Pembroke Concentrated Fund Commentary


October 2023


Taking Advantage of Uncertainty

In 2023, equity markets faced significant challenges. A resilient economy and solid employment figures were overshadowed by concerns such as persistent inflation, increasing interest rates, and looming recession fears. Additionally, the ripple effects of the COVID pandemic persist.

Many businesses are still addressing the surplus inventory accumulated during the early phases of the economy’s reopening. Amid these challenges, several companies have scaled back discretionary expenditures on projects, like IT upgrades. Driven by rising wages and input costs, management teams are emphasizing cost reduction to safeguard profit margins. This has led to what can best be described as “rolling recessions,” impacting different sectors at various intervals.

From an investment standpoint, this climate of uncertainty has prompted a surge towards cash and fixed-income securities. Ironically, the after-tax returns on many of these “safe” securities are lagging behind inflation rates.

The Silver Lining

Yet, within these challenges lie opportunities. The rising capital costs are prompting business leaders to scrutinize their operational costs. Notably, several high-growth, low-margin entities are now prioritizing profitability and free cash flow. This shift in focus is not the only sign of optimism. Technological innovations, particularly in artificial intelligence, are heralding a fresh investment era. Companies with robust financial health are capitalizing on this phase, acquiring distressed or smaller rivals. The aim? To re-emerge from the downturn stronger and more profitable.

From an investor’s perspective, there is an impending need to seek returns to outpace inflation and maintain purchasing power. Interestingly, a recession might alleviate certain economic strains, like labour shortages. This could result in decreased interest rates, giving investors a renewed sense of confidence.

Pembroke’s Approach

At Pembroke, our strategies hinge on meticulous market analysis. We rigorously assess our holdings for valuation, balance sheet resilience, and their track record in navigating past economic challenges. The nature of the market’s trajectory—whether it is a “soft” or “hard” landing—does not define our approach. Instead, our focus is on backing companies equipped to withstand either scenario.

The prevailing market dip presents investment opportunities, particularly in franchises witnessing plummeting valuations as investors gravitate towards cash. Historically, larger cap equities tend to be more resilient in tough market climates. However, 2023 has been an exception. If we exclude the performance of a few dominant mega-cap companies in the U.S., numerous large capitalization stocks are also floundering.

For Pembroke’s core small- and mid-capitalization growth strategies, the current valuation combined with solid fundamentals hints at a promising recovery. Predicting the exact timing of such upturns is inherently challenging. The market’s volatility in 2023 can be disconcerting. In fact, 2023 is on its way to being the fourth straight year during which the Russell 2000, the major index of small- to mid-cap equities in the U.S., moves by more than 1% on 40% of trading days.

Fortunately, prior periods marked by similar activity, such as the Internet bubble and the Great Financial Crisis, were followed by strong market moves to the upside (Furey Research Partners, October 2023). Until investors get comfortable that inflation and interest rates have peaked and that a severe recession is not around the corner, it is entirely plausible that the stock market will continue to face adversity.

Pembroke advocates for patience, diversification across various asset classes, and sound investment planning that balances near-term needs against long-term financial goals. Timing market turns is a “mug’s game,” while careful asset allocation and disciplined, strategic rebalancing between asset classes is the key to long-term success.

Pembroke Concentrated Fund

Over the last year, the Pembroke Concentrated Fund (PCF) gained approximately 9.6% compared to a 7.4% gain in the Fund’s benchmark, the Russell 2000 Index (R2000).

* All performance metrics stated for PCF A-Class units in Canadian dollars. Detailed performance by class and currency listed below.

