You may recall my last manager letter, in which I discussed how we had recently sold our position in AeroVironment (AVAV). The aerospace company simply wasn’t demonstrating the attributes (e.g. operational execution) that we look for in a Crabtree holding.
The discussion about AeroVironment was in the context of how autonomous drones are not only an exciting demonstration of technology, but also quickly moving from military applications to police work and shortly to every-day usage.
Despite AeroVironment being a leader in the manufacture of these amazing devices, we still require companies to perform operationally and financially before investing in them and asking clients to do the same.
On March 5, AeroVironment reported its fiscal third quarter (which ended January 26). Instead of reporting the $0.37 per share in quarterly earnings that Wall Street analysts were expecting, the company reported earning a mere $0.17 per share. What’s more, AeroVironment’s outlook for its fourth quarter was lowered dramatically. AVAV shares responded by dropping 25% early the next day.
As part of our investment process, we buy and sell a few dozen positions each year. We try to be cold-blooded in our analysis, closing positions and taking new ones to replace them and remaining disciplined in our strategy.
Because, in my opinion, a lower stock price never turns a bad company into a good one.
Meanwhile, among the companies we do own, February brought with it the second half of fourth quarter earnings season. The following Crabtree companies reported their earnings : ICU (ICUI) Medical, Asiainfo-Linkage (ASIA), Shutterfly (SFLY), Measurement Specialties (MEAS), Cerner (CERN), Cambrex (CBM), MAXIMUS (MMS), Broadridge Financial (BR), Heartland Payment (HPY), NIC Inc. (EGOV), CareFusion (CFN), Gencorp (GY), Cynosure (CYNO), ReachLocal (RLOC), Magic Software (MGIC), Stamps.com (STMP), EnerNOC (ENOC), CONMED (CNMD), Cray (CRAY), eHealth (EHTH), Computer Task Group (CTGX), Bruker (BRKR), Demand Media (DMD), EchoStar (SATS) and Teleflex (TFX).
Most met or exceeded expectations. There were notable exceptions, however. Cynosure (CYNO), Heartland Payment (HPY), Cambrex (CBM), MAXIMUS (MMS) and Shutterfly (SFLY) all beat expectations and issued guidance above prior expectations. Computer Task Group (CTGX) and Broadridge Financial (BR) fell short of expectations.
eHealth (EHTH) reported an excellent fourth quarter, and revenue guidance for the coming year was largely unchanged; EPS guidance for 2013 was below existing analyst consensus, but only because I believe the analysts covering the company were aggressive in their profit margin expectations. There was no change to eHealth’s expected cash flow, market opportunity, or ability to keep taking market share in the self-directed health insurance exchange market.
But the “optics,” as we call them on Wall Street, looked bad, even though they weren’t bad. EHTH shares declined 23% the next day.
So on February 25, we re-balanced the Crabtree Technology model, consistent with our strategy. We ran our quantitative model and out of our technology universe of 1150 companies, 94 passed. Nine existing Crabtree holdings were no longer demonstrating the attributes we like our companies to have and were therefore sold. These were Broadridge Financial (BR), Bio-Reference Labs (BRLI), CONMED (CNMD), Spansion (CODE), CoStar Group (CSGP), Computer Task Group (CTGX), Liquidity Services (LQDT), OSI Systems (OSIS) and Teleflex (TFX).
Replacing those companies were, Ambarella (AMBA), Telenav (TNAV), Jiayuan.com (DATE), Aviat Networks (AVNW), Silicon Graphics (SGI), Aeroflex (ARX), Portugal Telecom (PT), Cabot Microelectronics (CCMP), Hexcel (HXL) and Mine Safety Appliances (MSA).
Additionally, we trimmed three positions that had growth substantially, reducing them once again to roughly 2% of the portfolio: Audience (ADNC), EnerNOC and Shutterfly. And we added more to names in which we are confident, but whose performance had recently dropped them below 2%: Demand Media, LSI and, yes, eHealth.
Between the February 25 re-balancing and the end of the month, seven Crabtree holdings made earnings announcements: Accelrys (ACCL), Anika Therapeutics (ANIK), Jiayuan.com, American Software (AMSWA), EPAM Systems (EPAM), Catamaran (CTRX) and American Public Education (APEI).
Most met or slightly exceeded expectations; American Public Educations met expectations but its first quarter guidance was disappointing. Jiayuan.com (DATE), on the other hand, not only beat fourth quarter expectations by a wide margin, but also issued guidance for its first quarter that was well above the Street. Shares of DATE (the company is the largest online matchmaking web site in China) rose 7% the very next day.
Overall performance for the Crabtree Technology model in February was solid: modest on an absolute basis, but ahead of all the relevant benchmarks. The model gained 2.2% in the month (net of advisor fees), compared with a 1.0% gain for the Russell 2000 benchmark and a 1.1% gain for the S&P 500 (SPX). Our internal benchmark, the Merrill Lynch Technology 100 (MLO) rose 1.3% during February.
With Q4 earnings season now behind us, and the next portfolio re-balance scheduled for mid-May, I believe March ought to be a quiet month. But running a technology model means we’re prepared to be surprised. No matter what happens, we’ll report it in detail in next month’s letter. But if you have any questions or comments, you can reach us any time at firstname.lastname@example.org.
The investments discussed are held in client accounts as of March 1, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.
The Merrill Lynch 100 Technology Index is an equal-dollar weighted index of 100 stocks designed to measure the performance of a cross section of large, actively traded technology stocks and ADRs. The index was developed with a base value of 200 as of January 30, 1998.