Surprise , Surprise
Farsalas became a portfolio manager on the fund in 2015 , and he ’ s now the lead manager . James Oberweis , president of Oberweis Asset Management in the Chicago suburb of Lisle , Ill ., is listed as a co-portfolio manager . ( He ’ s also the firm ’ s chief investment officer .)
The three analysts on the investment team screen every day for micro-cap companies that have reported significant positive earnings surprises .
“ Our edge is at the company level , where we analyze what ’ s driving better-than-expected results ,” Farsalas says . “ We believe that investing in micro-cap companies that are growing earnings beyond expectations allows us to generate strong performance for our clients over the long term .”
Part of that is finding companies whose businesses , the team believes , are fundamentally misunderstood , a disconnect that might allow the stock to keep surprising on the upside . Sussing that out entails a 17-step fundamental research process that seeks to identify the reason for earnings surprises and a company ’ s perceived durability .
The team forecasts what they think the company can earn over the next 12 to 24 months . “ Looking out beyond two years for earnings in the micro-cap world is an exercise in futility ,” Farsalas says . “ We want to understand what we think the business could earn , and we compare that with Wall Street consensus expectations .
Manager Ken Farsalas Age 53
The delta between those two things is the earnings gap . All else being equal , the larger that earnings gap the more compelling that investment idea is .”
PEAD Syndrome
Farsalas says the firm ’ s investment philosophy is based on behavioral finance . “ We try to exploit a specific phenomenon called ‘ post-earnings announcement drift ,’ or ‘ PEAD ,’” he says . This relates to behavioral biases where investors tend to underreact to new information that shows up in an earnings report .
Why do they do that ? “ Because most investors tend to look at a company with preconceived notions about the fundamentals and earnings power of the business , and therefore what that business should be worth from a valuation standpoint .”
As a result , he explains , many investors are slow to fully appreciate what the new positive information actually means for the company ’ s earning power and what
“ We believe that investing in micro-cap companies that are growing earnings beyond expectations allows us to generate strong performance for our clients over the long term .”
— Ken Farsalas
Professional Background He joined Oberweis Asset Management in November 2004 and is director of U . S . Equities and portfolio manager for the firm ’ s domestic strategies . He became the lead portfolio manager of both the Micro-Cap Growth and Small-Cap Opportunities strategies effective January 1 , 2015 . Previously , he was employed at Dearborn Partners LLC , where he was a managing director and the director of research . Before that , he worked as a small-cap research analyst and portfolio manager at Sterling Johnston Capital Management and began his career at SEI Capital Resources as an investment consultant .
Outside Interests He enjoys cooking , especially Sunday dinner in his household where the meal is his responsibility . He also plays golf . the stock ultimately should be worth .
Farsalas says he sees four instances where this phenomenon plays out . One involves a company ’ s successful rollout of either a new product or the latest version of its most important product , which results in an earnings surprise .
The second pertains to the introduction of a new management team at a company , one that changes the strategic direction of the business , earning better performance and generating an earnings surprise .
The third instance is when a company gets a boost from some government action , such as a change in regulation , or an infusion of stimulus money for various economic projects that could benefit certain industries . “ All of this money can have a positive and substantial impact on a micro-cap company where it doesn ’ t take much to move the needle on the income statement ,” Farsalas says .
The fourth foreshadowing of a positive earnings drift involves a recent acquisition where investors fail to grasp its positive impact on the acquirer . “ The bottom line is that when a company reports an earnings surprise , and that surprise is driven by a big fundamental change , the academic research suggests that investors tend to overlook the new information and don ’ t appropriately understand what it means for the earnings power of the company ,” Farsalas says . “ In our view , that leads to mispriced and undervalued securities .”
Bus Stop
One of Farsalas ’ s recent winners was Blue Bird Corp ., which he added to the portfolio in the spring of 2023 after the maker of school buses reported a positive earnings surprise and his investment team discerned there was more upside in the tank .
He says there ’ s a tailwind for school bus makers thanks to a multi-billion-dollar government funded program to transition away from diesel school buses to electric buses . “ Blue Bird has about 30 % market share ,” Farsalas says . “ They ’ re seeing a big uptick in their business related to these EV school buses , and that ’ s supported by a large amount of money
52 | FINANCIAL ADVISOR MAGAZINE | JULY / AUGUST 2024 WWW . FA-MAG . COM