The Four-Year Harvest
Avocado trees take three to four years to bear first fruit and four to five years to reach full production. You can’t rush biology. A farmer who plants an orchard today is making a bet on conditions years into the future—conditions that are impossible to predict with certainty. The work happens anyway, because the alternative is having nothing ready when it’s time to harvest. Or… having no guacamole.
2025 tested the patience of quality-focused small-cap investors. Like many of our peers who emphasize profitable companies with strong management teams and reasonable valuations, we underperformed. The market rewarded speculation over fundamentals for much of the year, a pattern we’ve seen before. These periods are uncomfortable but not unprecedented—and history suggests they precede exactly the environment where disciplined investors are rewarded.
A Year of Whiplash
If you had told investors in January what 2025 would bring—sweeping tariff announcements, a market crash in April, and ongoing geopolitical uncertainty—most would have predicted a difficult year for equities. Instead, markets ended near all-time highs.
Small-caps entered the year with momentum from the November 2024 election, when the Russell 2000 surged nearly 6% in a single day and hit an all-time high later that month. That optimism faded quickly. By late March, tariff uncertainty had pushed trade policy anxiety to levels not seen since the Nixon administration. Then came April.
On April 2nd, the administration announced “Liberation Day” tariffs and markets cratered. The S&P 500 dropped nearly 11% over four days. Small-caps quickly entered a bear market declining more than 20% from their recent high. The reaction was swift enough that a 90-day pause in tariffs was announced a week later. In typical fashion, low-quality companies outperformed as the market exited bear territory. It was surprising how pronounced the low-quality rally was compared to similar historical periods. We believe the tide will turn and the quality factor will be a tailwind in 2026 and are already seeing early signs of improvement in how higher-quality stocks are performing relative to lower-quality peers.
When Quality Goes Out of Style
Roughly 43% of Russell 2000 companies are currently unprofitable—triple the rate from thirty years ago. During periods of speculative enthusiasm, these companies often outperform their profitable peers, though they do end up underperforming over the long run. Loss-making companies outperformed profitable companies by 900 basis points for the year and 360 basis points in the fourth quarter. Loss-making biopharma stocks contributed 25% of the Russell 2000’s total return for the year! Our strategies own no unprofitable biopharma companies, and all holdings generate strong cash flows and/or earnings.
At times, investors chase momentum, and money flows toward stories rather than fundamentals.
Source: Furey Research Partners and FactSet. Data as of 12/31/25. Based upon LTM Net Income as known as the start of each quarter.
“What’s Wrong, Warren?”
– Barron’s cover story, December 1999, questioning whether Buffett had lost his touch after underperforming the Nasdaq by 189 percentage points over eighteen months.
We’ve seen this before. In the late 1990s, Warren Buffett underperformed the Nasdaq by 189 percentage points over eighteen months.1 Within three years, Buffett had outperformed by 73%.
Julian Robertson’s Tiger Fund delivered 31.7% annual returns for eighteen years before the dot-com bubble made his disciplined approach look obsolete. He closed his fund in March 2000—just three weeks before the bubble peaked.2 The stocks he held at closure went on to outperform the S&P 500 by over 125% over the following six years.3
2025 was painful for quality-focused small-cap investors. The lesson isn’t that quality investors are always vindicated. It’s that the moments when discipline feels most painful often precede the periods when it matters most.
Patience isn’t passive—it’s the active decision to stay committed when commitment is hardest.
Patience in the Orchard
One holding that exemplifies our approach is Limoneira (LMNR), a 132-year-old California agribusiness company and the largest avocado grower in the United States. Limoneira has spent years expanding its avocado acreage—planting 1,500 acres, with 700 of those trees still maturing toward full production. Avocado trees require three to four years to bear first fruit and four to five years to reach full capacity. You cannot rush biology.
