Heartland Advisors

Heartland Small Cap Value Plus Strategy 1Q24 Portfolio Manager Commentary

Executive Summary

  • Large caps retook market leadership in the first quarter, as their profits held up better in 2023 than small-company earnings.
  • Next year, however, Russell 2000® Index profits are expected to climb faster than the broad market, which could provide a tailwind for small businesses.
  • We believe the small cap market continues to present opportunities, especially as many have already experienced recession-like conditions within their industries and have implemented self-help strategies in response.

First Quarter Market Discussion

After surging around 22% in final two months of last year, the Russell 2000® Index slowed considerably in the first quarter, posting modest gains of 5.2%, underperforming the S&P 500 Index by a wide margin.
While hope that a recession has been avoided and euphoria surrounding artificial intelligence (AI) helped put a spotlight squarely back on bigger companies, there was a fundamental reason why large caps regained the market leadership at the start of the year. Thanks to positive earnings revisions, companies in the S&P 500 are on track to see their 2023 earnings grow 7.2%, versus the projected 8.9% decline in Russell 2000® Index profits.   
The good news: There’s also a fundamental reason why the market may broaden out, potentially allowing small stocks to regain investor attention: In 2024, earnings for companies in the Russell 2000® Index are expected to grow 11.3%, outpacing the 10.6% forecast for large caps (see chart below).

Source: Furey Research Partners and FactSet, as of 3/31/2024. This chart represents the comparison between estimated Earnings Growth and Sales Growth for small companies, measured by the Russell 2000® Index, versus large companies, measured by the S&P 500 Index. All indices are unmanaged. It is not possible to invest directly in an index. Past performance does not guarantee future results.

The fact that small caps have already been through the wringer is another reason to be encouraged. Whether the market’s expectations of a ‘soft landing’ or ‘no landing’ for the economy materializes, many small businesses have already been through recession-like downturns in a variety of industries, suggesting there could be less downside for this group than is currently assumed. At the very least, the headwinds these companies have already faced sets up an environment with greater opportunities for small stocks, given their wide valuation disparities with mega caps.

Attribution Analysis & Portfolio Activity

In the first quarter, the Value Plus Strategy was up approximately 1.62%, trailing the Russell 2000® Value Index, which was up 2.9%. Stock selection, particularly in the Health Care, Information Technology, and Materials sectors, contributed to the underperformance. However, selection effect helped the Strategy outperform the benchmark in the Consumer Discretionary, Consumer Staples, and Financials sectors.

We remain committed to Heartland’s 10 Principles of Value Investing™, which favors companies with low leverage, strong free cash flow, and a successful track record of capital allocation. We also look for companies that are deploying self-help strategies to improve their competitive standing and profitability through strategic and operational improvements.

Lately, we’ve been finding opportunities in companies that have been through their own mini recessions and have proactively adjusted so that even if the economy doesn’t improve, their outlooks hopefully will. And should demand rebound, these companies that have already course corrected and taken costs out are likely to emerge stronger with higher operating leverage.

Here are two good examples of such opportunities:

Consumer Discretionary. In the first quarter, we initiated a position in Mohawk Industries (MHK), the leading manufacturer of flooring including carpets, tiles, and wood and vinyl products for the residential and commercial markets. In recent years, Mohawk has run into difficulties owing to rising interest rates, which affects its end markets, and inflation in source materials, which cuts into margins. Between May 2021 and October 2023, the stock lost nearly two thirds of its value.

But the worst of the company’s pricing pressures may be behind it. And after suffering five consecutive quarters of negative year-over-year sales comps and eight out of nine quarters of negative year-over-year EBITDA growth, Mohawk reversed the trend in the past quarter. Meanwhile, the company has been undergoing extensive self-help in recent years — for instance, it has been investing in automation to boost luxury vinyl tile production in North America and Europe.

While companies usually trade at high multiples at the trough, thanks to diminishing earnings, Mohawk’s shares are at their lowest valuation in recent memory. The stock trades at just 6 times EBITDA and less than 11 times trough earnings while sporting a strong balance with net leverage of 1.3x.

