Published on July 3, 2017

Everyone knows that investing in rapidly growing companies in emerging industries can be risky, but not everyone appreciates that coupling in-depth research with an opportunistic approach to buying the stocks can help manage risk and add value over time. When the market is skeptical about a company’s future prospects, disciplined investors can take advantage of this short-term noise to buy companies at very attractive valuations that may be below IPO and peak prices.

We categorize potential areas of short-term noise into three M’s: 

Mystery

Newer companies – and their industries – can be mysterious. They may be hard to understand and complex to navigate. In general people tend to ignore or avoid what they do not understand, and investing is not immune to this. Inogen, which touts itself on providing light and portable supplemental oxygen, falls into this category. It was new to the portable oxygen concentrator market and was misunderstood in an industry segment that was thought to be mature. The challenge for investors at the time was to look past the status quo and understand how Inogen was working to disrupt an industry. After doing extensive research and getting to know the company, we were able to take advantage of the mystery surrounding it and buy it at an attractive valuation.

Mismanagement

As venture capitalists or founders attempt to manage growth, early stage public companies may stumble from mismanagement and scare off would-be investors. Zeltiq Aesthetics, Inc. was a prime example. Executives did not do enough consumer promotion and product proliferation for this explosive aesthetics category. Zeltiq eventually replaced its initial CEO and hired a senior executive from another successful company who refocused Zeltiq operations. We have found that these types of inflection points  may provide very attractive entry opportunities.

Mistakes

Finally, rapidly growing, innovative companies can make short-term mistakes that cause investors to run for the exits. LDR Holding Corporation (acquired by Zimmer Biomet in 2016) is a medical device company that focuses on spine care. The company failed at forecasting its business and setting investor expectations in 2015, which caused its stock to collapse later in the year. It is during these points investors can reevaluate the company and determine if the issue is a permanent problem or just a failure in managing investor expectations. If you can determine that the business is still strong and growing, you can take advantage of these types of short-term disappointments.

As active managers, we look for companies that might be suffering due to one of the three M’s. We take the time to research these companies and leverage our experience and depth of knowledge to determine which of them may ultimately be success stories despite their short-term setbacks.

James L. Callinan

Vice President & Portfolio Manager

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Opinions expressed are those of the author, are subject to change at any time, are not guaranteed and should not be considered investment advice.

Holdings and allocations may change at any time due to ongoing portfolio management. References to specific investments should not be construed as a recommendation to buy or sell the securities. Current and future holdings are subject to risk.

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IPO refers to Initial Public Offering.

Past performance does not guarantee future results.

Mutual fund investing involves risk. Principal loss is possible. The Osterweis Emerging Opportunity Fund may invest in unseasoned companies, which involve additional risks such as abrupt or erratic price movements. The Fund may invest in small and mid-sized companies, which may involve greater volatility than large-sized companies. The Fund may invest in IPOs and unseasoned companies that are in the early stages of their development and may pose more risk compared to more established companies. The Fund may invest in ETFs, which involve risks that do not apply to conventional funds. Higher turnover rates may result in increased transaction costs, which could impact performance. From time to time, the Fund may have concentrated positions in one or more sectors subjecting the Fund to sector emphasis risk including the health care sector, which may be affected by government regulation, restrictions, pricing and other market developments and the technology sector, which tends to be more volatile than the overall market. The Fund may invest in foreign and emerging market securities, which involve greater volatility and political, economic and currency risks and differences in accounting methods. These risks may increase for emerging markets.

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