Discovery Group's affiliated funds maintain portfolios that are concentrated in publicly-traded small capitalization companies, with ownership stakes that may reach 20% of a particular company’s outstanding shares. Investment candidates are initially identified based on statistical criteria that suggest a discrepancy between public trading value and fundamental economic value. Generally, the cause of this condition is market obscurity. Specifically, these companies’ valuations suffer from a lack of both Wall Street research coverage and trading liquidity, leading to a dearth of institutional investor interest. Despite their weak public market valuations, companies selected for the portfolio exhibit exceptionally strong operating characteristics.
Portfolio companies typically possess a proprietary competitive advantage in their industry that is demonstrated by strong market share, favorable revenue growth and solid profitability. These businesses have sound balance sheets with little financial leverage. The management teams are experienced and, importantly, have a meaningful ownership stake that motivates them to improve value for all shareholders.
The Fund’s Managing Partners seek to maintain an active and constructive relationship with the Directors and Executives of its portfolio companies. The Managing Partners are former investment banking advisors with an extensive track record working with the Boards of Directors of small capitalization public companies. In meetings with the leadership of its portfolio companies, the Managing Partners often provide suggestions with respect to corporate finance matters. The Managing Partners have frequently been invited to present proposals and analyses to Boards of Directors. Discovery Group enters formal corporate finance advisory engagements with portfolio companies that are consistent with the investment objectives of its Funds. The Firm also selectively advises private-sector companies.