2 Small Caps: Do You Bet on the Horse or the Jockey?
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An eternal debate among the investment community is whether it is preferable to bet on the horse or the jockey of a particular company. In this case, the horse is a metaphor for the industry and business model of the company in question. The jockey refers to the senior management team, and in particular the CEO, who steers and directs the company.
Can a business model or industry be so compelling or strong that any jockey could essentially lead it to victory? While there is no doubt that some combination of the two play a role in success, some investment strategies place more emphasis on one or the other elements.
The debate has recently resurfaced in high profile fashion given the recent handing off of the reins to a new CEO at Starbucks (SBUX). Other examples abound, especially on the retail side, of new leadership being brought in to rejuvenate a brand.
Here we highlight two small caps under coverage by Zacks which illustrate this debate and offer potential investors an option to choose their personal preference.
Kingsway Financial Services (KFS) operates through two key segments: Extended Warranty and Kingsway Search Xcelerator (KSX). The Extended Warranty segment offers vehicle service agreements (VSAs) and warranty products across the United States for automobiles, HVAC systems, and commercial refrigeration. In 2023, the segment contributed $68.2 million in service fee and commission revenues (down 7.8% from 2022).
The KSX segment, which focuses on business services, generated $35 million in revenue in 2023 (up 81.9% from 2022). The company expects this segment to become an increasingly larger part of total revenue. The segment is based on the “search fund” model and is supported by empirical evidence from a 2022 Stanford Business School study which concluded that search funds generated superior returns from 1984-2021.
In fairness, the KSX segment is also betting on the horse, selecting certain industries which meet certain growth criteria. But the outsized emphasis on the jockey is the noteworthy. The company typically hires the CEOs for the acquired companies from top MBA programs. The company also seeks proven leadership skills and has a propensity to hire candidates with military experience.
Kingsway Financial Services (KFS) appears near an inflection point for operational performance. Our Neutral rating is based on the need for additional evidence that the acquired companies are being effectively digested and meeting performance goals.
The stock is currently trading at 2.1X trailing 12-month EV/Sales TTM, which compares to 2.3X for the Zacks sub-industry, 1.2X for the Zacks sector and 5.3X for the S&P 500 Index. Over the past five years, the stock has traded as high as 2.9X and as low as 0.9X, with a five-year median of 2.
