Fund's holdings and included Texas Pacific Land Trust (TPL) Brunswick Corp. (BC), Commercial Metals Co. (CMC), Eagle Materials Inc. (EXP), Exact Sciences Corp. (EXAS), Healthequity Inc. (HQY), Legacy Texas Financial Group (LTXB), Ollies Bargain Outlet Holdings Inc. (OLLI), Texas Pacific Land Trust (TPL), U.S. Concrete Inc. (USCR), WPX Energy (WPX).
As of 3/31/2019
Hodges Small Cap Fund vs Russell 2000
Inception: 12/18/2007 Annualized
Hodges Fund (HDPMX)
The Hodges Fund's first quarter 2019 return amounted to a gain of 27.10% compared to a gain of 13.65% for the S&P 500 Index. Improved relative performance in the recent quarter was attributed to significant increases in some of the Fund’s largest positions. The leading contributors to the Fund during the recent quarter included Texas Pacific Land Trust (TPL), Smartsheet Inc. (SMAR), Floor & Décor Holdings, Inc. (FND), and Cleveland-Cliffs (CLF). Early in the recent quarter we repositioned the portfolio to take advantage of oversold conditions in industrials, information technology, financials, as well as healthcare, which contributed to the Fund’s outperformance.
While the Hodges Fund has adapted to an everchanging investment landscape over the past 27 years, the core investment philosophy has not changed, and the portfolio remains focused on investments where we have the highest conviction. The number of positions held in the Fund at the end of the recent quarter was 40. Top ten holdings at the end of the quarter represented 42.24% of the Fund's holdings and included Commercial Metals Co. (CMC), Floor & Décor Holdings, Inc. (FND),Matador Resources (MTDR), Smartsheet Inc. (SMAR), Triumph Bancorp Inc. (TBK), Texas Pacific Land Trust (TPL), Twilio Inc. (TWLO), Twitter Inc. (TWTR), U.S. Concrete Inc. (USCR), and United States Steel Corporation (X).
As of 3/31/2019
Hodges Fund vs S&P 500
Inception: 10/09/1992 Annualized
Hodges Small Intrinsic Value Fund (HDSVX)
The Hodges Small Intrinsic Value Fund experienced a gain of 13.22% in the March quarter of 2019 compared to a gain of 11.93% for its benchmark, the Russell 2000 Index. The Fund’s relative performance was positively impacted by the Fund’s consumer discretionary, industrial, and financial stocks, which were among the sectors that experienced a significant recovery during the recent quarter. The top ten holdings at March 31, 2019 represented 45.42% of the Fund's holdings and included Brunswick Corp. (BC), Commercial Metals Company (CMC), Eagle Materials Inc. (EXP), Geo Group Inc. (GEO), Hallmark Financial Services Inc. (HALL), Regis Corp. (RGS), Seaspine Holdings Corp. (SPNE), TIER REIT Inc. (TIER), Tillys Inc. (TLYS) and Triumph Bancorp Inc. (TBK).
As of 3/31/2019
Hodges Small Intrinsic Value Fund vs Russell 2000 Value
Inception: 12/26/2013 Annualized
Hodges Small-Mid CapFund (HDSMX)
For the first quarter of 2019, the Hodges Small-Mid Cap Fund experienced a return of 15.41% compared to a return of 15.82% for the Russell 2500 Index. The Fund’s relative performance in the recent quarter was attributed just a handful of detractors, which included Dexcom, Inc. (DXCM) and RH (RH). Top ten holdings at the end of the quarter represented 45.10% of the Fund's holdings and included Conns Inc. (CONN), Cypress Semiconductor Corp. (CY), Eagle Materials Inc. (EXP), Five Below Inc. (FIVE), Fortinet Inc. (FTNT), Kansas City Southern (KSU), Live Nation Entertainment Inc. (LYV), Norwegian Cruise Line Holdings Ltd. (NCLH), Tandem Diabetes Care Inc. (TNDM) and WPX Energy Inc. (WPX).
