26 September 2023

Kyle Grieve chats with Jason Donville and Jesse Gamble about their investing strategy based on finding high and sustainable return on equity (ROE) businesses, why small-caps are inefficiently priced, the future of Constellation Software, the importance of focusing on fundamentals over share price, and much, much more!

Jason and Jesse are fund managers at Donville Kent Asset Management. They also write the ROE Reporter, a quarterly newsletter that outlines their investing philosophy, specific businesses they own, and where they are seeing opportunities in the Canadian market.



  • About their outlook for Constellation Software, a business they’ve held since it IPO’d.
  • How to utilize ROE in your investment process to make high return investments.
  • Why small-caps offer less competition from institutional investors.
  • Why Canadian small-caps have unique advantages to the US.
  • Why opportunities in small-caps are so enticing.
  • And much, much more!


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform difference

[00:00:02] Jason Donville: The challenge though that’s happened in my investing career is that balance sheets are getting distorted by a lot of different things. Which means calculating the true return on equity of a business, which can still be done, is not a five minute exercise with a calculator and the financial statements.

[00:00:16] Jason Donville: You would have to go back over the, almost the history of the company and re add everything in and all that kind of stuff. We’re increasingly looking at things like the relationship between margins, sales growth, that kind of stuff and saying, If this company had a normalized balance sheet, it would probably be a 25 percent ROE company.

[00:00:34] Kyle Grieve: On today’s episode, I chat with Jason Donville and Jesse Gamble. Jason and Jesse are fund managers at Donville Kent Asset Management. They write a highly informative and entertaining newsletter called the ROE Reporter. Articles date back to the great financial crisis and they do a wonderful job of discussing individual businesses in their portfolio, as well as what they’re seeing from a macro economic perspective.

[00:00:56] Kyle Grieve: Today we’ll be discussing their investing strategy, based on finding high and sustainable return on equity businesses, why small-caps are inefficiently priced, the future of Constellation software, the importance of focusing on fundamentals over share price, and much, much more. I first heard about Jason Donville from his chapter in Chris Meyer’s 100 Beggars book.

[00:01:15] Kyle Grieve: After scouring through his ROE reporter newsletter, I really enjoyed his emphasis on ROE. Jason and Jesse’s long term approach is apparent when you consider they’ve held Constellation Software since it IPO’d. Now, sit back and relax as we get right into this week’s episode with Jason Donville and Jesse Gamble.

[00:01:33] Intro: You’re listening to Millennial Investing by The Investor’s Podcast Network, where your hosts Robert Leonard, Patrick Donley, and Kyle Grieve interview successful entrepreneurs, business leaders, and investors to help educate and inspire the millennial generation.

[00:01:57] Kyle Grieve: Welcome to the Millennial Investing Podcast. I’m your host, Kyle Grieve, and today we bring Jason Donville and Jesse Gamble onto the show. Jason, Jesse, welcome to the podcast. 

[00:02:08] Jason Donville: Thanks, Kyle. Nice to nice to meet you in person. 

[00:02:11] Jesse Gamble: Thanks for having us. 

[00:02:13] Kyle Grieve: For listeners who are unfamiliar with Jason and Jesse, they run Donville Kent Asset Management, a fund based in Toronto.

[00:02:19] Kyle Grieve: On your website, you have one of my favorite Warren Buffett quotes, “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes”. Can you give the audience a broad overview of your fund and your major investing philosophy? 

[00:02:33] Jason Donville: Yeah, sure. That’s kind of a good introduction.

[00:02:35] Jason Donville: We’re ultimately looking for compounders like Buffett, looking for stocks that we’re not trying to catch a two or three month pop. We’re looking at stocks that we think we can grow at a rate that is well above what the, where the stock market is growing and to do so for a long period of time.

[00:02:50] Jason Donville: And typically that business has some kind of a mode built around. It’s got some kind of competitive advantage. So for us, it’s to try to look at the company and figure out what that sustainability is. And if we think we have a compounder we ease into the position and ideally we try to hold it for as long as we can.

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[00:03:05] Kyle Grieve: And so with your investing process, obviously you guys are only looking for businesses that are going to be compounding preferably for many years, I assume. 

[00:03:14] Jason Donville: Yeah, we’re generally not, let’s say you called me up and said, Hey, there’s a company coming out. I don’t have insider information, but just based on all the circumstances, I’m pretty sure that they’re going to beat, they’re going to surprise the market in two weeks time.

[00:03:24] Jason Donville: Right? And I look at the business, I say, okay, but longterm, I don’t really want to own a business like this because it doesn’t have a competitive advantage or whatever. I wouldn’t react to that call, I would say, thanks, but I’m not looking to buy those trades on just stocks where there’s a positive development coming, that kind of thing.

[00:03:39] Jason Donville: We’re looking for, like Buffett is, he’s also said in a similar vein, if you were required to hold everything that you bought for five years, and you weren’t allowed to sell it for five years you would view stock selection way differently. And we try to do the same thing. 

[00:03:53] Kyle Grieve: You guys specialize in smaller market cap businesses, but as you grow assets under management, smaller cap businesses won’t move the needle as much.

[00:04:01] Kyle Grieve: Will you have to adjust your strategy on small cap businesses as assets under management grow? 

[00:04:07] Jason Donville: Jesse, you want to take that one? 

[00:04:09] Jesse Gamble: Yeah, it’s a fair question. And Jason could probably give you some exact examples of hedge funds that did exactly that. They outgrew their specialty. And guess what?

[00:04:17] Jesse Gamble: Performance declined. We’ve seen that again and again, and there’s studies out there that’ll show you kind of what the ideal size of a fund is. And for us, we’ve done that math and we’re not going to go over the size that precludes us from that small cap area. We very much Our own money’s in the fund.

[00:04:34] Jesse Gamble: So we very much err on the side of performance versus empire building. It’s a very good point. We’re very aware of it. I think more people should be aware of it. But you know, yeah, that’s not an issue that we’re kind of have front and center for us right now. 

[00:04:48] Kyle Grieve: And you mentioned a couple of names that Jason’s gone through.

[00:04:52] Kyle Grieve: Can you provide those names? 

[00:04:54] Jesse Gamble: Oh, I don’t know if he wants to name specific funds, Jason, that kind of got too big for their britches. 

[00:04:59] Kyle Grieve: How about just, you know, what was the process like for them? 

[00:05:03] Jason Donville: We’ve seen companies like, let’s say in our space in Canada, where they were a hundred million, 150 million AUM, and they got really successful.

[00:05:10] Jason Donville: And they suddenly they were at a billion dollars, right. And they couldn’t get enough of those small, undervalued names that they could drive their portfolio. So they got forced into the TSX 60. They ended up owning the same large stuff that everybody else owns. And guess what? Their performance kind of got, went that way as well.

[00:05:26] Kyle Grieve: What are your average holding periods like for your fund? Do you always look for businesses that you think you can hold for five, 10 years? Or are you sometimes looking at maybe special situations or any type of arbitrage type deals? 

[00:05:39] Jason Donville: No, we’re always looking for the long term, but here’s what happens, what’s particularly when you have a company, like a large cap, which we have in the portfolio called Constellation Software, it’s got a long track record, easy to analyze, and easy to see that it’s just going to keep on chugging, right?

