Our portfolio declined roughly in line with our benchmark Russell 2000® Value Index in the third quarter. While we have experienced significant losses year-to-date in this difficult market environment, we would note that we are still doing better than the R2V index (-21.1%), which in turn is outperforming all other major indices; the Russell 2000® (-25.1%), S&P 500® (-23.9%), and NASDAQ® (-32.4%).

As we move through the fourth quarter, our attention will focus on two factors. First, we will be looking for a sharp increase in the number of buyback announcements driven by undervaluation. If managements can express confidence in the face of an extremely uncertain economic environment, then we will feel much better about stock market prospects. In retrospect, the lack of this development with second quarter earnings reports was a warning sign that the market had another leg down.

Second, we will be looking at individual stock reaction to disappointing earnings. Specific to our portfolio, we would highlight two companies which we feel could miss printed consensus numbers for their current fiscal year. Vista Outdoor has a division that manufactures outdoor recreation products, and there is currently an inventory glut at the retail level. They also produce ammunition, which too is going through an inventory correction phase. Vista stock finished the third quarter at $24 with a full year earnings projection of over $7.00 (March 2023 fiscal year).

Tri Pointe Homes is trading at $15, with a 2022 earnings projection of $4.80. With mortgage rates rising sharply, incentives necessary to sell homes will undoubtably cut into margins. The question in our minds is how much disappointment is already reflected in the current earnings multiples for these stocks, which would still be extremely depressed, even assuming a 10-20% earnings decline in their next fiscal year. If stock prices in these two companies can weather this earnings report, then we would feel much more confident about our portfolio prospects for 2023 – and note we have picked these companies because we feel they are our holdings most vulnerable to earnings disappointments.

Our strategy focuses on selecting companies AFTER earnings disappointments, not before. We feel that most other companies in our diversified portfolio will be able to manage through a potential recession well. We would expect our portfolio companies to express confidence in their situation through continued buybacks or other restructuring actions. If the market has its normal knee-jerk reaction to earnings disappointments, it does not necessarily imply further downside, but we would interpret the absence of this typical response to have very positive implications.

                                                                                                                                                Abbott J. Keller, CFA

                                                                                                                                            Chief Investment Officer