Granahan Small Cap Focused Growth Strategy Portfolio Manager Commentary
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G R A N A H A N I N V E S T M E N T M A N A G E M E N T I N C
Granahan Small Cap Focused Growth Strategy
Portfolio Manager Commentary
1st Quarter 2020
Goodbye to the Old Decade, Hello to the New, New World
Everything has changed. Abruptly.
The coronavirus pandemic is causing immeasurable pain, suffering and fear. The health crisis has quickly
become an economic crisis, and as with the 9/11 tragedies and other watershed events, this too will
change life and business in ways we've barely begun to comprehend. Going forward, life will likely be
defined by the period “Pre-COVID-19” and the period “Post-COVID-19”. I hope that you and those you love
and care about are making it through this difficult time OK.
Below I'll briefly discuss how the Granahan Small Cap Focused Growth strategy performed in the 1st quarter,
and then quickly turn to discussing the strategy and our lens in a post-COVID-19 world (“post-C-19”).
Q1 Results – A Rough Quarter in the Market, the Focused Growth Portfolio Performed
Relatively Well
The first quarter finished with both large cap stocks and small cap stocks posting their worst quarterly
returns on record, as the Dow Jones Industrial Averaging returned -23% and the Russell 2000 Index of
small cap stocks returned -31%. The Focused Growth portfolio was also down with a return of -17.3% net-
of-fees, which was ahead of its Russell 2000 Growth benchmark return of -25.8%.
The positive variance between the portfolio and the benchmark was a function of stock selection, led by
the consumer discretionary, producer durables, and financial services sectors. We also had strong
selection in the energy sector where our sole holding, Enphase Energy (semiconductor-based
microinverter technology solutions for solar power), rose 38% in the quarter versus the benchmark’s
sector return of -38%. This positive selection in the energy sector was partially offset by our overweight
position versus the Index, which was also the case for the producer durables and consumer discretionary
sectors. On the negative side, selection in the technology sector weighed on performance, though our
overweighting in the sector partially offset the overall effect. The portfolio's lack of exposure to materials
& processing was a positive, though the portfolio faced a modest headwind due to its low weightings in
utilities and healthcare (the two best performing sectors for the Index).What to Do, and What Not to Do ... These are the Questions In the midst of the significant changes brought on by the pandemic, investors may be tempted to radically alter investment course. Given my well-known aversion to attempts at market timing, it probably won’t surprise that I advise caution in this regard. A well-constructed asset-allocation plan is designed for any weather—even that as stormy as today’s. Granahan Focused Growth Post Covid-19: Navigating the New, New World Our Philosophy & Process Remain Sound The Focused Growth strategy has a distinct role within a well-diversified asset allocation plan, one which we believe remains relevant post-C-19. That is, to provide investors with a portfolio of attractively priced stocks of small cap sustainable growth companies – aka, tomorrow's Desert Island companies today. Similarly, our four-part process remains sound in a post-C-19 world. That said, while the philosophy and process have not changed, there are changes in what "Desert Island" means in this new world, what factors 2
go into our expected return (ER) valuation models, the probabilities and range of outcomes in those
models, and how we think about and manage risk at the portfolio level.
1. Company Analysis – Our mission remains to focus exclusively on "Desert-Island-worthy"
companies; that is, those companies that if taken to a desert island for 5-7 years, would be
substantially larger when we returned. In other words, we are not just looking for "survivors"
post-pandemic, but "thrivers." More on this below, but importantly as it relates to process,
focusing our attention on a relatively small number of companies we know well (i.e.,
approximately 100 companies on the "Desert Island Monitor”) allows us to better understand
how each company’s business might be affected by the current environment.
2. Stock Analysis Redoubled – Our Expected-Return methodology uses a multi-scenario probability-
weighted valuation discipline for each stock on the Desert Island Monitored list that incorporates
both good and bad scenarios. For example, we now include scenarios in which the COVID-19
virus persists for a long-time, as well as scenarios in which it is corralled more quickly, and/or
investors discount a quick recovery.
3. Portfolio Management - Our valuation methodology is disciplined. When price movements are
extreme, there are valuation disconnects – some stocks become overpriced, and others
underpriced. Knowing our companies well, and having a clear-eyed view on valuation, enables us
to lean into the volatility – buying shares in some companies, selling shares in others, as we
balance Desert Island worthiness, financial strength, and valuation (expected return and
risk/reward).
