Tom Maher on Small-Cap Investing, AI Infrastructure and Opportunities Beyond Big Tech

Jack Forehand (0:02)

Tom, welcome to Excess Returns.

Tom Maher (0:05)

Thanks for having me, appreciate it.

Jack Forehand (0:07)

You've spent most of your career studying and investing in smaller companies, and currently you manage Hilton Capital's small and mid cap opportunity strategy. And it's been a while since we've had anybody on to talk about small caps and small cap investing, an area that sometimes gets maybe overlooked by investors, particularly in the last decade, when it's been mostly a market dominated by the larger companies in the market. But I think as we'll talk with you today about, there's plenty of opportunities in small caps. We want to understand how you go about analyzing them, what you look at and how you build a portfolio of small cap companies. And in any response, if you want to work in any musical reference, any song, feel free.

Tom Maher (0:57)

I appreciate that offer. That's fantastic.

Jack Forehand (0:59)

Yeah, we were, and just so the audience knows, all of Tom's quarterly letters sort of start with a musical sort of tie-in title. And then you kind of flow into, you know, what you want to talk about with your investors, which we love. So, okay. So I think the first place we wanted to start is you recently wrote, you were describing sort of how you're looking at the market, how you're posturing.

And you were explaining that you're sort of driving with two feet, one on the gas and one on the brake. So kind of talk us through what you mean by that.

Tom Maher (1:32)

Absolutely. And if anything, since I wrote that letter, that's become more pronounced with the sort of day-to-day sort of volatility that we've seen, certainly in the small and mid-cap space, but even up market cap in the recent past. And what I meant by that is you've got a couple of very powerful, positive trends in place. I think broadly, obviously, AI build out, which we'll get into more detail, I'm sure, but that's a significant driver of GDP growth, a massive amount of capex coming through, and then all of the ancillary sort of follow-on businesses that should spring from that. So that's one big positive. In a more abstract sense, if you look at the expected earnings growth, particularly in the small and mid-cap space, it's quite strong. You have 20, 30 percent kind of earnings growth expected over the next few years, and that sort of jives with what looks like very strong GDP growth at the same time. So those are your sort of positive sort of influences, if you will, and that's where you want to be on the gas pedal, if you will. On the brake pedal side, I think you've had this sort of very pronounced sort of back and forth. First of all, since the second quarter, we have this sort of question of, have we seen sort of peak acceleration in that build out plan?

But I think on top of that, you also have, and this is not surprising given the fact that some of these trends or some of these potential developments would be so significant. The market is sort of struggling to figure out how to price them in. And so what that's sort of manifesting in the short term is very violent moves up or down. And I think that the most obvious that I've seen recently has been this sort of balance between software and semiconductors, particularly in technology. Recently, we have some days where they're both going in the same direction. But up until recently, if you told me semis are up 2% today, I could tell you the software went down 2% because the prevailing belief was AI is going to kill all software companies, right?

It was in the way the market is structured. Now, you have all these baskets and pairs, so you had that balance. That gives you some pause in terms of whether or not those positive trends can price through in each stock that you might have in the portfolio. Now, you can layer on top of that a couple of other worries, things like inflation, the Fed now in potentially rising cycle, and things like that will also give the market pause.

So you kind of put that all together. And I think as opposed to being sort of a nice, smooth mid-cycle period of time where you can sort of say, here are my good companies and I'm going to stay focused on them, you really have to be sort of on a hair trigger in terms of what you have to react to. And then more importantly, what you're not going to react to is you see these sort of day-to-day moves.