[00:05:53] Jason Donville: When you look at a small company, you don’t have that track record, so you think you might be buying a compounder, and then a year later, six months later, you realize that they’ve got issues. 

[00:06:03] Jesse Gamble: We go in with the idea of, yes, it’s a compounder, 5, 10 year outlook, and then you could ask, well, why is your holding period 5 to 10 years?

[00:06:11] Jesse Gamble: And like Jason said, sometimes you don’t, sometimes your investment thesis doesn’t necessarily play out. And that’s why we start small. We start with what we call kind of like a total position. And then if they do what they say they’re going to do, then we add over time. So for a stock to end up being a large position, we’ve owned it for most likely multiple years.

[00:06:30] Jesse Gamble: So that’s kind of on the risk mitigation side. And then what can also happen is, you know, new names come up or you need funds. So you rank your stocks and one ranks well above other ones. And you use that, that, that stock as a source of capital for your new investment, right? That’s kind of, you know, why there might be more turnover, but on average, it is multiple years on average holding.

[00:06:53] Kyle Grieve: So you mentioned that toehold investment to kind of get started. What does that usually look like before you gain enough conviction in an idea to go into a full position? 

[00:07:02] Jesse Gamble: Yeah, so they start out with, you know, half a percent weighting in the fund and you meet with management, you do your models, all that kind of, and then you kind of, you see their next quarter, it’s as expected or not, and then you re evaluate and if the stock starts to perform, then you add.

[00:07:19] Jesse Gamble: So it’s a combination of, you know, is there momentum, you know, our revenues and margins and execution, what you thought it would be. And if that’s the case, then, you know, you can slowly add over time. So I like, kind of, like we said, so like by the time it’s a larger position, you’ve met management 20 times or more, and you’ve gone, you know, through all the calls and you update your model 20 times.

[00:07:41] Jesse Gamble: And so you get to know the company. We argue we would know our largest company is, you know, better than anyone else kind of out there and that’s because it’s years and years of research. 

[00:07:52] Kyle Grieve: So you mentioned Constellation Software, which is a business that I highly respect. With the success of their business model, why do you think other businesses haven’t attempted to copy their model in different industries?

[00:08:04] Jason Donville: It’s a great question. We’ve had consolation going back right to the beginning of the fund. So we, when we started the first time we bought the stock, it was a 20 stock. And for your listeners, it’s now almost a 3, 000 stock. Plus there’s been two spin outs from it, right? And it was only a 500 million market cap.

[00:08:20] Jason Donville: So it was a true small cap when we started investing it, right? There have actually been a few people who said, Oh, we’re going to do what Consolation did, but it requires a lot of discipline and Mark Leonard has put in a system there of how to look at companies, kind of companies that fit, et cetera, et cetera, and how to integrate them into the broader whole that is It’s really interesting, and you look at it and go, well, anybody could copy that, and then they try it and they don’t.

[00:08:42] Jason Donville: There is something in terms of the internal culture that I think is hard to put your finger on it. But that being said, the two spin outs, Lumine and Topagus, seem to be operating exactly the same way. It is on some level replicable, but sometimes you’ll hear people comparing it, for example, to Danaher or something like that, and you look at Constellation’s numbers over the last 15 years versus Danaher, and it’s not even close.

[00:09:03] Jesse Gamble: I think it’s a good question because the company over the years has put out a lot of information on process and, you know, what they look for. So you it’s not like it’s a black box, but it is their discipline and it’s the machine. But to be fair, there has been off the top of my head Alimentation Couchetard or MTY Food or Boyd Group Automotive, which for maybe not as long as a period, did have kind of a similar type of, strategy and growth and success, but not on the same scale as a constellation.

[00:09:34] Jesse Gamble: It’s a good question and it kind of gets to the point of like Vertical market software. So they’re vertical market software facilitator. And the idea about V M S software is the fact that it is extremely small and niche, right? So they’re doing hundreds of acquisitions, a year of six, seven, $8 million plus a larger one.

[00:09:54] Jesse Gamble: And that’s the whole idea is private equity wont play in a niche V M Ss, and then. Again, the idea of having a system in place where you can do that many deals is very hard to do, right? And also get in front of that many companies. It sounds easy, but I think, like Jason said, they’re disciplined and I think they have a machine in place that allows them to do it.

[00:10:15] Kyle Grieve: Yeah, and one additional follow up on Constellation. As they’ve grown now, I mean, it’s pretty impressive they’re doing like, they’re still doing 5 million deals, but now obviously in order to really move the mark, they’re starting to move up to deals that are 500, I think 700 million. What do you think about their internal rates return on these types of acquisitions?

[00:10:36] Kyle Grieve: Are they going to be able to maintain their hurdle rates going forward? 

[00:10:40] Jason Donville: That’s a great question. And then, and here’s how people who are listening in who are do it yourselfers can look at it, right? When they have a company that’s growing over, you know, through acquisitions, so let’s say any company, Constellation Warehouse, and they’re doing 10 acquisitions per year, what you do is you start looking at, over time, what’s happening to their margins.

[00:10:56] Jason Donville: Are their margins going down? Are they going sideways? Are they going up? Because if they’re going down, then that means incrementally they’re adding probably weaker businesses into the mix. We were quite attuned to that because 50 percent of the growth through acquisition or roll up companies turn out to be crap.

[00:11:12] Jason Donville: Just when someone says, Oh my God, they’re doing a roll up strategy on the dry cleaning business, don’t get all excited because half the time these things turn out to be crap. Right? So that is one of the ways you can look and say, incrementally, are they on average, is that constellation has a lot of averages.

[00:11:25] Jason Donville: Are they on average adding businesses that are roughly as attractive as the ones that are running? Or are they worse or are they better? Equally, if they buy a company that’s okay in the first year and then turns out to be crap, same thing, you’ll get this fading in their margins and in their return on capital.

[00:11:38] Jason Donville: So when you take that criteria and you look at Constellation or Topless or Luminous, generally speaking, the margins and the return on capital are stable or rising. They’re incrementally adding really good businesses, and that’s not what you’d expect, because before Berkshire Hathaway and companies like Constellation and Danaher, there was a belief and a teaching that conglomerates were inefficient, that they were, you don’t want conglomeration because individual investors want to pick their own pieces kind of stuff, and a conglomerate would become this mediocre basket, and that’s clearly not the case with Constellation.

[00:12:08] Jesse Gamble: Not to focus on Constellation too much, but to get to your point of, we’ve had this discussion, and this discussion has been brought up about Constellation getting too big, right? And we had this 80 a share, 200 a share, 500, like we’ve had this along this whole entire path. And just to kind of put some numbers to it, in their funnel of BMS software businesses, they have, it’s 300, 000 that they’re tracking, and it’s estimated that there’s about a million out there, right?