4. Risk Management - We have redoubled efforts to ensure that at a company, stock, and portfolio
level, we are conscious of the risks we are taking and that the upside rewards are commensurate
with those risks.
Our Lens: Huge Effects, A Wide Range of Outcomes
In uncertain times, the range of potential outcomes widens both at a macro level and a company level. This
is a very uncertain time. Within our individual stock expected-return models, our baseline cases assume the
economic fallout will be severe and send the U.S. into a recession that lasts … well, a while. In terms of
valuation, we are first focused on making sure companies have the wherewithal to make it to the other
side of the coronavirus-induced recession. Then with this assumption, as we look past the downturn, we
are attempting to project: 1) What a company can generate in terms of sales and earnings 2-3 years out
(i.e., 2022 and 2023); and 2) The valuation multiples investors are likely to place on those metrics.
Seeking Thrivers
We seek to invest in companies that are not just post-C-19 Desert Island survivors (balance sheet and cash
flow), but also Desert Island thrivers. To do so, we attempt to view our companies with the lens of a post-
C-19 everything-has-changed world – emphasizing companies with financial strength, a compelling
customer value proposition, a management team with the vision and ability to deftly execute and who are
doing the right thing in this challenging environment for all of their stakeholders.
This analysis is difficult. We've not been here before, and as I often note, neither I nor anyone else has a
crystal ball. Yet, as forward-looking investors, we need to re-imagine and envision the world on the other
side. A handful of thoughts are listed below. If you have thoughts or suggested additions/changes please
email me at dbeja@granahan.com.
3Imagining Business, Cultural & Behavioral Changes in a Post-COVID-19 World
More Less
Elbow-Bumps Handshakes
Masks & Temperature Taking Hugs & Kisses when greeting strangers
Permanent Social Distancing & Testing for C-19 Annual Deaths Caused by the Flu & Pneumonia
Carding of 50-somethings at Whole Foods' Seniors Hour Carding of Teenagers at Bars' Happy Hours
Individual Savings Individual Debt
US Federal Deficits & Debt US Federal Surpluses & Debt Reduction
Work from Home Packed call centers
Healthcare for All Repeal of Affordable Care Act
Restaurant - Take-out & Delivery Tightly packed sit-down restaurants
WIFW WIFM
(What's in it for We) (What's in it for Me)
Domestic & 2nd Source Suppliers Global Supply Chains
Nesting 2.0 Crowded Sporting Events
(Netflix subs + 30% in March, expect uplift in better TV's & sound systems,
kitchens and furnishings)
Travel Insurance Business Travel
YOLO I'll do that when I retire
Competent and coalition-building politicians Incompetent and divisive politicians
Yoga from home Jam packed yoga studios
Plasma Donors Consumption of street-cart Doner Kebabs
Gardening Unguarded entries
Baking Venture-backing of highly unprofitable companies
Peloton Subscriptions Planet Fitness Subscriptions
Uber & Lyft Crowded Subways and Buses
Telemedicine Waiting in Doctor Offices
Alcohol LeCroix
Hair Haircuts
Focused Growth in the Time of COVID-19
As noted above, our philosophy and process haven't changed, but we are looking at all the variables in our
analysis through a Post-C-19 lens. A few specific company examples might be helpful.
Customer Value Proposition – Just three months ago, the zeitgeist when it came to delivery of consumer
goods was "I need it now." Looking forward I suspect less “need” for 2-hour delivery, and more appeal of a
home-made item from an Etsy (ETSY) seller delivered in a week with a personal note.
4Playing Aggressive Offense - CoStar (CSGP), which provides mission-critical information to the commercial
real estate industry, and also owns/operates Apartments.com (the #1 apartment search site in the U.S.), is
likely to aggressively pursue acquisitions that would be unavailable or unattractively priced during good
times. Thus, while the company has no debt, it recently drew an additional $750-million on its line of credit
despite sitting on a large hoard of cash (roughly $700-million after deducting $537-million the company is
scheduled to pay to acquire Apartments.com’s competitor, RentPath, from Chapter 11 Bankruptcy).
