Heartland Advisors

Heartland Small Cap Value Strategy 3Q22 Portfolio Manager Commentary

 Executive Summary

  • As fears of a Federal Reserve-induced recession have risen, speculative areas of the market have been crushed.
  • In this volatile environment, value continued to outperform growth.
  • Bear markets can be difficult, but often set up opportunities for the enterprising, patient value investor. 
  • Historically, our Ten Principles of Value Investing™ have helped identify such opportunities. 

“An era can be said to end when its basic illusions are exhausted.”

​​​​​​—Arthur Miller

In the third quarter, equity markets were highly volatile with a strong summer rally followed by a dramatic decline. In addition to the continuing war in Ukraine and supply chain bottlenecks, another negative was the Federal Reserve’s more hawkish stance. 

The Fed set a record by increasing rates +75 basis points for the third time this year and telegraphed its intent to keep hiking aggressively to combat inflation. All this, in the face of a dramatic decline in CEO confidence, an inverted yield curve, and long-term mortgage rates doubling to over 6%. The result: economic activity has slowed, fears over a Fed-induced deep recession have risen, and equity valuations have come down markedly. 

As the playwright Arthur Miller noted, eras only come to an end when its myths are extinguished. Well, the speculative mindset, fueled by a decade of “easy money” that led many equity investors to turn a blind eye toward valuations and leverage, seems to be over. As the chart below shows, the percentage of companies expected to see improving earnings over the next year is likely to be extremely low.
Heartland Advisors Value Investing Russell 1000 P/S Less Russell 2000 P/S Chart

Source: Piper Sandler Portfolio Strategy, Monthly data 12/31/1985 to 9/30/2022. The data in this chart represents the S&P 500 Positive Earnings Revisions (% of total) being led by The 2 Year Change in Basis Points Of The 10 yr. Yield. IBES Aggregates S&P 500 Analyst Earnings Revisions (Up – Down / Total), and Bloomberg US Generic 10 Yr Yield (USGG10YR In Bloomberg). Higher interest rates lead to fewer positive earnings revisions from sell side analysts. All indices are unmanaged. It is not possible to invest in an index. Past performance does not guarantee future results. There is no guarantee that a particular investment strategy will be successful.

Advantage: Value

In our opinion, this is precisely the time to be an active, selective investor. We also believe this is a backdrop in which value, after being out of favor for many years, can continue to outperform. Year-to-date, the Russell 2000 Value® Index is off 21%, while the Russell 2000 Growth® is down 29%. The valuation disparity between value stocks and growth/momentum favorites has narrowed, and with higher interest rates likely to compress further.

Patient investors should be rewarded for owning high quality assets with balance sheet strength and low price-to-earnings. But remaining disciplined will be key, as a combination of materially lower earnings estimates and stock prices will likely be needed to improve the risk-return profile of many companies on our research “watch list.”

Attribution Analysis

The Long Game in Energy. This is not to say that we weren’t buyers in the quarter. Where opportunities presented themselves, we initiated and added to positions as appropriate. 

In the third quarter, recession-related concerns weighed on crude oil as the price sank from $110/barrel to $80 at quarter’s end, causing the energy sector rally to wane. But there seems to be a longer-term trend at play. Traditional oil and gas spending peaked in 2014, and since then, multiple forces—including fears over peak oil demand, the rise of ESG focus, and capital discipline by producers—have delayed an upcycle in traditional oil and gas spending.

Post COVID-19, the demand for oil has been strong, expected to exceed 100 million barrels a day.  Our sense is that energy service-related companies have entered the early innings of a positive earnings revision cycle, a rarity in the markets.  To take advantage of this, we own NOV, Inc. (NOV), a leading oilfield services company that provides technical expertise, advanced equipment, and operational support for the oil and gas industry. NOV generated $4.6B in EBITDA in 2014, but just $230M last year, which speaks to the under investment in the broader energy patch. NOV’s outlook continues to improve though, as the company is now forecasted to produce over $600M and nearly $900M in 2022 and 2023, respectively. Interestingly, estimates are up ~10% since the start of the year and maintain an upward bias.

Being Patient with Healthcare. We continue to have a meaningful allocation to healthcare, but it proved to be a challenging quarter for the sector. Yet we remain patient in situations where we believe investors have overreacted.