[00:12:35] Jesse Gamble: So if you do that, if they continue on their pace. Mark Leonard, where it was just, it was, we had a meeting with the CFO and he was saying their issue isn’t enough BMS targets. It’s getting in front of them when those targets look to sell. A mom and pop at 5 million valuation don’t know who Constellation is unless Constellation was knocking on the door and sitting down with them and that’s their issue and they seem to have reorganized the business a few years ago where they accelerated that so again we’re harboring a Constellation but the idea that they’ll have to go up market for acquisitions isn’t the case but they do opportunistically get acquisitions on the larger scale.

[00:13:14] Jesse Gamble: They don’t drop their internal IRR on those acquisitions. Again, we’re harboring a constellation, but the idea that they’ll have to go up market for acquisitions isn’t the case, but they do opportunistically get acquisitions on a larger scale, but they don’t drop their internal IRR on those acquisitions.

[00:13:33] Kyle Grieve: So institutions can go in and buy stocks once they reach a specific market cap size. So some small-caps with less than 50 to 100 million dollar market caps just simply can’t be purchased by institution. But you’ve said that they can come in around 100 plus million dollars. Then as more eyeballs come on the stock can often re rate.

[00:13:54] Kyle Grieve: So do you guys have a specific market cap range that you’d consider your sweet spot? 

[00:13:59] Jason Donville: We’ll look at anything, but historically that the sweet spot in the Canadian market has been kind of starting at the 250 to 300 million market cap. where you buy a stock around there and you ride it as it goes from 300 million to two and a half billion and you get that over four or five years you get that combination of the company let’s say growing at 16 or 17 percent a year plus the multiple expansion so it gives you something compounding at 21 22 percent we’re comfortable coming in earlier than that we’re just not going to bet the farm on a stock that’s earlier Because even if you find a stock that’s growing, let’s say you find a stock that’s on five times earnings and it’s growing at 20 percent a year, even if there’s no re rating a year from now, it should still be on five times earnings.

[00:14:36] Jason Donville: So if nothing else, you’re still getting the growth rate. Whereas the lottery ticket comes from the potential that it comes on to more radar speeds and it gets that multiple lift. So we have a few stocks under a hundred million dollars in market cap, but we also have, you know, companies like consolation, which is now, I don’t know, 60 or 70 billion market cap.

[00:14:51] Jason Donville: So we’re not obsessed with small-caps. We just tend to have more of them because that’s where the value is. 

[00:14:56] Jesse Gamble: For the audience. It’s really interesting these days, specifically, because as the market cap grows, you know, then all of a sudden you can pick up the analyst coverage, which obviously gets more eyeballs and some investment advisors can’t own a stock unless it is a buy from an analyst, etc.

[00:15:12] Jesse Gamble: So you see that market cap step function, but what’s very important these days is index inclusion. And Jason and I were just talking about this because you get included with the increased passive investing, the amount of money in ETFs, as soon as you get, say, included in the Russell or booted out of the Russell, like the implications are big, right?

[00:15:30] Jesse Gamble: So if you have a 200 million market cap company that you think in two or three years will be. will get to a size that will get included into an index that is a massive catalyst. But then with that comes, you know, more volatility and all that kind of stuff. But the idea of getting into indexes as you grow is considerable.

[00:15:50] Kyle Grieve: So I’d be interested in knowing what are your exit signals for your holdings. Do you prefer using specific price targets or valuations? or better opportunities as your sell signals. 

[00:16:03] Jason Donville: Yeah, pretty much the latter, what you described, right? So either the return on capital is starting to fade, valuation has got ridiculous, or if we feel like management, for some reason, we don’t, we feel like we can trust management.

[00:16:14] Jason Donville: Every now and then you get a management team that just suddenly it’s obvious that they’re taking care of their own needs first and shareholders second. So it’s, those are the three criteria. Basically a change in that we no longer view it as a compounder that we want to own, the valuation gets crazy, or a question of integrity.

[00:16:33] Jesse Gamble: And I think a third would go along with the fundamentals. They take on too much leverage, so they do a deal, and they take on too much debt, because as soon as you take on too much debt, even if it’s a good deal, your optionality is gone. Now you’re, you don’t have that optionality anymore, and you’ve brought up risk, so that’s another reason.

[00:16:49] Jesse Gamble: A couple of examples I would say was we owned for a long time was both MTY Food Group and Dollarama. So Dollarama, Dollar Stores, MTY Food Court Restaurants. And what happened is phenomenal growth, phenomenal economics on an individual basis. So each of those units is still very good economics, but then they just, they ran out of.

[00:17:09] Jesse Gamble: runway. So their growth starts to slow. They start to, for Dollarama, like their growth is pretty much just the growth of suburbs, Canada now. And then for MTY, they had to expand to more restaurants in the U.S. Along with that, their ROE started to drop. So we held them for years, but then we rank other stocks and we kind of move on.

[00:17:33] Kyle Grieve: How do you guys view cash in volatile markets? Do you tend to stay fully invested through market cycles or do you increase your cash holdings when markets begin heating up and driving up evaluation so you can hopefully try to take advantage of large corrections? 

[00:17:48] Jesse Gamble: We’re pretty much always fully invested and people ask us well you know if you say you’re net 80 or you’re net 200 so you’re twice that cash or you’re 100 percent levered or you’re timing the market.

[00:17:58] Jesse Gamble: You’re implying that you’re timing the market, right? Like you think the market’s going to correct or it’s at a bottom and we don’t think we have that expertise. So we stay fully invested as long as our companies continue to grow revenue and earnings per share. and have a high ROE, then we continue to hold, right?

[00:18:15] Jesse Gamble: And that can be painful. Like I’m sure we’ll talk about how markets declined, especially in the small cap space in Canada over the last kind of two years. But guess what? Like record revenues, record earnings per share, high ROEs, right? So it’s one of those things where, yeah, it can be painful in the short term, but the companies are performing.

[00:18:34] Kyle Grieve: Most of the greatest investors I’ve researched tend to be very optimistic in their outlook on investing in a life. How do you guys view optimism as part of your outlook on individual stocks in the market? 

[00:18:46] Jason Donville: It’s a good point because the people who are the opposite were cynical or highly skeptical, right?

[00:18:51] Jason Donville: And they put that out as one of their virtues. And then we look at their numbers and they’re always crappy. Right? Like I think Buffett, once again, has written about, you have to see the possibility in commerce. You have to see the optimism in a business, right? And you have to also recognize when a company has challenges, that they’re soluble, that there’s good people in there, right?

[00:19:09] Jason Donville: You know, for example, when we get into an inflationary environment, sometimes people will worry or forget that a company can adjust its pricing fairly carefully. When you look at a large company like an Amazon or a Walmart or whatever, we’ve just gone through an inflationary cycle and their margins haven’t changed that much, right?

[00:19:25] Jason Donville: So their ability to adjust to a changing environment is excellent, right? So I think I am optimistic. I don’t think I’m stupidly optimistic. I also think there’s a couple of key things in the stock market. There’s always a worry about the consumer, right? Consumer debt, consumer, this, that, you know, everything.

[00:19:40] Jason Donville: The consumers, you and I, and when we have a problem in our lives, most of us adjust really quickly to that problem. So when people say, well, I’m really worried about the consumer right now because of this, that, or the other thing. Governments and some large kind of stale corporations can be very slow at adjusting to problems.

