[small cap advice]

Racemize, there is no mystery about small caps. It depends on how hard you look. It also helps when you find some original ideas. I apply Joel Greenblatt's concept to small/micro cap investing. The result is very satisfactory. I bought a few issues last year at 2-3x normalized earnings with high ROIC. And they returned triple digit.

 

can you give me detail in the process you look for them ? And how you value them?

 

Hi King, I have been thinking about giving an example. Here it is.

 

I own a company in AU called Jumbo Interactive. I bought it @ 30 cents. The annual report laid out everything very clearly. It is trading at 2.5x P/E before cash. JIN's business is to sell lotteries on the Internet, which is highly scalable. In the last five years, the business has grown just like other online businesses. In normal condition, this kind of business should garner 20x P/E. This is an outstanding business trading at ridiculous price. You see, magic formula wants good business trading at cheap prices. That is simply not enough for me.

 

But the situation is not normal here. JIN's online business hangs on a contract with Tatts, which is expiring at the end of 2014, although the contract will be renegotiated a year earlier. Tatts is a monopoly in the lottery industry which owns the only nation-wide license given by the government. Recently, Tatts launched its own website to compete with JIN. Therefore, the probability that JIN will renew the contract seems low.

 

I believe each of us has different opinion about risk/reward and you can make your own guess. Here is mine. Let's say JIN simply operates until the end of 2014 and then liquidate, the cash will cover more than the current market cap. This is third grade math so I would not give the details here. This is is the bottom line. I personally believe, after some thinking, that there is around 30% chance that the contract will be renewed as it is now. If it is renewed, I will hit a home run; if it is not, I would not lose much. There are also other complications, but I will keep things simple here.

 

This is basically how I make my investment decisions. Hope this helps.

 

Bao, great analysis!

A lot of times for micro cap there are issues with corporate governance or even fraud. How do you stay away from such companies?

The same way you stay away from fraud and bad corporate governance when you invest in a large cap. It isn't a micro-cap unique problem.

 

Agree that it's not micro-cap specific problem. However, in large cap, usually there are institutional investors or activist investors that helps keeping management or controling interest honest.

[small cap advice]

Racemize, there is no mystery about small caps. It depends on how hard you look. It also helps when you find some original ideas. I apply Joel Greenblatt's concept to small/micro cap investing. The result is very satisfactory. I bought a few issues last year at 2-3x normalized earnings with high ROIC. And they returned triple digit.

 

can you give me detail in the process you look for them ? And how you value them?

 

Hi King, I have been thinking about giving an example. Here it is.

 

I own a company in AU called Jumbo Interactive. I bought it @ 30 cents. The annual report laid out everything very clearly. It is trading at 2.5x P/E before cash. JIN's business is to sell lotteries on the Internet, which is highly scalable. In the last five years, the business has grown just like other online businesses. In normal condition, this kind of business should garner 20x P/E. This is an outstanding business trading at ridiculous price. You see, magic formula wants good business trading at cheap prices. That is simply not enough for me.

 

But the situation is not normal here. JIN's online business hangs on a contract with Tatts, which is expiring at the end of 2014, although the contract will be renegotiated a year earlier. Tatts is a monopoly in the lottery industry which owns the only nation-wide license given by the government. Recently, Tatts launched its own website to compete with JIN. Therefore, the probability that JIN will renew the contract seems low.

 

I believe each of us has different opinion about risk/reward and you can make your own guess. Here is mine. Let's say JIN simply operates until the end of 2014 and then liquidate, the cash will cover more than the current market cap. This is third grade math so I would not give the details here. This is is the bottom line. I personally believe, after some thinking, that there is around 30% chance that the contract will be renewed as it is now. If it is renewed, I will hit a home run; if it is not, I would not lose much. There are also other complications, but I will keep things simple here.

 

This is basically how I make my investment decisions. Hope this helps.

 

Bao, great analysis!

A lot of times for micro cap there are issues with corporate governance or even fraud. How do you stay away from such companies?