Bob Mitchell and Joe Monahan have visited enough companies over the years to know what gives them confidence in a potential investment—and what makes them leery. “Every company has its own culture, but as investors we look at small things,” says Mitchell, who has been investing in small-company stocks for most of his 20-plus year career. Luxurious offices, expensive art, and VIP parking spots for top brass give the duo pause. Another tell: “When the CEO or the CFO takes us through a facility,” he adds, “do they really know their way around, or do they only go there when they give tours to investors?”
These questions are indicative of Mitchell and Monahan’s no-nonsense approach to managing the $818 million Conestoga Small Cap fund (ticker: CCASX). “Our goal is to give investors the benefits of investing in small-cap growth, but with less volatility than is associated with this asset class,” says Mitchell, 47, who co-founded Conestoga Capital Advisors in 2001 and launched the fund a year later. Over the past decade, it has posted 9.2% average annual gains, better than 92% of small growth funds tracked by Morningstar. Meanwhile, its beta, which is a measure of market sensitivity, is just 0.78 against the Russell 2000 Growth index, based on quarterly data since inception. A beta of less than one suggests that the fund is less volatile than the market.
Conestoga’s own offices, located in a suburban office park near Philadelphia, are modest but functional. It’s here that the firm’s five investment professionals—out of a total of 11 employees—manage $1.7 billion in separate accounts, the small-cap fund, and the Conestoga SMid Cap (CCSMX), launched in 2014. Together, they look at roughly 100 ideas a year, from which they may add just six to a dozen new names to their small-cap portfolio of 45 to 50 stocks.
“We have investment meetings when we need them, but we don’t want to create a lot of bureaucracy,” says Mitchell, adding that the managers and analysts are all generalists. “Multiple people look at the ideas; no single individual has a monopoly on the information. There is no territory in our portfolio.”
Their initial ideas typically come from three main sources: screens for companies with low debt, insider ownership, and high return on equity; conferences and trade shows; and independent research firms “who know our style,” says Monahan, 56. In other words, they’re always looking for profitable companies with sustainable competitive advantages, earnings growing at a 15% to 20% annual clip, and the potential to double in value over a three- to five-year period.
Though the fund is overweight health-care and technology, no single sector can exceed 30% of the fund, and the managers generally cap individual holdings at 4%. They also try to stay fully invested no matter what is happening in the market. “We look for companies with differentiating products and solutions that do well in all environments,” says Mitchell. “Many of these are companies that let their customers lower their cost structure or operate more effectively.”
One such company is Blackbaud (BLKB), a leading provider of software used by nonprofits for fund raising and donor management. “It has been an interesting journey,” says Mitchell, who has owned the stock since 2006, when it traded in the teens. The stock stumbled a few years ago following several acquisitions, and this prompted the team to take a second look. When faced with a decision to hold or sell a stock, “we turn the file over to another member on the team to do an independent analysis,” says Mitchell. “It’s when we hear things like ‘losing market share’ or ‘pricing competition’ that gives us pause.”
In the case of Blackbaud, they concluded that the company still had an edge over its competitors and that new management had the chops to integrate the acquisitions. It didn’t disappoint, and the stock recently tipped past $70 a share. Now that the company has its house in order, Mitchell says, it is growing its sales 6% to 7% while improving operations and tapping into other facets of its niche, such as payment processing. “They have a very long runway,” he adds.
THE SAME COULD BE SAID for top holding Omnicell (OMCL), which makes products and software that allow health-care facilities to acquire, manage, dispense, and deliver medications and supplies safely and efficiently. “Historically, it’s been a manual process that is time-consuming and prone to errors,” says Monahan, noting 81% of Omnicell’s revenue is derived from medication-control cabinets, while 19% of sales are in medication-adherence packaging. The Conestoga team first invested in 2013, when the stock was trading for less than $20 a share; it was recently at $37. At the same time that Omnicell is taking U.S. market share from competitors, it has an opportunity to grow internationally: Just 10% of health-care facilities globally have such technology in place.
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