The Summit Creek team invests in high quality companies with consistent and above-average growth while paying close attention to valuation. Portfolio holdings tend to have greater earnings stability which, along with our focus on valuation, has led to strong downside protection. The merit of this disciplined process has been solid risk adjusted outperformance.
Since inception in December of 2006, the Small Cap Growth Composite has an annualized return of 10.0% (gross of fees) compared to 6.2% for the Russell 2000 Growth Index and 4.7% for the S&P 500 for the period ending March 31, 2020. Performance has been achieved with a three-year standard deviation lower than the Russell 2000 Growth Index (19.3 versus 20.7).
Strict Quantitative Criteria
Our process begins with a strict quantitative screen. To be considered, companies must have achieved at least three years of double digit growth in revenue and earnings. The team also focuses on companies with little if any debt, higher than average return on equity and an ability to internally fund growth. High inside ownership is also considered ideal. This initial screen significantly narrows the investable universe into a subset of proven growth, high quality companies. The team can then focus their efforts on fewer but more diligent investment decisions.
Hands-on Fundamental Research
After a company passes the quantitative screen, an in-depth analysis is conducted to determine whether the historical growth is sustainable. This phase of the process includes detailed discussions with company management, sell-side analysts and sources outside Wall Street. Throughout the analytical process, questions arise as to the strength of a particular business. Portfolio management is a team process with an individual sponsor for each stock responsible for detailed fundamental analysis, modeling and any follow up. The investment team relies heavily on each member to share alternative opinions during this step of the process. The ideal investment has the following traits: a large addressable market, secular growth drivers with a high level of visibility to that growth, a competitive advantage that appears sustainable and a management team with a track record of conservative forecasting.
Valuation and Price Target
Valuation is the final step in the process. A one-year price target is established for every stock in the portfolio and monitored for purchase. A great deal of effort is put forth by the team in determining a reasonable target. Generally, a stock must have a projected 12-month return of at least 20% to qualify for purchase. This process takes advantage of market volatility and the inevitable pullbacks. Historically, we have had success identifying high quality companies while they are still underfollowed.
The purpose of all hands-on research at Summit Creek, and a key factor in generating excess returns, is appropriately timing the sell decision. Stocks are replaced if our research indicates the business fundamentals will have difficulty sustaining the current valuation. An active new idea pipeline is instrumental in providing the flexibility to immediately sell an existing holding if the risks increase or the stock price exceeds our valuation target. We adhere to this discipline with an annual turnover rate of 40%, of which approximately half is driven from valuation trims.