After reviewing events in the banking sector since the early 2023 crisis, we also paused to reflect on the recent four- and five-year anniversaries of the early 2021 meme stock craze and the Covid-19 pandemic. Combined with the silver anniversary of the dot-com bust that began in Spring of 2000, the enduring impacts these periods had on our industry, business, and strategies is significant, especially given their dramatic market moves and excesses.

The Dot-com Bust
Has it really been 25 years since the dot-com bubble burst? For most of us on the Pacific Ridge Capital Partners investment team (dating back to predecessor firms), the wild-west commercialization of the internet fell in the early years of our careers working together or the bust served as the backdrop for our start in the business. (One notable exception: Our newest team member was still a newborn!) We see striking parallels between the stretched valuations in portions of today’s capital markets to what we saw in those days. So many companies made the case to investors how the internet would positively impact their business, with some attaching “dot.com” to the end of their company name in a blatant attempt to boost their stock price. We see the same thing today. Many companies have suddenly become AI businesses, grasping at a rationale how AI will help them grow.

Of course, there are differences between the two time periods, including the fact that most of the current “Mag Seven” large-cap growth stocks are highly established, highly profitable companies. Yet one can question, as we have, the lofty valuations that the market has put on these stocks. What is undeniable is the concentration of the market in these largest stocks and the stark similarity to what occurred before the dot-com bust. (See prior chart.)

In a similar vein, valuation disconnects between large cap and small cap equities existed both then and now. (See chart below.) Our strategies did very well coming out of the dot-com era as the gap slowly narrowed. Twenty-plus years have passed and we once again see a valuation gap. We have similar confidence as we did back then in how we remain positioned. While we cannot predict when this current gap will narrow, recently witnessing the swift market reaction to the new China-based AI tool DeepSeek demonstrates to us how quickly sentiment can change. It also reinforces our belief in the long-term effectiveness of investing in quality stocks with attractive valuations. We know it can take years to unwind valuation disconnects, and our patient investment philosophy will steer us through this gap as it has in the past.

Finally, in the same way that the internet legitimately changed how we do things, so too will AI. We remember the transition from receiving our company SEC data on CD-ROM discs via mail to the same data being delivered and commoditized via the online EDGAR database. This is only one small example of the impact technology has had on our business and process. We are beginning to see AI influence the way market participants instantly process and utilize massive quantities of data and information. Pacific Ridge is no exception. We are carefully incorporating AI into our processes wherever it can make us more efficient and better-informed. That said, AI can never replace the value added by our team; namely, sound judgment, honed over decades of experience. Our team knows how to leverage the long-term effectiveness of our patient and repeatable valuation-focused investment philosophy and process in a way that no AI model can reproduce.

The Covid-19 Pandemic
Has it really been five years since “two weeks to stop the spread”? From a market perspective, it was a bumpy ride. The initial shock created what fear usually does: tremendous opportunity. Who could have imagined the recovery would happen so quickly, or what would drive it? As it turned out, it was a relatively short-lived but spectacular stimulus-fueled rally. Leadership in our universe of smaller capitalization equities was driven by low-quality consumer stocks and unprofitable, largely pre-revenue biotechs, that made up roughly 20% of the Russell Microcap Value universe at their peak. These are not areas where we typically find strong cash flow-generating value opportunities, but our strategies have done well for our clients as we moved past those early days of the pandemic.

From a business perspective, we learned how to leverage technology and collaborate effectively while working remotely. That said, we prioritized a return to the office as soon as possible because we thrive on sharing information and input when we’re together. Among the permanent casualties from the pandemic are the regular in-person visits we used to receive from company management teams. These have largely been replaced with virtual meetings. While this shift has led to more interactions than ever before with management teams, we still value the investor conferences we attend each year to make personal connections.

Meme Stock Craze
Has it really been four years since an unprofitable and shrinking video game retailer famously had more than a 50x move over a couple of months, peaking at a $30 billion valuation, thanks to the backing of the retail investing masses and their “diamond hands”? While the documentaries and Hollywood movies about GameStop were fun to watch, the craze was truly unlike anything we had seen in our careers. While there were other meme stocks during this phase, by our calculation, simply not owning GameStop took over 400 basis points of relative performance away from our Microcap Value strategy during the first half of 2021. Adding insult to injury, it was removed from our benchmark as a midcap stock in mid-2021, before the shares fell back to earth.

Conclusion
Through all these periods of turbulence and uncertainty, our team at Pacific Ridge has remained steadfast in our investment philosophy. We buy shares in US public companies as if we were intending to buy the entire company and own it indefinitely, focusing on enduring value over fleeting trends. We have a long history of navigating volatile markets, adhering to our valuation discipline and looking for opportunities. Through this lens, we do our best to avoid even the noisiest of circumstances.

We anticipate a broadening of the market and a return to an emphasis on valuation in the years to come, as the market has favored large cap and growth stocks for much of the past decade-plus. Looking ahead, this likely creates an opportunity, and we believe we are well positioned by continuing to do what we have always done: diligently seeking out value in the least efficient portion of the US equity market.

Thank you for your interest and partnership. As always, we are eager to continue the conversation with you.

Sincerely,

Pacific Ridge Capital Partners