[00:19:55] Jason Donville: Households adjust to them right friggin now because that’s the reality that we all live in. I’m not worried about the, I tend to be way more optimistic on the consumer. And, yeah, I think we, my optimism is that I think the world is geared towards growth it’s geared towards inventing new things, making new things, making the world a better place, but I don’t think it takes me away from the judgment of saying, this is crap, or these guys don’t know what they’re doing.

[00:20:18] Jason Donville: I think I got that side. I got that side of my brain is fairly well developed as well. 

[00:20:23] Jesse Gamble: It is hard because sometimes it’s the pessimists that sound smart on TV, right? And that’s what makes good headlines. That’s what makes good media. But that’s what Jason, like over time it’s wrong. It’s a hard balance of do you want to sound smarter?

[00:20:37] Jesse Gamble: Do you want to have some good investments? So it’s, that’s the world we live in. Like the stock 

[00:20:42] Jason Donville: market in general is not a coin toss. It’s not 50 50. At the start of every year, you just own the index, it’s not a 50 50 chance that you’re going to make money. It’s skewed towards going up. It goes up more years than it goes down.

[00:20:54] Jason Donville: And in the average year that it goes up by more than it goes down in the negative years. So the cumulative effect of owning an ETF or a portfolio for 10 years, The probability that you’re not going to make money is extremely low. It’s not a 50/50 coin toss the way some of the cynics will point out, right?

[00:21:10] Kyle Grieve: Jason, you mentioned in Chris Meyer’s 100 Beggars that returns on equity, which I’ll just refer to as ROE, I’m pretty sure the audience is going to know that, but is a decent proxy for the returns you can get from investing in businesses over the long term. And then in your interview in Market Masters, you mentioned that growth in book value is a good indicator that a stock is increasing in value.

[00:21:32] Kyle Grieve: Do you think this concept applies to all businesses in all industries, especially in respect to, you know, say like a tech versus a CapEx heavy retail type business?

[00:21:42] Jason Donville: First of all, let’s go back to the first part, which is Return on equity and growth and book value is more or less the same thing. If your book value goes by 20%, your ROE is essentially 20%.

[00:21:51] Jason Donville: So in a sense, it’s just two different ways of saying the same thing. The challenge though that’s happened in my investing career is that balance sheets are getting distorted by a lot of different things, which means calculating the true return on equity of a business, which can still be done is not a five minute exercise with a calculator and the financial statements.

[00:22:08] Jason Donville: You would have to go back over almost the history of the company and re add everything in and all that kind of stuff. We’re increasingly looking at things like the relationship between margins, sales growth, that kind of stuff and saying, if this company had a normalized balance sheet, it would probably be a 25 percent ROE company.

[00:22:23] Jason Donville: One of the other sort of metrics that investors can look at is this rule of 40 that people use for software companies, but it’s actually worth looking at any company with, which is just basically saying, Look at the profit margin of the company and in this case, we would call it the cash earnings profit margin.

[00:22:39] Jason Donville: Let’s just say it’s 20%. It’s not that different from ebitda, so let’s just say it has a 20% EBITDA margin and it’s growing by its revenues by 20%. Those combined pieces come up to 40%. With a lot of companies, that rule of 40 number is not too far away from where their ROE is. And so if you have a low margin company that’s low growth, even though it’s on five times P eight, it could be a value trap, right?

[00:23:00] Jason Donville: Equally, if you have a high ROE company, and this is not one in the portfolio, but it’s an example that everybody can look at, which is Apple. Apple has super high margins, but not a lot of growth right now, but it has like a 50 percent margin. They’re growing to some extent by buying back their stock every year because they’re so profitable.

[00:23:17] Jason Donville: Every dollar that you spend at Apple, 50 percent of it goes to profit. That’s how big their mode is, right? So those, now ideally what you want is a company that’s, let’s say, has a 30 percent profit margin and 20 percent growth. But looking at that metric, that rule of 40 metric, where you add together basically the revenue growth rate of the company and the margin as another excellent proxy for looking for a high quality business.

[00:23:38] Jesse Gamble: And Jason’s used Apple as an example, so I pulled it up just to kind of give the listeners an idea of what we’re talking about. Businesses don’t necessarily operate their companies off their balance sheet, right? Like financials do, but with Apple, so Apple has 60 billion in equity on the reported balance sheet, and they’re going to make 100 billion in earnings, so 100 billion.

[00:24:01] Jesse Gamble: 67 percent ROE. Do they have under 67 percent ROE? No, they don’t. But that’s what if you just took your textbook calculation would tell you, but what you will have to do is Jason and I, if we were like, if we were digging into it, we would go, okay, what’s their real cash margin. What type of leverage factor?

[00:24:18] Jesse Gamble: So that’s where that DuPont analysis comes in. What type of leverage factor? What type of asset turnover do they have? So like Jason said, they have a really high net margin. So they’re going to have a higher ROE. Their stocks compounded in the last 20 years at 39%. So that probably gives you in the range of what their ROE has been with multiple expansion, right?

[00:24:37] Jesse Gamble: Now, constellation software at times has had negative equity on the balance sheet. So how do you calculate an ROE then? It’s the same type of idea. You break it down into your parts. So it’s, it is a lot more cumbersome than your finance 101 class would kind of tell you it is, but. That’s kind of how we really kind of delve into it.

[00:24:55] Jesse Gamble: So it’s more work than just screening for higher. 

[00:24:59] Kyle Grieve: Piggybacking on this question and you kind of answered it already, but so a business like IBM, I looked at, and if you look, like you said, at the textbook definition of ROE, it was high, like 27 percent for a decade, but pretty recently, but it had a massive debt load.

[00:25:14] Kyle Grieve: So the ROE looks super attractive, but when you looked at returns on invested capital and added debt back in. It was bad, mid single digits. And then when you look at the share price, they basically were destroying shareholder value during this time. Do you guys, when you’re doing the ROE, do you guys take into account, you must take into account debt?

[00:25:33] Kyle Grieve: So like, how does, how do you guys kind of compare the ROE versus ROIC numbers? Are they, do you use them interchangeably or how do you guys look at them? 

[00:25:42] Jason Donville: I mean, first of all, we have a, we don’t want to own a company that if you take their annual cash flows, that they couldn’t pay it all back in four years.

[00:25:48] Jason Donville: So it’s gotta be four years or less, right? Well, that’s the upper limit for us. Typically, we want to own companies that are at two times or less because that means that they’ve got the capacity to do big acquisition, right? But let’s say we own a company that’s you know, got two years of debt and then they do a big acquisition, the stock pops, but now it’s got four years of debt.

[00:26:06] Jason Donville: We’re likely to, that would be a stock we might take some profits in or something like that because they’re not likely to acquire anything for a while. So they’re, if they’re a grow to acquisition company, they’re just going to spend the next two or three years paying down that debt before they can really take anything on.

[00:26:19] Jason Donville: Or they’re going to do a dilute of financing or something like that, right? So we look at that balance sheet level all the time. As well, when we look at a company that has a high ROE, but maybe it’s not reflected in certain other metrics, one of the first things we’ll say is, Oh, the only reason their ROE is high is they’re leveraged up the wazoo, but they’re not actually running a great business.

