The beat goes on. While the phrase generally refers to music, in this case it applies to the first quarter performance of the S&P 500® (up over 10%) compared to the Russell 2000® Value Index’s 3% gain. Led by Nvidia’s 82% gain and other artificial intelligence related stocks, the S&P 500® and NASDAQ® continued their market dominance. Sadly, our portfolio lacked any direct AI exposure (a cynic might say there were other kinds of intelligence missing as well), and we lagged slightly behind even the R2V index. We generally do not perform well in frothy markets, given our focus on risk avoidance.

One area where we will occasionally take risks is with financially leveraged companies, as long as we are convinced that their excess cash flow is sufficient to both manage interest payments and return cash to shareholders. We find investor bias against leveraged companies sometimes presents opportunity. Our biggest winner in the quarter was Tenet Healthcare (+39%), a leveraged owner of hospitals and surgery centers. Tenet enacted several transactions in the quarter, selling hospitals at a higher multiple of earnings than was implicit in the stock price. Sale proceeds are being used to pay down debt, bringing Tenet’s leverage down to where investors don’t seem to be applying a penalty any longer.

Of course, leverage cuts both ways. We sold our position in struggling retailer Kohl’s at a small loss during the quarter. We had stayed with the company through a management change, when an experienced retailer who had previously been responsible for a turnaround at Burlington Stores took charge. While we were encouraged by modest fundamental improvements taking place in the business, a recently proposed legislative change in maximum allowed credit card late fees from $32 to $8 per month concerned us. Kohl’s has a large credit card portfolio and this change could affect profitability. Given Kohl’s high leverage and the difficult retail environment, we were not willing to take this additional risk. Risk minimization remains the dominant feature of our investment approach, and we will not compromise to fit a “risk on” market environment.

How long will the beat go on? A former Citigroup CEO once famously said “as long as the music is playing, you need to get up and dance”. We are still dancing, but apparently to a rhythm that few people are able to hear yet. We expect that the dance will end badly for some of the large cap technology stocks leading the current advance. Our hope is that current investors learn to dance to a different tune – one that favors small cap value stocks.

                                                                                                                                                Abbott J. Keller, CFA

                                                                                                                                            Chief Investment Officer