Commentary - March 2024Greenspring Mid Cap Fund

Portfolio Managers Chip Carlson, CFA and Michael Goodman, CFA discuss current valuations, the preferred qualities of mid-cap companies they favor, and current catalysts that may be overlooked by investors.

Would you please discuss current valuations of mid- and large-cap stocks?

Last year, there was a growing disparity in the price-to-earnings (P/E) multiple of mid- and large-cap stocks. Specifically, by the end of 2023, the forward P/E of the Russell Midcap Index was about 15% lower than the P/E of the S&P 500 Index. This differential was nearly the largest in over a decade.

Although both indices rose during the first quarter of 2024, the valuation disparity between mid- and large-caps has grown even wider. Given this trend, we believe mid-caps continue to look attractive.

As an actively managed Fund, would you please describe the qualities you seek in mid-cap companies?

We are bottom-up, fundamentally driven managers looking for “All- Weather” mid-sized companies that are well-positioned to create long-term value regardless of the economic environment. We are always looking for companies that generate ample free cash flow, have strong balance sheets, and have experienced management teams with solid track records of deploying free cash flow in shareholder-friendly ways.

These qualities provide the opportunity to create shareholder value in several ways, including the financial flexibility to pursue acquisitions, reinvest in the business, or repurchase shares. We also seek companies with company-specific or industry catalysts that can help drive earnings and cash flow per share growth over time.

By focusing on these financial attributes, we aim to position the Fund with companies that offer higher free cash flow, better growth potential, and less leverage compared to the broader mid-cap market.

What is a current industry catalyst or tailwind that could benefit individual Fund holdings?

Currently, there is tremendous interest in investment opportunities associated with artificial intelligence, cloud computing, electrical vehicles, the reshoring of manufacturing back to the U.S., and energy sustainability and efficiency. Several high-profile companies involved directly in these new technologies garner significant media attention. However, a large and very diverse ecosystem of quality companies participates in these secular themes and may benefit greatly but often fly under investors’ radar.

For example, MYR Group is one Fund holding that has created significant shareholder value by positioning itself to benefit from multi-year industry growth tailwinds. MYR is a specialty electrical contractor that helps build the electrical infrastructure critical for many new technologies to function efficiently or expand. Its highly skilled workforce is relied upon to build the complex power configurations required by data centers, as capacity is expanded to support the growth of artificial intelligence and cloud computing.

In addition, companies looking to bolster supply chains rely on MYR to provide the electrical services needed to expand domestic manufacturing capabilities and develop new facilities for various high-tech industries. The company also has a large business unit serving electric utilities’ transmission and distribution needs. This segment provides specialized services to modernize and improve the reliability of the electric grid, critical to connecting new sources of renewable power generation and addressing changing electric power distribution requirements, such as the build-out of an electrical vehicle charging network.

In recognition of its attractive prospects, MYR’s valuation multiple has expanded and earnings have increased—a powerful combination for shareholder returns. MYR also has a strong balance sheet, solid free cash flow generation, and a long-tenured management team.

Despite being less glamorous than many of the industries it serves, we expect MYR to continue to grow shareholder value throughout a variety of macroeconomic and equity market environments.