1-Month3-MonthYTD1-Year3-Year5-YearSince Inception, annualizedSince Inception, cumulative
PCF A, CAD-7.76 %-6.76%3.51%9.58%5.25%7.28 %10.36 %74.79%
PCF A, USD-7.71%-8.82%3.48%11.32%4.69%6.32%8.50%58.73%
PCF F, CAD-7.85%-7.03%2.62%8.28%4.03%n/a6.98%31.00%
PCF F, USD-7.80%-9.08%2.60%10.00%3.48%n/a6.40%28.05%
R2000, CAD-5.96%-3.12%2.36%7.44%7.65%3.29%5.37%34.54%
R2000, USD-5.89%-5.13%2.54%8.93%7.16%2.40%3.62%22.33%
S&P 500, CAD-4.95%-1.61%11.48%17.96%8.93%8.98%9.47%67.01%
S&P 500, USD-4.87%-3.65%11.68%19.59%8.44%8.03%7.65%51.85%

Performance Commentary

Since its inception in January of 2018, PCF has compounded value at approximately 10.4% per annum, compared to the R2000 at roughly 5.4%. The PCF declined 6.8% in the third quarter of 2023, but has gained 9.6% in the last 12 months, compared to the R2000’s 3.1% decline in the third quarter of 2023, and 2.4% gain over the trailing 12 months.

Our weak relative record in the last quarter was driven by challenging market factors, sector moves, and short-term performance issues by several of our higher quality investments in technology and health care. On the market factor side, value factors, such as high financial leverage and cheap valuations performed well in the quarter, while traditional growth factors suffered.

From a sector perspective, roughly two thirds of our relative underperformance in the quarter was due to our lack of energy, financials and consumer staples stocks. As PCF investors will know, we avoid energy and financials investments due to the binary risk inherent in both sectors. As for consumer staples, we struggle to find businesses in the small- to mid-cap range that can satisfy both our strict quality and growth requirements.

Lastly, on the micro side, we had a series of high-quality names give back some strong year-to-date performance, despite solid fundamental prospects.

Two stocks that made positive contributions to returns of the strategy during the past quarter

Shares of Sprout Social, Inc. (“SPT”) rose by over 8% in the third quarter of 2023, in contrast to the Russell 2000 benchmark, which declined by more than 5%. SPT reported robust revenue and free cash flow for the quarter, significantly surpassing consensus forecasts. Beyond the financial metrics, SPT has sustained its rapid growth trajectory and solidified its leading position in the highly consolidated social media management software market. The company recently acquired Tagger, the premier provider of influencer marketing software. We view Sprout as a distinct leader in a vast, yet under-penetrated market, characterized by swiftly growing margins and steered by an aligned management team.

Shares of Stoneridge, Inc. (“SRI”) appreciated by over 6% in the third quarter of 2023, while the Russell 2000 benchmark declined by more than 5%. SRI has demonstrated strong performance as automotive production and demand have rebounded from the lows experienced during the pandemic. The company’s growth rate has surpassed the market, it has been successful in widening its margins, and it has preserved its competitive stance and relevance to major industry trends, reinforcing our original investment premise. We maintain our confidence in the potential and anticipate several years of consistent growth in the future.

Two stocks that made negative contributions to returns of the strategy during the past quarter

Shares of Paycom, Inc. (“PAYC”) fell nearly 19% in the third quarter of 2023, while the Russell 2000 benchmark saw a decline of more than 5%. PAYC’s projected revenue growth for the latter half of 2023 did not sit well with the market. The company projected its growth rate to be in the low 20%, a step down from the 30% expansion observed in 2022. Additionally, the market perceives PAYC, in its role as a payroll processor, to be vulnerable if a recession materializes and unemployment rises. While we refrain from making short-term economic or market predictions, we recognize in PAYC a company that boasts revenue and earnings growth exceeding 20%, coupled with impressive margins, returns, and free cash flow. Additionally, PAYC has a robust balance sheet, a dedicated management team, and a valuation that appears quite reasonable. We remain confident in the business’s quality and see tremendous potential in the stock for the long haul.