[00:26:37] Jason Donville: So we’re adjusting to that, but let’s say a company just sort of comes to my attention that I’ve never looked at before, you know, one of the first things that I’ll look at is just pull up the 10 year share price chart. This business, as it appears to me right now, it should be reflected in a chart that is showing the company performing over time, and if that company has been going sideways or whatever, then the first question I have to ask myself is it, did it suddenly get changed?

[00:26:57] Jason Donville: Is there somebody improving it? Is there something new going on here? Or what explains why, if these numbers, they’re putting up numbers like this, what explains why this stock hasn’t gone anywhere? And sometimes it’s a phenomenon like good year, bad year, good year, bad year, good year, bad year phenomena.

[00:27:10] Jason Donville: Sometimes it’s a change. You know, we’ve seen some pretty interesting turnarounds in companies where they change management or they reposition themselves. Sometimes in the SaaS area, it’s a company converting over from the old system of purchasing software to subscription models, and they often will have an 18 month period where their numbers will kind of make it look like they’re not doing too well when in fact it’s just the conversion.

[00:27:29] Jason Donville: And often if you can get in late in that conversion, you can actually do really well.

[00:27:34] Kyle Grieve: I’m interested in knowing how you use ROE just with upcoming businesses that aren’t yet optimized for profitability. So are you using an adjusted number? I guess you, you mentioned using EBITDA and how’s this adjusted number been a good measure for you guys for future value creation?

[00:27:51] Jason Donville: I think so for a company that’s kind of just coming, like looks, but we think it’s going to be a higher ROE company, but stock way there, we’re looking at the trapped. Right? We’re looking at the direction it’s moving. So I’ll give you an example, a company called Docebo, right, which software company, you know, it’s kind of headquartered in Canada, does a lot of their operations in Italy.

[00:28:07] Jason Donville: This company was unprofitable, and now it’s starting to move towards breakeven, but it’s still on a pretty high multiple. It’s probably on 40 or 50 times, right? So this is one that I’m watching. Where it’s okay, at some point this I think is going to become a fairly interesting company. The question is it today or is it 12 months from now?

[00:28:22] Jason Donville: But the trend line, they’ve gone from being quite significant losses to above break even now. So that trend line is exactly where you want to go. And if you can catch a company that’s going through that re rating, they can often be real rocket ships. 

[00:28:33] Jesse Gamble: Yeah, I think Jason said that since kind of the first day I started working here is it goes, what’s the only thing better than a higher ROI business is a company becoming a higher ROI business, because then with that you get the multiple expansion and the new eyeballs and all that along the way, right?

[00:28:48] Jesse Gamble: Like you’re saying, there’s margins and there’s growth and there’s ways to project out what it could be over time. So that’s kind of what we’re doing. Right.

[00:28:57] Kyle Grieve: So since you guys like to invest in businesses with such a high ROE, this usually means that from a business standpoint, the best use of earnings is to pump it back into the business at the high rates of return.

[00:29:11] Kyle Grieve: So a business that you guys own, such as Hammond Power Supply, pays a small dividend. Whereas a business like Decisive Dividend pays a pretty big dividend. How do you guys analyze businesses with high ROE but are also distributing profits back to shareholders as dividends? 

[00:29:27] Jesse Gamble: From just from a mathematical standpoint, we have something that’s called a sustainable growth rate.

[00:29:33] Jesse Gamble: You take that ROE Say it’s 20 percent and we’ll use decisive dividend as an example, but they aim to have their payout ratio at 60%, but I think it’s like 42 percent right now, right? So anyways, 20 percent ROE, they pay out 42%. So that’s a sustainable growth rate of roughly 12%. Right? So that’s how we kind of start to do apples to apples, and then you’re like, okay, as a shareholder, then you obviously get the yield as well, which is around 6%.

[00:29:58] Jesse Gamble: percent as a return, which you compare to an 18 percent ROE or an 18 percent yield with no growth. Like it’s a way to, it’s a way to compare apples to apples. So we have something that we call internally we call the sustainable growth rate. And that’s kind of how we calculate it.

[00:30:18] Jesse Gamble: So then we can compare that growth rate to its earnings and we’ll say, well, how much growth are we getting per unit of value? Anyway. So that’s kind of like the technical way we do it. Jason, you kind of have an idea. 

[00:30:30] Jason Donville: Yeah, that’s essentially what Jesse’s saying is. We can convert a dividend paying stock.

[00:30:35] Jason Donville: It’s converted to ROE. We have, there’s a formula and we didn’t invent the formula. I guess it’s in the textbooks. So you can say, okay, this 20 17 percent ROE company. We’re

[00:30:47] Jason Donville: triply trying to find 20 percent ROE companies, but we’ll take something a little bit lower than that. If we like the, you know, the valuation and all that kind of thing. 

[00:30:55] Kyle Grieve: Can you guys talk a little bit about Hammond Power Supply? I’d love to know what is it about that business that you guys like so much.

[00:31:03] Jesse Gamble: Yeah, so it’s a new name. It’s not a massive name for us and we’ll get to what they do, but what I’ll start with is we don’t invest in like a theme necessarily, right? The investment was found in the true margins and growth and valuation. That’s where we always start is with the numbers. The numbers led us to this company.

[00:31:23] Jesse Gamble: Net margins have doubled over the past couple of years and continue to grow and growth has accelerated. So you look at a company, like Jason said, we’ll pull up the stock price chart. Why has it been doing well recently and not in the past? It’s well, because margins are doubling and growth is accelerating.

[00:31:39] Jesse Gamble: Right? Okay. Well, what’s that play there? Hammond Power is the leading manufacturer of transformers. And why? Okay, that’s great for infrastructure, but the idea that almost every single city in the entire world needs to upgrade its infrastructure if they want to hit their EV or heating goals. Because if we hit the goals now with the way the infrastructure is, the grid can’t handle it.

[00:32:05] Jesse Gamble: I have a couple, I’m just pulling up my email of a couple studies, but there was a study in Palo Alto that more than 95 percent of residential transformers will be overloaded if the city hits at 20, 30 electrical targets. So pretty much all of the grids will get overloaded if they hit the targets that they’re trying to push for.

[00:32:23] Jesse Gamble: And then there’s another one that where most electrical grids. The clusters themselves are designed to be cooled at night because that’s when electrical demand is less. But, if we hit our EV targets, that’s when everyone’s charging their EVs. The idea that a level 2 charger used to be, used to last 3 to 4 years.

[00:32:43] Jesse Gamble: Because it kind of went through that cycle. They’re predicting that it’ll last three years if it has to hit this kind of like always on, always working type of model. Right? So that’s the reason. So when Jason was mentioning before of well, what’s changed, That’s one of their fastest growing segments is on kind of like the EV renewable side, but then it’s just the grid in general, right?

[00:33:05] Jesse Gamble: It’s air conditioning, it’s these buildings, it’s growth in population, it’s the need for these transformers where you can stand back and you go, okay, it makes sense that. Growth’s accelerating and margins are improving and the stock still looks extremely cheap for its size. So that’s kind of the Hammond Power investment in kind of a nutshell.

