1. finance
2. investing
3. stocks

 The N.A. Stewart Capital Management LLC Small Cap Strategy
…Is an actively managed portfolio of 12-25 businesses that form a unique subset of the small
cap stock universe. The strategy looks not just for outstanding economics (as defined by free
cash flow, return on invested capital (ROIC), hidden assets, and a sustainable competitive niche,
but also for the “owner operator” management model. By this I mean companies where the CEO
is often a founder and/or the management team is major shareholder in the business. I believe
that owner-operator CEOs bring a passion to their businesses and an alignment of interest with
other shareholders that is seldom matched by employee CEOs.
Stocks selected for the portfolio will generally fit the following profile:
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A Market capitalization of between $100 Million and $2 Billion dollars (The average
market cap as of 4/20/2015 is approximately $440 Million)
An “owner-operator” management model – The CEO is a large shareholder, or even the
founder and controlling shareholder
Strong gross margins and operating margins
Strong return on invested capital (ROIC)
Prudent capital allocation policies – our companies often pay special dividends or buy
back their own shares when they are undervalued. They are opportunistic in their
financial decisions. For example, you can expect many of these companies to pay a large
special dividend if there is a future tax increase on dividend income.
A stable business model with reliable, recurring revenue
A durable competitive position or market niche
A lack of mainstream coverage or understanding
Less liquid trading volume and a relatively small float (shares that can be purchased by
outside investors), which discourages institutional participation
These companies are usually in “non-glamor” industries that don’t attract much in the
way of media headlines or accolades
The strategy prefers steady, persistent growers and free cash flow to volatile “shooting
stars” and “media darlings”
Most holdings have below average sensitivity to the overall stock market (called beta) –
these stocks “march to their own drum” much more often than the average stock
Occasionally:
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The GAAP (Generally Accepted Accounting Principles) balance sheet accounting hides
undervalued or irreplaceable assets that create the prospect of future gains if and when
monetized. An example of this would be real estate assets whose value is not correctly
reflected on the balance sheet.
The strategy might invest in smaller or larger capitalization “owner-operator” businesses
that I view as exceptional and which otherwise fit our criteria
When it comes to selecting individual securities, I assess:
1. The business’s underlying quality
2. My estimate of the business’s fair valuation
3. The CEO’s track record and incentives
Business economics matter – but so do people
While valuation and “the numbers” are critical, this strategy focuses heavily on management
incentives and stock ownership. The ideal situation is to find a business with great economics
that is being managed by what I call a “wealth creating” CEO.
Allow me to explain that last statement. In studying various small capitalization companies, I
have noticed that some leaders persistently create wealth for shareholders, while others move
from blunder to blunder or absorb all of the positive economics of even a very good business for
themselves (via stock-based compensation or other measures).
We want to invest with the first group, the wealth creators, while staying as far away from the
second group as possible. Bottom line: we want to invest with leaders who get rich with
shareholders – not at the expense of shareholders.
Value is good – yet good businesses are great
When it comes to value, “undervalued” is ideal, however fair value is often an excellent purchase
price for a good business. Good companies with great leaders are usually not undervalued,
except in rare circumstances. Waiting for “great value” on a wealth-compounding stock could
mean sitting out and missing many years of gains.
Who should invest?
This strategy is intended for sophisticated investors who would like to make a long-term
investment in a concentrated portfolio of small-capitalization businesses. This strategy requires
a long-term perspective for a number of critical reasons. First, I want our results to reflect the
success of the underlying businesses over time – and this process itself takes time. Second,
these stocks usually have lower liquidity relative to other common stocks. This means that they
are more expensive to trade – to offset this, we must have a longer-term holding period.
My way of thinking about it is that we are buying a partial share in a private business that “just
happens” (fortunately for us) to be publicly traded. The portfolio manager believes that potential
investors should plan to invest in the strategy for at least five years, and preferably longer.
Investors should consider this investment as a long-term allocation within a larger portfolio similar to the endowment model that is utilized by institutional investors.
My philosophy on investing client capital
The number one focus of N.A. Stewart Capital Management LLC is on achieving strong results
for existing clients – not the maximization of assets under management or the number of client
relationships. Capital contribution to this small-cap strategy will be capped at $40 million.
After this point, all potential gains in assets under management will come from returns generated
in the market – in other words, asset growth will reflect gains made by investors.
Niche strategies (such as focused small-cap) are destroyed by continuous fund-raising
The problem with “raising money” is that in niche strategies, capital raised beyond a certain
point dilutes the return of existing investors – much like a corporation can dilute shareholders by
issuing stock. This is because the best ideas must be split between more investors, which
prevents an ideal allocation of each new idea to each specific investor. I am determined to take a
different path.
My business goal for this strategy is to get assets under management to the 40 million dollar
figure as quickly as possible, after which point I will be 100% focused on the investment process
- following events at portfolio companies, making decisions as to how or when to add companies
to the portfolio, and correcting mistakes (which are inevitable, unfortunately) as they reveal
themselves.
Tax efficiency will always be considered
The portfolio will utilize tax minimization strategies if and when possible. An example of this
would be selling and reallocating any investments presently trading at a loss relative to our
purchase price if and when large gains are taken in a different holding, as part of the loss taken
can be used to offset the taxable gain. This strategy is particularly likely to occur if I believe
that a different stock that the strategy is not presently invested in offers an equal or greater
opportunity relative to the position(s) being sold.
Why is this a niche strategy relative to other small-cap approaches?
For a few very important reasons. This strategy often invests in securities that have a large or
majority shareholder and/or a relatively small number of shares outstanding. This means that the
“float” (number of shares available to be purchased by the public) is not large. There are simply
not enough shares for everyone who might like to invest (such as large funds) in many of these
companies. Combine the above with our philosophy of focusing the portfolio in a relatively
small number of investments, and the capacity constraint becomes an issue that can’t prudently
be ignored.
As a result of this philosophy, it is important for investors be are a good “fit” with the program
and its objectives. Suitability will be critical to the success of each investor and to the
investment program itself.
Conclusion:
My firmly held belief is that by investing in small, first class businesses with great leaders,
investors will be rewarded (over time) with an above-average return relative to the risk taken.
If you have any questions about this strategy or its potential suitability to your investment
objectives, please do not hesitate to contact me.
Nathanael Stewart, CFA
N.A. Stewart Capital Management LLC
909 West Washington Boulevard Unit 604
Chicago, IL 60607
312‐343‐3842
www.nastewart.com