U.S. Small and Mid Cap

U.S. Small & Mid Cap

Seeks to find the best domestic small and mid-cap companies built for the long term

Investment Objectives

The investment objective of the U.S. Small & Mid Cap Strategy is to achieve long-term capital appreciation. The model pursues its objective by investing primarily in common stocks of U.S. companies. We seek to earn market-beating returns by searching for high-conviction, high-quality companies among the small and mid-cap companies based in the United States.

Portfolio Managers

Who should invest?

We believe that all long-term investors benefit from investing in smaller and mid-cap companies in the United States, as they tend to be less followed than their large-cap peers. Since the adoption of Regulation Fair Disclosure in 2000, the number of companies in the United States that have more than one Wall Street analyst covering them has dropped precipitously. We believe that this lack of coverage lowers the level of efficiency in pricing among smaller companies, as evidenced by their wider price swings relative to their larger compatriots. In time, investors with a significant enough time horizon should benefit from being able to buy (and sell) at advantageous points in time.

Philosophy and Strategy

The U.S. Small & Mid Cap Strategy pursues its investment objective by using a growth at a reasonable price investing style. The strategy invests in high quality domestic companies that have market capitalizations similar to its benchmark, the S&P MidCap 400. We do not time the market and aim to be fully invested at all times.

In our research to identify high quality businesses we evaluate four criteria: management, culture, and incentives; the economics of the business; competitive advantage; and the durability of the competitive advantage period.

Management, Culture, and Incentives

We believe that management is a key element to long-term success at most businesses. We evaluate the management team and the board of directors with particular attention paid to the clarity of their strategies, corporate culture, management tenure and turnover, ownership in the business, compensation structure, capital allocation choices and results, and overall treatment of stakeholders.

Economics of the Business

The economic performance of a company is a key signal of its quality. Our research process evaluates long-term returns on capital in all business environments, the scalability of the business model, profit margin trends, business and product cyclicality, and business specific key performance indicators.

Competitive Advantage

Competitive advantages allow a company to generate attractive returns on capital for a sustained period of time. We assess a company’s pricing power, barriers to entry, network effects, brand strength among other factors.

Durability of Competitive Advantage Period

We consider what a company is likely to look like over the next ten years. Is the business likely to grow, become more profitable, introduce new products, etc? Does the company have the financial resources and management acumen to become a larger and stronger business than it is today? We are wary of businesses that look fantastic over short periods of time due to a favorable product cycle or fickle consumer preferences.

The portfolio managers believe that investors in the small and mid-cap model should have a long-term investment horizon of at least three years.

Portfolio Management Process

We are long-term investors looking to find companies that we can own for many years to come, so you should not anticipate much trading activity on a day-to-day basis To ensure a diversified portfolio, we expect to own at least 30 companies at all times.

Most positions will be between 1.5% and 5% of the portfolio. We will let our winners run to larger position sizes, but for portfolio risk management purposes, we limit our exposure to any one holding to 8% of the portfolio’s total value. While we do not intend to invest in all industries at any one time, we will not put more than 40% of the portfolio into any one industry.

However, in the event that a particular portfolio holding or exposure to a particular industry exceeds our position size guidelines discussed above, we will not mechanically sell a position or trim industry exposure. Rather, we will take appropriate measures to reduce position sizes in a manner consistent with our investment tenets and prudent management.

Investors should recognize that liquidity is often lower in smaller-capitalization stocks, which sometimes manifests itself as higher volatility than with larger, more efficiently traded companies. We ignore the natural ups and downs of individual stocks and the portfolio as a whole as long as the price moves are not due to either deteriorating business performance or worsening economic conditions. We evaluate all earnings reports and if a company is not meeting our expectations we will sell it.

Investment Risks

The value of investments in the U.S. Small & Mid Cap Strategy may increase or decrease, which will cause the value of the investor's portfolio to increase or decrease. Investors may lose money on their investment and there can be no assurance that the strategy will achieve its investment objective and goals.

The principal risks inherent in this strategy are:

Equity Risk

The stock of any company may not perform as well as expected, and may lose value, because of factors related to the company, including adverse developments regarding the company's business, poor management decisions, or changes in the company's industry or popularity of its goods and services. In the event a company becomes insolvent, stock holders will generally have lowest priority among owners of that company's obligations as to the distribution of the company's assets. Stocks may also be affected by general market and economic factors, even when their companies' respective business fundamentals are unchanged.

Small and Mid Capitalization Companies

The securities of smaller companies may involve greater risks than do those of larger, more established companies, because the small companies may, for example, lack the management experience, financial resources, product diversification and competitive strength of larger companies, and their trading may be more volatile.

Please see Appendix B to our Investment Advisory Agreement for a discussion of additional risk associated with this strategy. A link to the Investment Advisory Agreement is provided at the bottom of this page.

Each Personal Portfolio is subject to an account minimum, which varies based on the strategies included in the portfolio. Motley Fool Wealth Management retains the right to revise or modify portfolios and strategies if it believes such modifications would be in the best interests of its clients, and we may modify allocations within a client's account subject to the constraints of each client's current risk score and objective. Clients should be aware that their individual account results may not exactly match the performance of the Model Portfolios.

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