Corporate takeovers are of great interest to Stephen Arpin, vice-president at Beutel Goodman&Co. Ltd. and lead manager ofBeutel Goodman Small Cap Fund. Cash takeovers establish a "real world" value for companies, indicating what a buyer is actually willing to pay.
"We want to buy [a stock] at a price that's less than the takeover price for a comparable firm," says Arpin, who oversees about $750 million in small-cap assets at Toronto-based Beutel Goodman, includingIG Beutel Goodman Small Cap C and institutional accounts. If he buys at a good price, there's a good chance the holding could become an acquisition target itself, thereby creating a gain for the fund. Large companies often find it more economical to acquire smaller operations than to build from scratch, a trend that fuels takeovers in the small-cap arena.
Arpin defines his Canadian small-cap universe as companies with market capitalizations of $100 million to $1 billion. He looks for a healthy return on capital, ample cash flow, and a strong balance sheet with low debt and good interest coverage.
When he meets management, he asks tough questions about their strategy for profitable growth. "We look at a company's track record, and how it has weathered recessions," he says. "We want a stable business that trades at a deep discount to underlying value. In buying with a margin of safety on price, we set ourselves up for opportunity."
A student of history, Arpin found his way into investment management by accident. After obtaining a BA in political studies and history from Queen's University in 1991, and an MA in American history from York University in 1993, he was hired by Beutel Goodman as a temporary clerical worker in the mailroom.
He was fascinated by the investment world and quickly found a job as an assistant on the trading desk. Soon he became a full-fledged trader, and within a year he had found his calling in small-cap portfolio management. When Beutel Goodman Small Cap was launched in January 1995, Arpin came on board as an analyst working closely with manager Denis Marsh. Arpin, who obtained a CFA designation in 1997, became a co-manager of the fund in 1999, and lead manager in late 2000.
Under Arpin's tenure, the fund, which rated five stars by Morningstar, has done well during both short and long-term time periods. As of Oct. 31, its one-year return was 35.4%, beating the category median of 16.5%. Over five years, its average annual return of 17% is well ahead of the median 6.2%.
"Investing is an art," Arpin says. "A lot of it is understanding history — such as how famous investors made and lost money in the past. And if you can't evaluate your own mistakes and successes, it's hard to do well as an investor."
What Arpin finds particularly exciting is "finding the small-cap businesses that could be the leaders of tomorrow." He looks for companies with potential to grow 20% to 30% per year over three to five years, a growth rate that is difficult for large companies to achieve.
"We don't hit all the time," Arpin says. "But a high return threshold is necessary to offset the inherent liquidity risks and trading costs of small-cap stocks, as well as higher business risk."
Arpin prefers to hold companies as they mature, and he says his "core" portfolio turnover rate is about 35% annually. Over the past five calendar years, his overall turnover in Beutel Goodman Small Cap has ranged between 23% in 2001 and 59% in 2000. When a company reaches his target price, he will review it, but will not necessarily sell if the risk/return factors continue to be favourable.
The average holding accounts for 2.5% of the fund's assets. Arpin is not afraid to buy enough of a company to take it to 5%, and as the stock price rises he may hold a company until it reaches the 10% legal limit.
"One of the ways to make money in small caps is to hang on to your winners," he says. "We don't want to give away a good business because of a hard and fast rule on selling. Often the opportunities change along the way, and growth potential increases."
If the stock price falls by 25%, the decline would trigger a review, but not necessarily a sale. If his original thesis is still intact, he may buy more.
"There are businesses that will be worth many times what they are today in five years and some that won't be around at all," Arpin says. "That's what makes small caps so fascinating, and also what creates volatility in the sector."
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