[00:33:22] Jesse Gamble: They are expanding capacity at two sites. So when you ask about growth, you know, you have to be able to make these transformers at scale. And with their expansion that’s undergoing, they should be able to grow revenue over 50 percent with those two expansions. So we think it’s a good growth, good margin, good return, and still looks fairly cheap to us.

[00:33:42] Kyle Grieve: Excellent. And what about can you give me the, your nutshell for decisive dividend as well? 

[00:33:48] Jesse Gamble: Sure. Jason, do you want to take that one? 

[00:33:49] Jason Donville: I mean, it’s a pretty straightforward manufacturing company. The people that run it have a good background both in acquiring companies and also in running companies.

[00:33:58] Jason Donville: And really it is an arbitrage, I guess, between the fact that you can buy small industrial companies that manufacture things like heating supply stuff or fireplaces or whatever. Bundle those companies together, pay out a dividend, and the market will pay you, you know, pay you a good rate. Stock market’s been great.

[00:34:13] Jason Donville: I’m not suggesting in any way this is a consolation software, but as they acquire more businesses, their dependency on any single business diminishes over time, so it becomes more of a diversified basket of manufacturing companies that have good cash flows. and creates a lot of value. The payout ratio is reasonable right now.

[00:34:28] Jason Donville: So even if there’s a little bit of a whoops, they should be able to kind of get through from a dividend payout point of view. We like it. We met with management twice in the last three or four months. It’s early days still, but the stock’s performing quite well. And like I said 

[00:34:40] Jason Donville: Very attractive.

[00:34:42] Kyle Grieve: So you’ve mentioned in a previous interview a couple of years ago that you shifted your strategy From looking mostly at profitable businesses to more tech type businesses that are maybe sacrificing a little bit of profitability now to improve relationships with potential customers. Just wondering what brought this strategy change on?

[00:35:00] Jason Donville: I think we’re still fairly focused on profitability. It’s just, it’s more like what Jesse talked about before, which is the ROE is on its way to where we want it to go. So let’s say using a Dogebo is an example of something we’re looking at right now, right? But you were getting all these really interesting tech companies that, you know, like Magnet Forensics, for example, that came out and now it’s disappeared because it went private, but you’re getting all these interesting tech companies and we had to be just a little bit more flexible because a lot of them were in really fast growing places where they were focused on market share and things like that more than they were focused on the bottom line profitability.

[00:35:31] Jason Donville: So we just wanted to give ourselves a bit more of that flexibility. Probably. But I still think if you go through the portfolio, we don’t own very many stocks that are not profitable. They just may not quite have the ROE today that we think they’re going to have in a year or two. 

[00:35:43] Jesse Gamble: I don’t think I would call it a change in strategy because it’s still pairing, profitability, valuation, but I think what happened was like with SAS specifically it’s one of the best business models that there ever has been, right?

[00:35:56] Jesse Gamble: In a sense of how you can scale and how profitable you can be. And then what Jason was getting to is like literally there was probably 10 tech names you could count in Canada for years. Blackberry, Constellation, CGI. OpenTest. And then there’s been, there has been like kind of an explosion of new up and coming, like Jason mentioned, Magnet Forensics, where really interesting new tech names came to the market.

[00:36:22] Jesse Gamble: So it was starting to evaluate these new businesses that are new to the market, not new businesses that have been around and That was kind of what, well, your tech weightings up significantly. Well, it’s not necessarily us trying to invest in tech. It’s us just trying to invest in the best companies we can find, and which happens to be tech because you can have high growth, high margins in tech.

[00:36:43] Jesse Gamble: So that’s kind of been what’s happened, but I wouldn’t necessarily call that a change in strategy. 

[00:36:48] Kyle Grieve: So I’ve noticed over the years, your fund has also moved towards investing in business that are coming out of the IPO phase. What advantages are you seeing in Canadian businesses that are entering public markets this way?

[00:37:01] Jesse Gamble: Yeah, so I think it kind of just goes back to what we were just referencing was for years there just wasn’t anything coming to market that kind of fit what we were looking for and now they’re now there is but real companies real earnings market and We did a significant amount of work on this in one of our past newsletters, but people like well, why now?

[00:37:21] Jesse Gamble: And it’s because the business models work now. The cost of being in the cloud, the be and accessibility of the internet, the proliferation of the smartphone, you add all those together and guess what? You actually, you can have real business models in the cloud on phones around the world, right?

[00:37:39] Jesse Gamble: Where that just wasn’t the case. The cost of the cloud was too much or. Bandwidth wasn’t enough. And you kind of got this perfect storm of infrastructure and accessibility all at the same time. So the idea that, you know, new business models could work was a real thing. Again, we’re a very concentrated fund.

[00:37:57] Jesse Gamble: So we weren’t adding a ton of these, but every one or two a year, you’re taking a really good look at some new business a couple of times a year. 

[00:38:04] Kyle Grieve: And so just to follow up about the IPOs in Canada versus the U.S., I don’t know how much you guys follow U.S. markets, but it seems like in the U.S., a lot of these businesses are IPO ing now way later in their growth stages.

[00:38:16] Kyle Grieve: Is there something specific about Canada that is allowing these businesses to IPO earlier? Is there just more need for capital from these businesses? Or what are the differences you see in Canada versus U.S.? 

[00:38:27] Jason Donville: The only thing that I see in Canada, because we watch, but the IPO market will kind of is like open and closed.

[00:38:31] Jason Donville: Right. So I think we watch the U S tech market fairly closely. And I think Canada and the U S or have some similarities, but one of the differences in Canada is companies will go public as much smaller companies, right? Like a company is happy to go public with a hundred million dollar market cap, not small a company in the States really gets orphaned.

[00:38:48] Jason Donville: It’s questionable whether you should go public or that small in the States, whereas in Canada you’ll get paid attention to. So that would be. That’s one of the things that I would say is different, but there are tons of the SPACs and the pre profitable companies in the States, they have tons of those as well.

[00:39:01] Jason Donville: We have them in Canada, but we don’t know a lot about them because we don’t spend a lot of time looking at the pre profitable ones, but as they, but we keep them in databases, so as, every quarter that goes by, as they go from being unprofitable to profitable, we go, hey, Maybe it’s time to revisit company X, Y, Z, that kind of thing.

[00:39:15] Jason Donville: And there’s definitely a few of those in Canada, the tech companies that went public two or three years ago that have been doing actually fine on a revenue business development side, but they’re slowly but surely working their way to profitability. And we can come in before they’re profitable if we think the trend line is fast enough, right?

[00:39:29] Kyle Grieve: I’m interested in knowing, out of the companies that you guys have owned during the entirety of the fund, what have you held on to the longest? Does this go to Constellation Software? What other names have you guys held for long periods of time? 

[00:39:41] Jason Donville: We’ve had that for a long time. Collier’s would be another one we’ve had for a long time.

[00:39:45] Jesse Gamble: We mentioned earlier, we owned MTY Food, Alimentation, Kushtar, Boyd Group, each for long periods of time. But Constellation would be the winner because we still own it. We owned it since the beginning. Jason, any other ones that come to mind? 

