In the extremely difficult market environment, which characterized the first half of 2022, we performed about how we would have expected. We held up very well in the first quarter, and then as the decline accelerated, our correlation with the Russell 2000® Value Index moved closer to parity as almost all stocks were dragged down. We still managed to outperform the index slightly in the second quarter, and extend our outperformance year-to-date. The relative good news is that virtually all other sectors did substantially worse, with first half losses for the Russell 2000® Growth and NASDAQ® indices each approaching 30%.

While it is convenient to blame all of our losses on market movement, we did have our share of analytical clunkers. Most managements of our companies are unlikely to earn bronze plaques in the pantheon of management all-stars – if they were in that category, their companies would not have dropped into our universe. In transitional periods like the second quarter, management weaknesses become more apparent. Sometimes, even our relatively modest expectations of competence are not met.

Big Lots had the incredible good fortune of being able to keep all of their stores open in 2020 (they sold food items) while many of their competitors were forced to shut down. Results deteriorated through 2021, as operational issues developed, but the chain remained highly profitable. In the second quarter of 2022, their chief merchandising officer finally managed to get in front of supply chain issues by ordering huge quantities of big-ticket items such as furniture – just as demand was dropping off sharply. With inventories +40% and major markdowns looming, we sold our position before things got any worse (for the now ex-CMO, we would find him eminently qualified for a retail job that involves the phrase “would you like to supersize that”).

On the bright side, in difficult times, you can always rely on taxes. Our big winner for the quarter was H&R Block. They are having some success improving their base with both small business customers and unbanked consumers. Their major competitor (Intuit) is also under more regulatory scrutiny. While taxes might be the star performer in times of extreme uncertainty, we are seeing a shift in buyback announcements to areas of high cyclicality, where stock prices are depressed, particularly housing and retail. Recent additions to the portfolio include Tri Pointe Homes, Torrid Holdings (plus-sized apparel), and Dine Brands (Applebee’s and IHOP). At quarter-end, Tri Pointe traded at nearly a 30% discount to book value, which might be an even better measure of undervaluation than the exceptionally low P/E of less than 4x current year estimated (but likely unsustainable) earnings. Either way, an attractive investment.

We believe we are at the beginning of a long-term trend of value outperforming growth. Having said that, we would not be surprised to see some of our companies reporting disappointing numbers for the second quarter as they react to slowing demand in a transition period. We do expect to see a wave of motivated buyback announcements, which will give us fertile hunting grounds for potential replacement names.

                                                                                                                                                Abbott J. Keller, CFA

                                                                                                                                            Chief Investment Officer