Make no mistake: We are not simply hiding in defensive areas of the market. We are, for example, overweight in economically sensitive Industrials and Materials relative to the Russell 2000 Value® Index. And our second-largest weighting, after Industrials, is in Financials, another classic cyclical part of the market.
Instead, we have focused on companies throughout our portfolio, across all sectors, that tend to have defensive characteristics and margins of safety. In the quarter, this posture contributed to underperforming the small-cap value benchmark, which witnessed a rebound in speculative securities in July and early August. But it also contributed to outperforming the Russell 2000 Value® Index year to date, during which time the broader market seems to have fallen into a bear market.
Industrials. An example of a high-quality company in an economically sensitive area is Douglas Dynamics (PLOW). Douglas, an Industrial company, manufactures commercial vehicle attachments such as snowplows, salt spreaders, and lawn-care equipment. If you live in the Northeast and see a snowplow, there’s a good chance that it is either a “Western” device made by Douglas, or a BOSS snowplow made by the Toro Company. Douglas and Toro are leaders in what is effectively an oligopoly.
PLOW is a vivid example of a good business with low leverage and the potential to buy back its stock and grow its dividend. In fact, the company has consistently raised its payout every year for more than a decade.
But the stock has been weighed down because roughly two-thirds of its revenues are tied to snow- and ice-removal equipment, and there has been lower-than-average snowfall over the past several years. The stock is currently priced as if a traditional winter will never occur again. If we see a winter with simply average snowfall, it could be a catalyst for the stock. Meanwhile, the stock is currently yielding more than 4%, so investors are being paid for their patience.
Outlook and Positioning
Against this economic backdrop, one of our primary responsibilities is to protect investors from the downside. We feel we are well-positioned in companies that can help us fulfill this goal, such as Douglas.
The markets are likely entering a period of negative earnings revisions, as we began to see in mid- to late-September. While our portfolio won’t be immune to those effects, we think our companies will be less affected than the broader market. Meanwhile, our companies seem to be positioned to weather an economic slowdown.
We believe our current portfolio construction and a disciplined application of our Ten Principles of Value Investing™, will serve our clients well and help us navigate the quarters ahead.