When Ari Sass moved into the portfolio manager role at hedge fund M.D. Sass four years ago, it was a long-expected transition at the company his father had built, but Sass said he embraced it as a new opportunity. “Myself and the team really did a lot of introspection,” Sass recalled, in an interview with CNBC. “… This was somewhat of a chance … to disrupt ourselves.” Founded by Sass’ father Martin in 1972, the firm manages about $5 billion in assets for a variety of clients. Among the fund’s strategies, there is the M.D. Sass Concentrated Value portfolio, which the younger Sass manages. He sharpened the focus of this strategy by zeroing in on 20 to 25 high-conviction concentrated investments. Previously, the firm invested in about double that amount, he said. By limiting the number of stocks, Sass said he can do extensive due diligence and research into each of the companies it owns. The goal is to find value in underappreciated companies that are in the midst of a transformation that will accelerate growth and ultimately lead to a boost in a stock’s value. “I don’t believe in diversification for the sake of diversification,” he said. “I believe that our clients, generally, if they want more diversification, they can hire other investment managers around us to create whatever diversification they want.” Last year, Sass saw his first down year since he began managing the portfolio. Its value fell 5.4%, net of fees, however, it outperformed its benchmarks. But since its inception in January 2019 through the end of 2022, it’s gained 88%, net of fees, compared with gains of 50.5% and 49.9% for the Russell 1000 Value and Russell 3000 Value indexes, respectively. “We try to really focus on having very company-specific value drivers that we think can work in any cycle,” he said. ‘Digging under rocks’ To place his bets, you won’t see Sass looking strictly at a stock’s price-to-earnings multiple. That metric is “just an observation,” not “a thesis,” he said. Valuation can provide a margin of safety — or an idea of what the risk-reward could be — but Sass said he is not screening to find stocks that have fallen out of favor. He explained that most stock screens will tell an investor more about the past or the present than the future. One exception is screening for insider buying, he said, explaining that insider selling can mean a lot of things, but buying is usually only indicative of one thing: an expectation that the stock is going to rise. Still, that’s just a signal that is the start of the work, he said. “We’re really looking for companies undergoing change,” he said. “A company that we think is at an inflection point in their business that is misunderstood by the Street.” Often, these types of scenarios can be created by specific kinds of catalysts, including the arrival of a new management team that will take a good company and make it better or transformative M & A. After the signal, comes the real work of discovering broader themes that might be underappreciated, he said. “It’s really digging under a lot of rocks.” A multiyear story A good example is the stake they hold in Formula 1-owner Liberty Media (FWONK), which the firm thought was a great asset that was poorly run, Sass said. When it was acquired by John Malone, they “dove in deep.” It’s been a multiyear story, he said, adding that Liberty Media still has a lot to prove and is still undervalued. “We are happy to own it as long as the valuation is reasonable, which we think it is,” Sass said. Liberty Media shares fell 5.5% in 2022, but the stock has rallied 17% since the start of this year. It has an average analyst rating of buy and a price target of $70.88, according to FactSet. That’s about where shares closed Friday. Among M.D. Sass’ largest positions is CACI International , an IT defense company. Sass explained that CACI has been investing in acquisitions that have shifted its business from more commodity services to technology that provides greater value to the defense department. That’s helping it win more contracts and grow its profit margins. “Our thesis was really more around a company somewhat transforming themselves into more value-added services,” he said. CACI’s total backlog grew 10% to $26.5 billion as of Dec. 31, 2022 from $24.1 billion in the prior year. Funded backlog was at $3.2 billion, which is 3% higher than it was in the prior year. According to Sass, most people assume defense budgets will be going up, but he doesn’t think the market fully appreciates the pace of the increase. Cash outlays fell short of the defense budget last year, partially due to supply chain issues, and Sass expects that will provide extra padding for the growth ahead. The best part, he said, is the pace of the revenue growth has nothing to do with whether or not the economy avoids a recession. CACI shares gained 11.7% last year, and have inched up about 1% so far in 2023. On average, analysts rate the stock an overweight with an average price target of $336.54. With CACI shares closing at $304 on Friday, the implied upside is more than 10%, based on those analyst targets. Finding opportunity Sass said it has been a bit difficult to find companies that will be driving earnings higher in the current climate. At the time of this interview, Sass said he had about 14% of his assets in cash and positions in about 18 stocks. When Sass adds a position, he expects to own the stock for two or three years, but that can change if the consensus view catches up faster than expected or if the team makes a bad bet. “We are very, very, very diligent about creating a culture of intellectual honesty within our group,” he said, explaining that people need to be able to make mistakes and admit when the hunch may have been off. “In this business, if you’re right 60% of the time and you’re wrong 40% of the time, but you cut your losses when you’re wrong before they really hurt you, your winners really are able to allow you to enjoy the fruits of being right,” he said. “That combination over time is pretty powerful, I think.”