Throughout his 36-year career, Kevin Rendino has rarely been this excited about an investment.
Smaller companies haven’t been this cheap in decades, the activist investor said in a recent interview with Business Insider. Rendino remarked that the small-cap-heavy Russell 2000 ended 2023 at one of the lowest relative valuations versus the Russell 1000 in 25 years.
Kevin Rendino, 180 Degree Capita
Investors ditched small caps in early 2022 as the Federal Reserve signaled that it would rapidly raise interest rates to contain multi-decade-high inflation. The group kept lagging last year as markets braced for a recession that would especially hurt economically sensitive small caps.
That doomsday narrative never came true, but shares of smaller firms still suffered. Micro caps trailed the large growth names in the Nasdaq 100 index by 46 percentage points in 2023, Rendino noted. He’s quite puzzled by that underperformance, given that the bears were wrong.
Small stocks’ disappointing run has led to a brutal stretch for 180 Degree Capital (TURN), the publicly traded closed-end fund where Rendino is CEO. However, Rendino refuses to divert his focus from small- and micro-cap firms — even if he looks foolish now.
“‘The one willing to look stupidest the longest wins,'” Rendino wrote in his Q4 shareholder letter, citing a quote from a friend. “We feel stupid on the one hand, yet on the other, we couldn’t be more optimistic about what we own and convinced significant value appreciation is possible in the next few years.”
The 2-part case for a small-cap comeback
Small caps are close to a long-awaited turnaround for two key reasons, Rendino said: their valuations are too cheap to ignore, and the Federal Reserve is done raising interest rates.
In the short term, the market has a habit of overlooking low earnings multiples. Companies that effectively grow earnings and revenue are often rewarded with loftier valuations while firms that fail to execute tend to trade at inexpensive levels.
But eventually, Rendino said investors gravitate toward groups of stocks that get too cheap.
“We believe that the price that you pay for the business that you own has the highest explanation for long-term returns, and the price is right,” Rendino told Business Insider.
And although the market isn’t on small caps’ side, Rendino believes historical precedent is.
Smaller firms have risen in 14 out of the last 15 instances when the Fed’s hiking cycle ends, Rendino said, adding that their average gain in that scenario is 23%. The longtime investor is sure that the US central bank won’t raise interest rates again since the economy is healthy.
By extension, rate cuts are also out of the picture until the back half of 2024 at the earliest, Rendino said. While only one or two cuts would disappoint many in markets, the market veteran said what matters most for small- and micro-cap companies is that the economy keeps growing.
The Russell 2000 is roughly flat this year after a furious run in late 2023. However, Rendino isn’t discouraged by small caps’ slow start and is instead pleased that his firm is outperforming.
“Small caps were up in the fourth quarter, and we’re having a really good year,” Rendino said. “The worry is not the reality.”
An investing strategy that activates gains
Even if Rendino is right about the small-cap rally he’s spent years waiting for, he’ll have little to show for it unless he correctly identifies which companies are set up for success.
“At the end of the day, if you don’t get your stock-picking right, it doesn’t matter,” Rendino said.
Choosing the right stocks takes focus, though many fund managers would say that Rendino’s team takes concentration to the extreme. 180 Degree Capital’s portfolio only holds seven to 10 stocks at a time, which means Rendino’s basket has far fewer eggs than most of its peers do.
“When you run a concentrated portfolio like we do, your performance numbers — it’s not a straight line,” Rendino said. “We have very high deviation from the indices.”
Keeping an ultra-narrow focus allows Rendino and his team to know each of their investments intimately. Most top portfolio managers would also say they’re keyed into their holdings, but Rendino takes hands-on investing to another level by employing an activist turnaround strategy.
Activist investing goes well beyond active stock-picking, which involves choosing companies based on their fundamental qualities. Rendino and his colleagues identify small-cap stocks that aren’t living up to their potential and work side by side with management to provide guidance and advice as needed. If Rendino’s suggestions lead to success, everyone wins.
However, if the company’s executives refuse to cooperate, Rendino isn’t afraid to get tough.
“We’re trying to help them; we’re not trying to be combative with them,” Rendino said.
He added: “We’re just taking all the years of experience that we’ve had, and we’re applying it towards these small companies that, quite frankly, many of ’em don’t know how to be a public company. We’re trying to teach ’em how to grow up.”
Investing for three and a half decades has given Rendino a strong sense of what makes for a sound business and a capable management team — and the difference between the two.
When looking for investments, Rendino said he aims to emulate a pair of stock-picking legends: Benjamin Graham and David Dodd. Healthy balance sheets are a top priority, as are valuations. But perhaps the most critical determinant of a company’s success or failure is its management.
“I’ve seen it all, and I know what a good management team looks like and smells like, and I know what a lousy one looks like and smells like,” Rendino said.
The beauty of Rendino’s activist approach is that he can play a role in turning executives from a liability into an asset. Whether it’s giving tips on governance or managing operations, Rendino boosts firms by helping their leaders maximize their potential.
“I know from my experience how management teams can achieve a better shareholder return profile than maybe they’re achieving,” Rendino said. “And I know why companies aren’t in the good graces of investors and why certain investors shy away from companies.”
4 favorite investments to make now
Besides outlining his bullish thesis for small caps and his activist investing strategy, Rendino spoke about four companies he’s most excited about.
Almost two years ago, the market veteran recommended three companies to Business Insider. Since then, one has soared, one is roughly flat, and the other tanked. Last summer, Rendino reiterated that winning pick and shared four other top names, all of which have traded higher.
Below are Rendino’s best ideas now along with each one’s ticker, market capitalization,and Rendino’s price target and thesis.