[00:39:59] Jason Donville: In the past, we’ve had some that we had for a long time. Paladin Labs would be one.

[00:40:04] Jason Donville: I think we had Dollarama for a fairly long time. I think we had First Service for a long time. We still have Colliers. 

[00:40:11] Jesse Gamble: So yeah, those would be the major names. 

[00:40:14] Kyle Grieve: So let’s discuss another business that your fund owns, which is ReadyShred, which most people think just does paper shredding, but it clearly do quite a lot more than that.

[00:40:23] Kyle Grieve: Can you guys explain why you own this business and what you think its future prospects are like? 

[00:40:29] Jesse Gamble: We found the business, again, years ago. We’ve been investing in this for a few years. Because you could see when you were looking at the income statement that it was actually a good growth and profitable business, but they were over levered.

[00:40:43] Jesse Gamble: So we went to them and we said, okay, well, let’s help solve your debt issue, which we did. We helped invest into that business, solve their debt issue, and then they’ve been off to growth phase since then. But why we really the business is one, the unit economics of running a shredding truck are really good.

[00:40:57] Jesse Gamble: So can you scale it? And then the management team in place is phenomenal. So they’re on top of all their metrics and if I were to say, well, what does a shredding company look like, and just to use kind of a number that everyone would know, but they have 30 plus percent EBITDA margin, right, for a shredding company.

[00:41:14] Jesse Gamble: Okay, can you scale it? And yes, the answer is yes, they’ve been scaling extremely well and with scale comes route optimization. And the ability to kind of, it’s called bailing you’re on paper. So you actually can resell for more than you could otherwise. And all this kind of comes with scale, right? What’s the market missing?

[00:41:31] Jesse Gamble: The stock trades extremely cheap and it’s, again, it’s growing well and it has a long runway still in front of it. But the idea that people always push back on is paper use, right? Yes, paper use has been declining for something like 20 years at a gradual pace, right? But what has been happening is the actual amount of paper making it into shredding boxes is increasing, it’s growing.

[00:41:55] Jesse Gamble: And what does a shredding company care about? It cares about the paper in the box, it’s not necessarily paper overall, right? It’s going in because of security reasons, paper that needs to get shredded because, well, there’s new regulations that say it has to. Or just the way it’s getting used, or from an environmental standpoint, a lot of younger employees know that if it goes in a shredding box, it actually gets recycled.

[00:42:16] Jesse Gamble: Versus, for example, in our office, if we throw it into our garbage beside our table, it doesn’t get recycled. So there’s that aspect to it, of actually the volumes getting shredded are increasing. So the idea that it’s a declining market isn’t necessarily true, but everyone would at first glance would assume that you kind of go through this whole idea.

[00:42:35] Jesse Gamble: It’ll never trade at a premium valuation, but the idea that it’s growing at 20 to 30 percent a year at really good margins and we’ll be able to do so for a while and trades extremely cheap. That’s it kind of ticks a lot of boxes, even how small it is. 

[00:42:49] Kyle Grieve: I’d like you guys to tell me a little bit more about your investment in GoEasy.

[00:42:52] Kyle Grieve: It looks like a high ROE business that is guided for an ROE that’s above your 20 percent threshold over the next two to three years. When businesses guide for growth like this, how likely are you guys going to trust what they say? Obviously, you’re probably pretty comfortable with M management, but I’m interested in knowing how you guys view this company’s guidance.

[00:43:11] Jason Donville: There’s a couple of reasons why we’re comfort there is we’ve been invested with this company for a while. So management says something, we see what they do, you know, do they actually live up to what they say? Devastating But also, before I got into the hedge fund business, I was a financial services analyst you know, I used to analyze companies like GoEasy, so I’m fairly comfortable with their model, when they cover it, recently changed the whole lending structure for the super high interest stock, I was very relaxed with that, but the market sold off, so I would say a combination of we have a good trust with management combined with the fact that I know a little bit more about this industry than the average Joe, I think those two factors mean that for us, we know that GoEasy is always going to be super volatile because it becomes kind of a proxy for people’s perceptions of whether the economy is strong or weak.

[00:43:52] Jason Donville: So we live with that. And then, and if anything, if there’s a sell off, you know, we would add to the position, but that said, we have a pretty large position in the stock. We’re very comfortable with it, but a lot of companies that are like subprime lenders, that kind of stuff, like GoEasy, we say they have a lot of headline risk.

[00:44:07] Jason Donville: There’s a headline in the newspaper about something to do with the economy, the lenders all sell off kind of stuff. You just have to live with that and know that’s just part of the game. 

[00:44:15] Kyle Grieve: So let’s move into some of the small-caps and microcaps. So why are small and microcaps in Canada so inefficiently priced?

[00:44:23] Kyle Grieve: Have you guys observed this inefficiency in other geographies as well? How long has it been this way? And do you think it’s likely to change in the future or is it just 

[00:44:32] Kyle Grieve: cycles?

[00:44:33] Jason Donville: Yeah, so I would start with Canada versus the US. So we started looking more closely at 

[00:44:38] Jason Donville: the US, I don’t know, five or six years ago.

[00:44:40] Jason Donville: And we thought the fund would have more exposure to the US. But just the difference in multiples, the quality is, you know, in Canada, we have extremely high quality, but it makes, doesn’t make a lot of sense to invest in the U.S. names that we’re finding because we can find cheaper, higher quality names here.

[00:44:58] Jason Donville: So that, that goes to your question of like, why? And now, obviously, Jason, I think you’ve been in this industry for long enough. You have your thoughts on why Canada might be underpriced versus other countries. I don’t know if it’s, 

[00:45:11] Jason Donville: Once again, I think a lot of companies in the States are discouraged from going public at the size that they do in Canada.

[00:45:16] Jason Donville: So I think, I don’t think it’s like their small cap market is more efficient than ours. I think that ours is actually relative to the size of the country, a lot larger. And it goes back to the whole CPC kind of way of thinking and, you know, Western Canadian entrepreneurialism and all that kind of stuff.

[00:45:30] Jason Donville: But as far as why that segment, the microcaps are generally speaking, so inefficient, that’s the whole story, because if something goes wrong down there, you don’t have a lot of liquidity, that kind of stuff. And you don’t have institutional money in there pushing up valuation. So as you go from large to medium to small to micro, the valuation should come down, right?

[00:45:48] Jason Donville: And, you know, it’s a risk reward. If you’re comfortable going into that area, like microcaps, we’re probably more of a small to mid cap fund with some microcaps. You’ve got to be really patient and you have to recognize that it’s kind of like a venture capital almost with a little bit of liquidity. So you really can’t play these where you say, Oh, on any day I want to, if I want to take a hundred thousand or whatever off the table in the microcaps, you can’t do that.

[00:46:09] Jason Donville: You have to basically say four or five years from now, it’s going to get taken out and it’s going to move out very sporadically. It’s going to always trade on very low volume and you’ve got to use that inefficiency to your advantage not be beaten up by it. 

[00:46:22] Jesse Gamble: And then you mentioned like the cyclical nature of valuations.