Case in point: Patterson Companies (PDCO), a leading distributor of dental and animal health related products, reported first quarter results that included a sequential decline in dental equipment-related sales and price deflation in consumables. The former is in part a hangover from a strong fourth quarter while price deflation is being driven by inventory build-ups during COVID-19. With a healthy 4% dividend yield and attractive valuation, only 11X estimated earnings, we continue to hold Patterson. Notably too, a competitor in the dental space, Henry Schein, Inc., trades at a 1.5x+ premium to PDCO on estimated EBITDA while Covetrus, Inc., an animal health player, was acquired for 14.0x EBITDA in May.

Financial Opportunities. Banks have been buoyed by rising interest rates that offer larger spreads. The question is, ‘How bad will credit get during the current downturn?’ 

Texas Capital Bancshares (TCBI) is a Dallas-based middle market commercial lender with a particular focus on the four major Texas markets of Dallas-Fort Worth, Houston, San Antonio, and Austin. TCBI is a classic self-help story: Prior management ran the bank as a “growth at all cost” institution. When the bank was small and rates were at historic lows, it was easy to sustain growth by booking new loans and growing deposits regardless of the quality of either relationship. Credit problems began to percolate after the company downgraded several levered loan credits in 2019. Last year, a new CEO was brought in from J.P.Morgan Chase who quickly exited risky loans and reoriented TCBI as a local Texas commercial lender with a niche focus on deep customer relationships.

A position was initiated due to our belief that under new management’s focused strategy, the bank is on the verge of improving its returns and market perception. The stock trades at only 1.1 times tangible book value, compared to 1.8 times for regional banks in general. Granted its return on assets is below the average for peers. In our opinion, over time TCBI will close the return gap with valuations likely to follow suit.


Our purchase of TCBI demonstrates the Team’s focus on the margin of safety in all of your investments. This focus requires understanding the fundamentals, both the qualitative and quantitative, through the application of our Ten Principles of Value Investing™. We believe the output from this process produces a portfolio that exhibits balance sheet strength and below market valuations, two attributes that could offer relative downside protection as the markets move on from an era of speculation and irrationality.

We are encouraged by the renewed interest in value investing and the portfolio’s relative performance. Based on valuations, we remain optimistic on the long-term outlook. 

Thank you for your continued trust and confidence.

Small Cap Value Composite Valuations

Heartland Advisors Value Investing Value Fund Valuations

Source: FactSet Research Systems Inc., Russell®, Standard & Poor’s, and Heartland Advisors, Inc., as of 9/30/2022. Price/Earnings and EV/EBITDA are calculated as weighted harmonic average. Certain security valuations and forward estimates are based on Heartland Advisors’ calculations. Certain outliers may be excluded. Any forecasts may not prove to be true. Economic predictions are based on estimates and are subject to change. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future returns.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Will Nasgovitz

Will Nasgovitz

CEO and Portfolio Manager

Heartland Advisors Value Investing Portfolio Manager Bill Nasgovitz

Bill Nasgovitz

Chairman and Portfolio Manager

Composite Returns*


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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)

Source: FactSet Research Systems Inc., Russell Investment Group, and Heartland Advisors, Inc.
*Yearly and quarterly returns are not annualized. The Strategy's inception date is 10/1/1988. 
**Shown as supplemental information. 

The US Dollar is the currency used to express performance. Returns are presented net of advisory fees and net of bundled fees and include the reinvestment of all income. The returns net of bundled fees were calculated by subtracting the highest applicable sponsor portion of the separately managed wrap account fee from the net of advisor fees return.

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©2023 Heartland Advisors | 790 N. Water Street, Suite 1200, Milwaukee, WI 53202 | Business Office: 414-347-7777 | Financial Professionals: 888-505-5180 | Individual Investors: 800-432-7856

Past performance does not guarantee future results.

The Small Cap Value Strategy seeks long-term capital appreciation by investing in micro- and small-cap companies, generally with market capitalizations of less than the largest companies in the Russell 2000 Value Index, at the time of purchase. The micro- and small-cap segment of the stock market is robust with thousands of publicly traded issues, many of which lack traditional Wall Street research coverage. Thus, we believe this market is often inefficient, mispricing businesses and offering opportunities for fundamental research-minded investors such as Heartland.

The Small Cap Value Strategy invests in small companies selected on a value basis. Such securities generally are more volatile and less liquid than those of larger companies.

Value investments are subject to the risk that their intrinsic value may not be recognized by the broad market.