This patient capital allocation now looks prescient. The United States imports roughly 90% of its avocados from Mexico, creating meaningful supply chain vulnerability. Cartel activity in the growing regions has led to multiple USDA inspector assaults and temporary import suspensions. Tariff discussions have added another layer of uncertainty. Meanwhile, Limoneira’s domestic orchards—planted years before anyone anticipated these disruptions—are approaching peak production. Avocados grown in Southern California also mature when Mexican avocado shipments are at a nadir, providing a window of opportunity.
The stock has struggled over the last year, declining significantly from its highs. The short-term picture has been difficult. But management has been building something for years that competitors cannot replicate quickly, regardless of how the policy environment evolves. That’s the kind of company we want to own—and the kind of investment that requires patience to hold through difficult periods.4
The Setup Ahead
Small-caps remain compellingly valued. The Russell 2000 trades at a significant discount to large-caps on a cyclically adjusted basis—a gap that has historically preceded periods of substantial outperformance. The last time small-caps traded at this kind of discount relative to large-caps was the late 1990s, and we know how that was resolved.
Source: Furey Research Partners and FactSet. Data as of 12.31.25. Represents Median P/E using latest available trailing 12-month earnings. Profitable companies only.
None of this tells us when the turn will come. Valuations aren’t catalysts—they’re fuel waiting for a spark. But when that spark arrives, we believe the companies we own will be positioned to benefit. They have the management teams, the balance sheets, and the competitive positions to compound value over time. What they’ve needed is for the market to care about those qualities again.
The farmer planting avocado trees doesn’t know exactly when conditions will favor domestic production. Weather, trade policy, and countless other factors influence the timing. What the farmer knows is that the work being done today creates the conditions for eventual reward. That’s how we think about the current environment.
Ten Years of Building
We understand the patience we ask of our clients because we’ve lived it ourselves. As Riverwater approaches its tenth anniversary and is approaching a $100 million milestone in our flagship strategy, we’re reminded of how many boxes emerging managers must check before many investors take notice.
Track record length. Assets under management. Organizational infrastructure. Compliance frameworks. For years, the work felt invisible—building a foundation that wouldn’t be recognized until it could support something larger.
We’re deeply grateful to the clients who believed in us before we checked those final boxes. Your patience made our growth possible, just as your continued patience through difficult markets allows us to maintain the discipline that we believe will serve you well over time. We don’t take that trust for granted.
Looking Forward
We enter 2026 with optimism about what lies ahead—for small-caps as an asset class, for the companies we own, and for Riverwater as a firm. The conditions that have frustrated quality investors are precisely the conditions that create long-term opportunity. Discounts to fair value don’t last forever. Patience gets rewarded.
Thank you for your continued trust and partnership. We wish you a healthy and prosperous new year.
Adam J. Peck, CFA
Founder and CIO
This commentary reflects the views of Riverwater Partners as of December 2025 and is subject to change without notice. It is provided for informational purposes only and does not constitute investment advice or a recommendation to buy or sell any securities. References to specific securities are for illustrative purposes only and may not be representative of all client portfolios. Any forward-looking statements or forecasts are based on assumptions that may not come to pass. Past performance is not indicative of future results. Investors should consult their financial adviser before making any investment decisions. Riverwater Partners and its clients may hold positions in the securities discussed, which may create a conflict of interest.
Footnotes
1 Alpha Architect, “Why Did Warren Buffett Struggle During the Dot Com Bubble?” (January 2018). Performance measured June 1998–February 2000. Barron’s, “What’s Wrong, Warren?” (December 27, 1999).
2 Wikipedia, “Julian Robertson,” citing Robertson’s March 2000 closing letter to investors. Performance measured 1980–1998.
3 Whitney Tilson, Value Investor Insight. Tiger holdings performance 2000–2006.
4 Limoneira has restructured its business to focus on avocados versus lemons and ended a strategic review process because they did not receive a bid that was worthy of the underlying value. Avocados generate around $12-15,000 profit per acre versus lemons at breakeven.