As of 3/31/2019
Hodges Small-Mid Fund vs Russell 2500
Inception: 12/26/2013 Annualized
Hodges Blue Chip Equity Income Fund (HDPBX)
The Hodges Blue Chip Equity Income Fund experienced a gain of 13.12% in the first quarter of 2019 compared to a gain of 14.00% for the Russell 1000 Index. Negative performance relative to the benchmark during the recent quarter reflected weakness among several of the Fund’s high-quality industrials and energy stocks. Looking ahead, we see the current investing landscape as offering plenty of attractive high-quality dividend-paying stocks with solid upside potential, as well as an opportunity for dividend income supported by corporate profits. The Blue-Chip Equity Income Fund remains well diversified in companies that we believe can generate above average income and total returns on a risk adjusted basis. Top ten holdings at the end of the quarter represented 48.47% of the Fund's holdings and included Amazon.com Inc. (AMZN), Apple Inc. (AAPL), Boeing Co. (BA), Caterpillar Inc. (CAT), Home Depot Inc. (HD), Johnson & Johnson (JNJ), Lowe’s Co. (LOW), Microsoft Corp. (MSFT), Union Pacific Corp. (UNP) and Visa Inc. (V).
As of 3/31/2019
Hodges Blue Chip Equity Income Fund vs Russell 1000
Inception: 09/10/2009 Annualized
In conclusion, we remain optimistic regarding the long-term investment opportunities surrounding the Hodges Mutual Funds. By offering five distinct mutual fund strategies that cover most major segments of the domestic equity market, we have the opportunity to serve the diverse needs of most financial advisors and individual investors. Our entire investment team of portfolio managers, analysts, and traders are rigorously studying companies, meeting with management teams, observing trends, and attempting to navigate today's volatile financial markets. Feel free to contact us directly if we can address any specific questions.
The above discussion is based on the opinions of Eric Marshall, CFA, and is subject to change. It is not intended to be a forecast of future events, a guarantee of future results, and is not a recommendation to buy or sell any security. Portfolio composition and company ownership in the Hodges Funds are subject to daily change.
Mutual fund investing involves risk. Principal loss is possible. Investments in foreign securities involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks are greater for investments in emerging markets. Options and future contracts have the risks of unlimited losses of the underlying holdings due to unanticipated market movements and failure to correctly predict the direction of securities prices, interest rates and currency exchange rates. These risks may be greater than risks associated with more traditional investments. Short sales of securities involve the risk that losses may exceed the original amount invested. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer term debt securities. Investments in small and mediumcapitalization companies involve additional risks such as limited liquidity and greater volatility. Funds that are non-diversified are more exposed to individual stock volatility than a diversified fund. Investments in companies that demonstrate special situations or turnarounds, meaning companies that have experienced significant business problems but are believed to have favorable prospects for recovery, involve greater risk.
Value investing carries the risk that the market will not recognize a security’s inherent value for a long time, or that a stock judged to be undervalued may actually be appropriately priced or overvalued.
Diversification does not assure a profit or protect against a loss in a declining market.
Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.
Investment performance reflects fee waivers in effect. In the absence of such waivers, total return would be reduced.
The S&P 500 Index is a broad based unmanaged index of 500 stocks that is widely recognized as representative of the equity market in general. The Russell 1000 Index is a subset of the Russell 3000 Index and consists of the 1,000 largest companies comprising over 90% of the total market capitalization of all listed stocks. The Russell 2000 Index consists of the smallest 2,000 companies in a group of 3,000 U.S. companies in the Russell 3000 Index, as ranked by market capitalization. The Russell 2500 Index consists of the smallest 2,500 companies in a group of 3,000 U.S. companies in the Russell 3000 Index, as ranked by market capitalization. The Russell 3000 Index is a stock index consisting of the 3000 largest publically listed companies, representing about 98% of the total capitalization of the entire U.S. stock market. You cannot invest directly in an index. The Russell 2000 Value Index measures the performance of small-cap value segment of the U.S. equity universe. It includes those Russell 2000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2000 Value Index is constructed to provide a comprehensive and unbiased barometer for the small-cap value segment. The Index is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set and that the represented companies continue to reflect value characteristics.
Cash Flow: A revenue or expense stream that changes a cash account over a given period.
Price/earnings: The most common measure of how expensive a stock is.
Earnings Growth is not a measure of the Fund’s future performance.
Forward Earnings Yield: The same earnings per share for the projected 12-month period divided by the current market price per share.