Heartland Advisors, Inc. (the “Firm”) claims compliance with the Global Investment Performance Standards (GIPS®). The Firm is a wholly owned subsidiary of Heartland Holdings, Inc. and is registered with the Securities and Exchange Commission. For a complete list and description of Heartland Advisors composites and/or a presentation that adheres to the GIPS® standards, contact Institutional Sales at Heartland Advisors, Inc. at the address listed below.


As of 9/30/2020, NOV Inc. (NOV), Patterson Companies, Inc. (PDCO), and Texas Capital Bancshares, Inc. (TCBI) represented 1.73%, 2.32%, and 1.30% of the Small Cap Value Composite’s net assets, respectively. Covetrus, Inc. (CVET) and Henry Schein Inc. (HSIC) were unowned. 

The future performance of any specific investment or strategy (including the investments discussed above) should not be assumed to be profitable or equal to past results. The performance of the holdings discussed above may have been the result of unique market circumstances that are no longer relevant. The holdings identified above do not represent all of the securities purchased, sold or recommended for the Advisor’s clients.

Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk.

In certain cases, dividends and earnings are reinvested.

GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Separately managed accounts and related investment advisory services are provided by Heartland Advisors, Inc., a federally registered investment advisor. ALPS Distributors, Inc., is not affiliated with Heartland Advisors, Inc.

The statements and opinions expressed in this article are those of the presenter(s). 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. The specific securities discussed, which are intended to illustrate the advisor’s investment style, do not represent all of the securities purchased, sold, or recommended by the advisor for client accounts, and the reader should not assume that an investment in these securities was or would be profitable in the future. Certain security valuations and forward estimates are based on Heartland Advisors’ calculations. Any forecasts may not prove to be true. 

Economic predictions are based on estimates and are subject to change.

There is no guarantee that a particular investment strategy will be successful.

Sector and Industry classifications are sourced from GICS®.The Global Industry Classification Standard (GICS®) is the exclusive intellectual property of MSCI Inc. (MSCI) and S&P Global Market Intelligence (“S&P”).  Neither MSCI, S&P, their affiliates, nor any of their third party providers (“GICS Parties”) makes any representations or warranties, express or implied, with respect to GICS or the results to be obtained by the use thereof, and expressly disclaim all warranties, including warranties of accuracy, completeness, merchantability and fitness for a particular purpose.  The GICS Parties shall not have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of such damages.

Heartland Advisors defines market cap ranges by the following indices: micro-cap by the Russell Microcap®, small-cap by the Russell 2000®, mid-cap by the Russell Midcap®, large-cap by the Russell Top 200®.

Growth and value investing each have unique risks and potential for rewards and may not be suitable for all investors. A growth investing strategy emphasizes capital appreciation and typically carries a higher risk of loss and potential reward than a value investing strategy; a value investing strategy emphasizes investments in companies believed to be undervalued.

Because of ongoing market volatility, performance may be subject to substantial short-term changes.

Dividends are not guaranteed and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.

There is no assurance that dividend-paying stocks will mitigate volatility.

Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indices. Russell® is a trademark of the Frank Russell Investment Group.

Data sourced from FactSet: Copyright 2023 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

Heartland’s investing glossary provides definitions for several terms used on this page.

Active Investing is an investment strategy involving ongoing buying and selling actions by the investor. Active investors purchase investments and continuously monitor their activity in order to exploit profitable conditions. Bear Market occurs when the price of a group of securities is falling or is expected to fall. Book Value is the sum of all of a company’s assets, minus its liabilities. Dividend Yield is a ratio that shows how much a company pays out in dividends each year relative to its share price. Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) measures a company’s financial performance. It is used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. Inflation Risk is the possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency. Leverage is the amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged. Margin of Safety is a principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value. Passive Investing is an investment strategy involving limited ongoing buying and selling actions. Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance. Russell 3000® Growth and Value indices consist of stocks within the Russell 3000® index with respective value and growth characteristics as determined by Russell Investments. S&P 500 Index is an index of 500 U.S. stocks chosen for market size, liquidity and industry group representation and is a widely used U.S. equity benchmark. All indices are unmanaged. It is not possible to invest directly in an index. Volatility is a statistical measure of the dispersion of returns for a given security or market index which can either be measured by using the standard deviation or variance between returns from that same security or market index. Commonly, the higher the volatility, the riskier the security. Yield Curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. In a positive-sloping yield curve, short-term debt instruments have a lower yield than long-term debt instruments of the same credit quality. A negative, or inverted, yield curve occurs when short-term debt instruments have a higher yield than long-term debt instruments of the same credit quality. 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.