Valuation Matters - Particularly at the portfolio level, we have to balance Desert-Island-worthiness and
staying power, with valuation. For instance, consider OneSpaWorld (OSW), which operates spas on cruise
ships. In "normal" downturns, cruise operators cut prices to keep occupancies full, and OneSpa World is
largely shielded. However, when ships do not sail, the company is not generating revenue. This first-ever
environment, together with a leveraged balance sheet, has hit the stock hard (-77% in Q1). The scenario
where the company's equity is left worthless is a real possibility. Yet, if the company can navigate through
these very troubled waters and avoid Chapter 11, the equity is likely to go up multi-fold from here.
Balancing all of the above, we are currently choosing to maintain our position which is, given the price
move in the stock, a relatively small one in the portfolio.
Taking Advantage of Volatility
In recent weeks we have had an unusually high level of dollar turnover in the portfolio. That is, the
turnover is unusual relative to usual times, though not unusual relative to unusual times. We have sold
some stocks where the long-term pathway to profitability is now more in question – e.g., Casper (CSPR –
direct marketer for online mattresses). We have also trimmed some stocks whose companies are
beneficiaries of the pandemic but where stock gains have left expected-returns and risk/rewards
diminished – e.g., Teladoc (TDOC - telemedicine leader), and Zscaler (ZS – cloud security platform
benefitting from mass adoption of work-from-home).
At the same time, we took advantage of price declines to increase positions in a number of existing
holdings – e.g., EverQuote (EVER, an online marketplace for auto insurance), and SPS Commerce (SPSC,
cloud-based supply chain management software for retailers). We also re-initiated positions in two "oldies
but goodies" that I did not expect we would own again as they had grown too big and too expensive –
Bright Horizons Family Solutions (BFAM, leading provider of employer-sponsored child care centers), and
The Trade Desk (TTD, operates an online advertising platform for ad buyers). The market decline gave us
very attractive entry points to reinvest in each of these stocks.
I suspect we haven’t seen the end of the current period of volatility. Does this mean we will "retest" the
March 18th market lows? That we will break that level? That we will continue the current (as of this
writing) recovery? I don't know … no one does. But if history is a guide, I suspect stocks will discount the
other side well before the fundamentals begin to turn, and that owning a portfolio of stocks of Desert
Island companies capable of solid compound growth will prove worthwhile.
Don't Let a Crisis Go to Waste – Consume Great Content!
If you are looking for some content to pass the time, here are a few ideas:
Two Good Novels -
i. The Plague - Albert Camus' novel presages the current pandemic.
ii. The Dutch House - Nothing to do with pandemics, just a good new novel from Ann Patchett.
5Two Interesting Articles -
i. Bill Gates' Plan Now - In this Washington Post piece Bill Gates outlines the three steps we need to
take now: 1) A consistent nationwide approach to shutting down; 2) Ubiquitous and safe testing;
3) A coordinated data-based approach to developing treatments and a vaccine.
ii. Chris Voss on Negotiating During C-19 - Short blog post by former FBI hostage negotiator Chris
Voss laying out how to work with vendors, clients, and colleagues during the pandemic.
Two Desert-Island-Worthy Series about Broadcast News -
I grew up religiously watching the nightly news with my dad, and I believe fervently that the press plays
a critical role in our society. Thus, the news has a special place in my heart and head. I recommend the
following:
i. The Newsroom - Sits atop my Desert Island list of "Best TV Series Ever.” Just watch the first 8
minutes of Season 1, Episode 1. Jeff Daniels character, Will McAvoy, has a tirade that concludes
with a recipe for the US post-coronavirus. If you aren't hooked on the series after these 8
minutes, I'll refund your money!
ii. The Morning Show - Season 1 was great--I'm anxiously awaiting Season 2.
Summary
On behalf of the entire team at Granahan Investment Management, thank you for entrusting us with the
management of your capital and note that it is managed alongside our own. I should also note that the
team is doing well. We are all healthy, working from home, and collaborating often and productively with
each other.
Don't hesitate to reach out. Please stay safe, know that the sun will shine again, that well-positioned
Desert Island companies will have opportunity to grow, and if we're lucky, we may emerge from this living
in a better/closer world.
Sincerely,
Andrew L. Beja, CFA
dbeja@granahan.com
Disclosure:
The information provided in this commentary should not be considered a recommendation to purchase or sell any particular security.
There is no assurance that any securities discussed herein will remain in an account's portfolio at the time you receive this report or
that securities sold have not been repurchased. The securities discussed do not represent an account's entire portfolio and in the
aggregate may represent only a small percentage of an account's portfolio holdings.
It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the
investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the
securities discussed herein.
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