Brian Bares on Investing in Small-Cap Quality Companies

We are pleased to bring you an interview with Austin, Texas-based investor Brian Bares. Bares started his investment firm, Bares Capital Management, in 2000, focusing initially on micro-cap public companies. The firm launched a small-cap institutional strategy in 2001 and now manages assets in two value-oriented strategies. Bares Capital Management is quite unique in the institutional asset management world, as it has adhered to a disciplined business strategy, limiting the growth of assets under management to benefit investment performance. Both of Bares’s institutional strategies have beaten their respective benchmark indices by wide margins since inception.

MOI Global: Since starting your firm nearly ten years ago, you have focused on investing in small public companies. What prompted this focus, and has your approach changed at all in light of the fact that many large companies have looked inefficiently priced recently?

Brian Bares: There are really two reasons for our focus on small companies. The first is that small companies are more likely to be inefficiently priced. Our investment process mandates a comprehensive understanding of our portfolio companies. It is much more likely that we can profit from this understanding in small caps, where information scarcity allows for opportunity. We also cap assets to maintain our focus on small companies. Our competitors have a difficult time running a strategy like ours because success creates profit motives that tend to move them up the market cap spectrum or into excessively diversified portfolios in order to accommodate a larger asset base.

The second reason is structural. Our firm manages money in replicated separate accounts, and our relationships are largely direct with foundation and endowment clients. These clients employ many specialist managers in a number of different niche areas. They understand that our value to them is our area of competence: small-company common stocks. And they pay for our best ideas as we typically hold between 10 and 20 positions. Our clients allow us to do this because they have other managers looking at mid- and large-caps, international companies, commodities, real estate, etc. So we have really absolved ourselves of making many difficult macro and asset allocation decisions. Instead, we simply hunker down and focus on our little corner of the market. Our success is judged against small company benchmarks. The only time we think about what is happening with large-caps, international stocks, and other asset classes is when factors affecting these could affect the underlying business performance of the companies we own.

MOI: When it comes to stock selection, what are the key criteria you look for? Is there a price at which you would buy into a bad business, or do you weed out such companies before valuation even enters the picture?

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