Bio-Techne (“TECH”) stands as a premier supplier of consumables and analytical instruments pivotal for life science research and advanced drug production. The pandemic acted as a catalyst for growth in research, as biotech firms amassed unprecedented capital. Concurrently, vaccine manufacturing resulted in remarkable profits for pharmaceutical entities and their corresponding suppliers. This period also saw an unparalleled surge in merger and acquisition activities, inducing substantial valuation growth for the sector. However, fast-forwarding two years reveals an industry contending with challenges, which drove valuations to historically low levels, creating an opportunity for patient investors. Elevated interest rates have curtailed the allure of long-duration assets, causing biotech funding to revert to levels observed between 2018 and 2019. Consequently, less financially secure biotech entities have adopted stringent cash conservation strategies. Another challenge emerged from supply chain disturbances, prompting customers to overstock inventories, which they have been depleting throughout the year, affecting their suppliers. Nonetheless, Pembroke remains optimistic, perceiving these challenges as fleeting, and believes in Bio-Techne management’s recalibrated long-term growth and profitability projections, as unveiled during their recent analyst day. With an available arsenal of $5 billion for merger and acquisition pursuits, and given the industry’s subdued valuations, Bio-Techne is strategically poised to make counter-cyclical acquisitions of distinctive and rapidly expanding assets. Pembroke posits that as a critical equipment provider in the biotech arena, Bio-Techne offers an enticing avenue for investors to be exposed to this perpetually growing industry, while circumventing the inherent uncertainties tied to drug development.

Portfolio Actions

Our trading activity was above average in the quarter, with one new position added (Watsco), one sold (Shutterstock), along with more typical portfolio maintenance: we trimmed winners and added to relative underperformers.

Watsco (‘WSO’), the largest independent distributor of heating ventilation and air conditioning (HVAC) in North American, is one of the highest-quality and well-run businesses in all of Pembroke’s portfolios, and a stock long considered for inclusion in PCF. As PCF investors know, it is not sufficient to simply be a high-quality growth business: the entry point matters. We require 100%+ upside on a four-year basis, using reasonable valuation assumptions. In the case of WSO, we benefitted from a sell-off in the stock following a strong earnings report and compelling inorganic growth, such that our upside requirements were finally met. While the stock entered the portfolio with a relatively low weight (3%), we will look to add on any weakness going forward.

We sold out of Shutterstock (‘SSTK’) because it triggered our first stop-loss threshold limit. As we discussed last quarter, SSTK has battled the prevailing artificial intelligence (AI) narrative that traditional stock images will quickly lose share to AI-generated images. While our fundamental work points to AI as a near and long-term benefit to the company, the stock market is deciding otherwise. Our sell discipline is informed by 55+ years of Pembroke history in small- and mid-cap growth markets, so when it triggers, we respect it.

In addition to WSO, we added meaningful weight to Globus Medical (‘GMED’), Bio-Techne (‘TECH’) and Core & Main (‘CNM’), by trimming several recent winners with lower-than-average upside to our four-year target prices. We find GMED particularly interesting at these levels, as the market is baking in the worst-case scenario for their recent acquisition of Nuvasive, an excessively punitive outcome in our opinion. We see a stronger company than before the acquisition, a solid organic growth profile, a good competitive position, and the best management team in the space. All that points to a 100%+ upside on our four-year target price.

Portfolio Characteristics

Pembroke believes that a portfolio of stocks containing the following attributes, over the long-term, should better protect capital in down markets and outperform in up-markets. Our holdings generally show faster growth, higher margins, higher returns, and are better financed and more aligned with investor interests, as compared to the market. While we pay a slight premium over the near-term, our portfolio’s faster growth rate typically reverses that dynamic. As we often say, PCF is “near-term expensive, mid- to long-term cheap.”


MetricStrategyRussell 2000
Price/NTM Earnings23.3x18.8x
NTM Sales Growth10.5%4.7%
NTM Earnings Growth9.9%7.4%
Return on Equity (ROE)12.3%8.0%
Return on Invested Capital (ROIC)12.0%5.3%
Net Debt to NTM EBITBA0.3x1.8x
Market Cap in $ Billions (Weighted Average)$7.72$2.86
Insider Ownership11.4%4.6%


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This report is for the purpose of providing some insight into Pembroke and the Pembroke funds. Past performance is not indicative of future returns. Any securities listed herein, are for informational purposes only and are not intended and should not be construed as investment advice nor is it a recommendation to buy or sell any particular security. Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Pembroke seeks to ensure that the content of this document is correct and up to date but does not guarantee that the content is accurate and complete and does not assume any responsibility for this. Pembroke is not responsible for decisions or actions taken or made on the basis of information contained in this document.