Industrials. Kennametal (KMT), which manufactures industrial cutting tools and components, is another new position initiated during the quarter. The company operates two businesses: a metal cutting unit that sells into a variety of end markets including aerospace and defense and energy, along with an infrastructure unit that provides earth cutting and wear solutions.

The company hit a rough stretch recently, due to rising raw material costs, foreign exchange headwinds, and decreased sales volume in its infrastructure segment. KMT has also experienced contracting year-over-year EBITDA growth in six of the past seven quarters. However, the company has been undergoing extensive self-help, eliminating $200 million in structural costs, reducing its headcount by 20%, and closing six plants over the past five years. 

In our opinion, the heavy lifting is done. If demand remains tepid, the company should continue to optimize capacity via additional cuts and more plant consolidation. EBITDA is likely to grow on flat to moderately declining revenue. And if Kennametal sees any slight uptick in demand in its end markets, it could provide an immediate and robust boost to its operating margins. Yet the stock trades at less than 8 times EBITDA on trough earnings, a 3% dividend yield and modest net leverage of 1.7x.


While challenges remain in this economy, macro concerns are not preventing us from finding new opportunities. The recession-like setbacks that many small companies have already experienced - weighing on their stock prices but also promoting self-help initiatives - should be beneficial. We believe our focus on low valuations and leverage, strong free cash flow and balance sheets, and sound capital allocation and business strategies, as outlined in our 10 Principles of Value Investing™, will help guide us to solid long-term holdings.

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Portfolio Management Team

Heartland Advisors Value Investing Portfolio Manager Andrew Fleming

Andrew J. Fleming

Director of Research, Vice President, and Portfolio Manager

Composite Returns*


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Since Inception (%)10-Year (%)5-Year (%)3-Year (%)1-Year (%)YTD (%)QTD (%)
Small Cap Value Plus Composite (Net of Advisory Fees)**7.385.429.271.023.551.751.75
Small Cap Value Plus Composite (Net of Bundled Fees)6.584.908.750.523.041.621.62
Russell 2000® Value7.266.878.172.2218.752.902.90

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 11/30/2007. 
**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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©2024 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 Plus Strategy primarily invests in companies that have a market capitalization consistent with the capitalization range of the Russell 2000 Value Index, with a majority of its assets invested in companies that pay dividends. The Strategy intends to capture the long-term appreciation of small-caps, while minimizing the volatility of returns inherent in the small-cap market.

The Small Cap Value Plus 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 the Institutional Sales Team at Heartland Advisors, Inc. at the address listed below.

As of 3/31/2024, Kennametal, Inc. (KMT) and Mohawk Industries, Inc. (MHK) represented 1.62% and 3.60% of the Small Cap Value Plus Composite’s net assets, respectively.  

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.

Statements regarding securities are not recommendations to buy or sell. 

Portfolio holdings are subject to change. Current and future 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®.

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.

CFA® is a registered trademark owned by the CFA Institute.

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 2024 FactSet Research Systems Inc., FactSet Fundamentals. All rights reserved.

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

Artificial intelligence (AI) is intelligence—perceiving, synthesizing, and inferring information—demonstrated by computers, as opposed to intelligence displayed by humans or by other animals. 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. Free Cash Flow is the amount of cash a company has after expenses, debt service, capital expenditures, and dividends. The higher the free cash flow, the stronger the company’s balance sheet. 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. Operating Leverage is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. A business that makes sales providing a very high gross margin and fewer fixed costs and variable costs is considered to have high leverage. The higher the degree of operating leverage, the greater the magnitude of changes in sales to potential profits. 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 Russell Investment Group.  Russell 2000® Index includes the 2000 firms from the Russell 3000® Index with the smallest market capitalizations. All indices are unmanaged. It is not possible to invest directly in an index. Russell 2000® Value Index measures the performance of those Russell 2000® companies with lower price/book ratios and lower forecasted growth characteristics. All indices are unmanaged. It is not possible to invest directly in an index. 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. 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.