[00:46:27] Jesse Gamble: Again, I would reference kind of the newsletters we’ve written on our website, but what we’re seeing in the current small cap space is all time lows in valuation. So what happened in the kind of the 2021 tech craze and then everything kind of blew up sold off. Guess what? Everything sold off.

[00:46:46] Jesse Gamble: Indiscriminately of valuation and earnings and business outlook, maybe accept the large cap names that everyone knows about. But what we’ve seen is, yeah, there was a hundred percent. There was definitely companies that should have sold off. They were a bubble. They were overvalued. They shouldn’t have been trading at a hundred X, whatever multiple.

[00:47:05] Jesse Gamble: There’s, we have companies that were trading on 12 times. That’s so that have now sold off to four times like cash earnings. net cash balance sheets. And that’s the market we’re living in now. And, you know, we’ve referenced this idea of a pendulum before, but that’s kind of the cyclical nature is we think we have a basket of stocks in our fund that is literally the cheapest that we could have, that we could find through history.

[00:47:29] Jesse Gamble: And we compare it to 08, 09 bottom. And we think the stocks now in the fund are cheaper with higher growth margins than 09. So that’s kind of. It’s crazy to think about because it’s a different segment of the market and it’s not the Nasdaq’s hitting all time highs and it’s Apple and Amazon and Google, Microsoft.

[00:47:48] Jesse Gamble: That’s just not the world we’re living in. And then that’s where we see this opportunity is these names are just so under followed at the moment. But if you go through history, that it’s a cycle and the cycle swings the other way. And so that’s kind of how we’re positioned is for that cycle to swing the other way.

[00:48:05] Kyle Grieve: What are your catalysts going to be to narrow the price value gap for some of the heavily underpriced names in your portfolio? In your most recent newsletter, you discussed how you believe that interest rates were the prime culprit for suppressing value of many of your holdings. Are there other macro catalysts outside of declining interest rates you believe that will help re rate some of the small cap names in your portfolio?

[00:48:28] Jesse Gamble: Yeah, so I think rates are number one, right? Like your discount rate you use on your valuation is exactly tied to interest rates, right? Interest rates go down, technically the value of your stock is worth less. That’s what’s happened with fastest increase in interest rates in history. But that being said, we think that’s peaked.

[00:48:45] Jesse Gamble: And then so people start to look at these small growth names, but to your point, are there other macro issues? I don’t think I see any. I’ll let Jason answer too, but what we’ve also been seeing is kind of activism and takeouts, right? So we ourselves have been pushing some of our names to really increase the amount of buybacks they’re doing.

[00:49:03] Jesse Gamble: Because those companies will look back years from now and we’ll be astonished with how accretive some of these buybacks at these levels will be from that standpoint. And we’re starting to see a little bit more of takeouts, right? Where if a stock is, we’re really worth. What we think it’s worth, a company will come in and buy it out, right?

[00:49:20] Jesse Gamble: So that’s what we’re starting to see. I would say that’s only within the last kind of few weeks, month. 

[00:49:25] Jason Donville: I think the interest rate cycle globally is the big one, right? And I don’t think interest rates are going to go much higher. The question is, are we just going to stay up here or are we going to roll over, right?

[00:49:35] Jason Donville: Other stuff that can, that is interesting that’s out there that could be positive for small-caps are the following, the war in Russia and Ukraine would be one, and China figuring out its place in the world, given that everybody’s deep, like disinvesting in China, right? All these things, though, speak to a phenomenon which we refer to as risk on, risk off, right?

[00:49:53] Jason Donville: Kyle you know that, that term. So we’re, we were in a massively risk off posture up until probably three or four months ago, then the large mega cap tax started to roll and now it’s starting to trickle down. So we’re not back to normal as far as sentiment and all that kind of stuff, but we’ve just started to turn that corner.

[00:50:10] Jason Donville: Interest rates are going to be the big driver. I would say the war in Ukraine and then just China figuring out whether it’s a growth story or not. I think that’s, those are kind of add ons. I don’t think the war in Russia is sustainable. I’m not sure what brings it to hand. Is it a coup? You know, does Putin get replaced or God knows what happens, right?

[00:50:28] Jason Donville: But Russia’s already lost the war. It’s just a question of when they realize it. 

[00:50:32] Kyle Grieve: So in your January 2023 ROE reporter, you said that the portfolio went through some painful losses. However, the bulk of your investments were on pace to have record years in terms of fundamentals. As of right now, this quarter, are you still seeing massive improvements in the fundamentals of some of your highest concentration bets?

[00:50:51] Jason Donville: So companies are reporting right now, so we’re right in the middle of Q2 results, right? And so generally speaking, the results are coming in. What’s kind of not happy is if a company comes in and they miss by 1 or 2%, they’re often getting whacked by 20 or 30%, right? And we know that’s the way the algos are starting to trade the markets now, right?

[00:51:08] Jason Donville: So you’re getting these hyper reactions to small misses are resulting in massive movements in the stock. Now, given the nature of algos, they’ll do the same in the other direction as well. So we’ve got to be attuned as we move forward and we tweak the portfolio that if a stock, and I’ll use an example like Nuve has just been absolutely crushed.

[00:51:27] Jason Donville: And it trades on four and a half times earnings now, right? And it’s growing at 17 percent this year, right? So instead of growing at 20, they’re now growing at 17. And that’s the movement that this stock took. So we’ve got to be able to say, Hey, are we going to, once it’s settled down, are we going to add to some of those positions when they’ve been really crushed?

[00:51:41] Jason Donville: Right. You know, we added to die in Durham when it got down to kind of 16 or 17. So you got to let the stock kind of find its bottom and settle up and then be prepared to take some moves there. But some of these stocks, the misses are. Not even misses sometimes, where sometimes it’s a little change in their working capital and the sell off of the stock is just un, it’s unbelievable.

[00:51:57] Jason Donville: So that’s part of that, the world that we live in. 

[00:52:00] Jesse Gamble: Yeah, so Jason’s referencing a lot of the stock price moves. I’m just looking at the portfolio now and from what we have eight of our top 11 investments, which make up majority of the portfolio or on pace again for record revenues and record earnings this year.

[00:52:15] Jesse Gamble: With no kind of outlook that’ll decline going forward, right? So that’s a majority of those names. And some of the other ones would be like a Collier’s that slowed down because of commercial real estate, but it’s still obviously making money and is a strong business. But that’s kind of what we were referencing before, where just everything sold off indiscriminately.

[00:52:33] Jesse Gamble: And now we’re finding stocks, 17, 20%. That’s just not sustainable in the sense of where stocks will trade. So yeah, it’s painful in the short term, but as long as we’re deadly focused on making sure, you know, revenue and margins and management teams continue to execute, like that will reverse what that’s kind of power position.

[00:52:56] Kyle Grieve: Jason, Jesse, thank you so much for joining me today. Before we close out the episode, where can the audience connect with you guys and learn more about your fund? 

[00:53:05] Jesse Gamble: Yeah, we write a quarterly newsletter. So if you’d like to get on that list, you can email info at donvillekent.com or all that information is on our website at donvillekent. com. 

[00:53:16] Kyle Grieve: Okay folks, that’s it for today’s episode. I hope you enjoyed the show and I’ll see you back here very soon. 

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