At Heron Bay Capital Management, our investment philosophy centers on owning durably good businesses— companies that meet four key criteria:
- Cash generative with favorable, enduring economics.
- Protected by sustainable competitive advantages that are likely to persist.
- Benefiting from long runways for growth.
- Led by rational, owner-aligned management teams.
To earn a place in our portfolios, a business must also trade below our estimate of intrinsic value. In essence, we seek to buy quality at a fair or better price and let the compounding of business fundamentals work in our favor over time.
This discipline often leads us toward high-quality, profitable companies that may be temporarily out of favor. From a factor standpoint, our portfolios blend characteristics of both value and growth. For instance, the Heron Bay Large Cap Discretionary strategy currently trades at a valuation multiple meaningfully below that of the broader market, while maintaining above-average quality and profitability metrics.
Market Overview
Following the tariff-driven volatility of the second quarter, U.S. equity markets extended their post-2024 momentum. However, performance has diverged sharply across capitalization tiers and factors. The market has oscillated between AI-driven enthusiasm and expectations for a rate-cutting cycle, pushing momentum and leveraged trades further into speculative territory. The S&P 500 and large-cap growth cohort now trade roughly 30% above their 25-year average valuation, marking one of the longest large-cap leadership streaks in modern history—well beyond the usual seven-to-ten-year cycle. In contrast, small-cap equities remain deeply discounted, trading at about 1.5 × book value, versus nearly 5 × for large caps—the widest valuation gap since the late 1990s. Historically, such extremes have tended to precede multi-year reversions favoring smaller companies, particularly as easing cycles and renewed M&A activity (up roughly 25% year-to-date) take hold.
Quality vs. Narrative
Year-to-date, markets have rewarded growth and momentum over value and quality. As shown below, quality oriented exposures—represented by iShares Quality ETF (QUAL) and Berkshire Hathaway (BRK.B)—have trailed the S&P 500, which itself has lagged Momentum (MTUM) and the speculative ARK Innovation ETF (ARKK). A similar pattern emerges in factor spreads: a long–short portfolio buying high-quality businesses and shorting low-quality ones has underperformed by the widest margin since 2020.
(Source: FactSet)
Short-Term Voting, Long-Term Weighing
In narrative-driven markets, discipline can look like stubbornness—but staying anchored to fundamentals protects investors when sentiment turns. We see meaningful long-term opportunity today in health care, industrials, software, and construction, where valuations are attractive and business quality remains high.
Looking back over a five-year horizon, the pattern reverses: quality strategies like QUAL and Berkshire matched or exceeded the S&P 500, while speculative growth baskets such as ARKK significantly underperformed. As Ben Graham observed, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.”
Periods of exuberance often redirect capital away from sound businesses and into “story” stocks. This mispricing plants the seeds of future outperformance for investors willing to be patient. In that spirit, we trimmed or exited fully valued holdings, such as Fox Corp (FOXA), and redeployed capital into companies whose fundamentals remain strong but sentiment has turned negative.
(Source: FactSet)
Positioning and Portfolio Actions
In an environment that discounts quality, we see opportunity. Our focus remains on upgrading the overall quality of the portfolio—buying businesses we’d be proud to own for the next decade at valuations that make sense.
During the quarter, we added to positions in FactSet (FDS), Salesforce (CRM), and Adobe (ADBE). Each is under pressure amid concerns that AI-driven tools will displace their entrenched workflows. We believe these fears are overstated. Their products are deeply embedded in enterprise infrastructure, and the market appears to be pricing in disruption far faster than is likely to occur. We are taking the other side of that bet.
Conversely, we continue to avoid companies that remain unprofitable or face deteriorating economics despite compelling narratives—names such as Okta, Bloom Energy (BE), Lucid (LCID), and Palantir (PLTR). We also exited Warner Bros. Discovery (WBD) as both the thesis and financial trajectory weakened. We do not chase price momentum unless it is backed by improving fundamentals. While this can temporarily weigh on performance, it protects capital over full cycles.
Evidence-Based, First-Principles Investing
At Heron Bay, our process is guided by two complementary disciplines:
- Evidence-based investing means grounding decisions in data and long-term base rates. Decades of empirical research show that “lottery-ticket” stocks, IPOs, SPACs, and companies pursuing transformative acquisitions tend to underperform. We avoid them. Evidence also shows that managers who remain consistently in the top half of their peer group compound superior long-term results—steady discipline beats erratic brilliance.
- First-principles investing focuses on the fundamental drivers of value creation. One enduring truth: investors will always pay more for a high and growing stream of cash flows.
As a validation of our investment process, we are pleased to share that multiple equity strategies have been named to the PSN Top Gun List, representing one of the top ten equity strategies relative to a peer group. PSN is an independent performance reporting company. Our Small-to-Midcap Discretionary (SMID) strategy received the award for a one-year time period; our Large Cap Select strategy achieved a one-year and three-year award. While awards are nice confirmations, our focus is on long-term outcomes for clients.
Our goal is simple—to avoid permanent loss and build portfolios on a foundation of strong economics and prudent valuation. As managers who invest the majority of our own net worth alongside our clients, we are fully aligned in both philosophy and outcome.
That alignment—and our evidence-based, first-principles approach—allow us to sleep well at night. We hope it does the same for you.
As always, we are grateful to serve and look forward to more updates in the future.