RS Investments' Allison Thacker says the funds have seen software-as-a-service names recently looking more attractive, while they have been trimming traditional consumer-discretionary names.
Ryan Leggio: You have done, especially in the small-growth fund, extremely well over the last couple of quarters, despite the fact you have owned some lower-beta names. Just really kind of stock-by-stock names have worked well for you. Can you talk a little bit about with the recent market correction that's happened, we're talking right now in mid-June, how you're thinking about possibly repositioning the portfolio for some opportunities ahead?
Allison Thacker: Well, the fund has done very well during the last six months or so both in up markets and particularly on downside protection, and I think it has to do with building it up on a stock-by-stock basis and requiring good upside to downside.
I would expect to see us pick up during this downturn some more software-as-a-service names. Those are always the most expensive names, partially because they're recurring-revenue business models, which means contrary to a license software model, where you get to book all the revenues upfront and make money on day one, you spread the revenues over the lifetime of the company, and so you make a little bit less along the way, which means your margins tend to be lower when you're a young company and then higher as you become a mature business.
So, software-as-a-service stocks have been very expensive; they've gone from four to six times price to sales, or ... 25 to 35 times free cash flow, all the way up to six to nine times price to sales and 35 to 50 times cash flow over the last couple of years--that's been the multiple expansion. And we're starting to see some of the names come back into that target range that we look to pay, kind of 25-ish times cash flow.
Leggio: Well, the last thing I wanted to ask you about is really valuations across the small-, mid-, and large-cap spectrum. You have the benefit of running funds in all of those spectrums and can see what the landscape looks like. We've heard from at least a few managers who are a little bit more worried about small-cap valuations in general than larger- and mega-cap names that we've talked about before. What do things look like to you, and are you finding better opportunities in the large-cap area right now?
Thacker: I would say that our team is finding opportunities across the spectrum. As I mentioned, in small cap we're only looking for 90 names. So we're not looking for across the huge universe. And I would agree that there are areas that seem relatively expensive. We have tended to try to stay away from the areas and to sell-off stocks that we feel won't continue to exceed estimates and aren't trading within a reasonable valuation range. But…
Leggio: And we've talked about consumer discretionary as possibly one example?
Thacker: We've sold off ... absolutely we have moved very aggressively away from consumer discretionary traditional areas, because not only did the stocks become expensive, now we've had the double whammy of huge cost pressures.
So, I don't know if you've been aware of it, but cotton prices are up about 100% year-over-year globally, which puts a big cost pressure on a lot of apparel retailers. Food costs are also going to be a real issue in the back part of the year, and there is simply no pricing power with consumers when they have gas costs up and unemployment still running at 9%.
So, consumer discretionary, we continue to own names, it's always an area where there are growth companies, but it's much less oriented around traditional consumer areas like apparel retail, or food retailers than possibly in the past.
Valuations overall, there are some great valuations in large cap. Our technology fund has been looking at investing in some of these great businesses that are yielding over 10% free cash flow yields to provide a good contrast to, on the small-cap end, maybe owning some dynamic growth companies posting over 50% year-over-year growth. And on the large-cap side owning some ballast in these 10%-14% free cash flow yield names to provide a yin and yang within the fund. But I would say, valuations on the small-cap side, we would probably say they are balanced.
Leggio: Well, Allison, on that note thank you so much for joining us today.
Thacker: Great. Thanks.
Leggio: And thank you for joining us. This is Ryan Leggio for Morningstar.
