small cap advice

[racemize]

Forgive me if this has already been discussed (I did try searching), but I noticed in another thread that some of you guys invest mostly in small or micro cap companies.  Most of my reading is based on Buffett or similar styles, which focus on large cap (e.g., since he can't really buy into small cap anymore), and I've been using ValueLine as a security blanket.  I also read a Buffett quote that said he would be looking at small caps if he were to start over again (I think he also said he could guarantee 50% returns!). 

 

Accordingly, I wouldn't mind hearing any tips or wisdom you guys have in that space.

 

For example, how active are you (e.g., turnover %)?  Do you do much buy and hold at that level?  What do you use for dd other than the filings?

[SharperDingaan]

Racemize.

 

Once the FBK saga is over we will do a multi-part thread on small cap investing using FBK as the example.

There is no right or wrong to it, but it is definately not boring  ;)

 

SD

[racemize]

Racemize.

 

Once the FBK saga is over we will do a multi-part thread on small cap investing using FBK as the example.

There is no right or wrong to it, but it is definately not boring  ;)

 

SD

 

that sounds brilliant!  I'm looking forward to it.

[Baoxiaodao]

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.

 

 

[Green King]

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?

[racemize]

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.

 

So, are you adding anything to his magic formula, or are you just selecting particular ones you like?  Any additional criteria you use?

[oddballstocks]

I tend to favor small caps, I'll really look at anything from the Magic Formula stuff, to net-net's.  I like small caps because they're often a lot simpler so it's quicker to analyze.  As an example I was looking at Renault recently and to get a good grasp on their operations I'd have to dig through about 150pgs of reports and filings.  I also looked at a small pink sheet company, the annual report was 15 pages long.

 

To me the goal is to turn over as many rocks as possible, the more rocks overturned the better the chance of finding the fat pitch.  I would rather sit on cash and look than invest in marginal investments.  Small caps make it easier because I can read the annual reports of 10 companies in the time it takes me to read about one mid/large cap.

 

I don't limit myself to any size though, I'll invest in anything.  I own shares of Intel ($127b) and shares of Titon Holdings ($6m) and anything in between.

[racemize]

I tend to favor small caps, I'll really look at anything from the Magic Formula stuff, to net-net's.  I like small caps because they're often a lot simpler so it's quicker to analyze.  As an example I was looking at Renault recently and to get a good grasp on their operations I'd have to dig through about 150pgs of reports and filings.  I also looked at a small pink sheet company, the annual report was 15 pages long.

 

To me the goal is to turn over as many rocks as possible, the more rocks overturned the better the chance of finding the fat pitch.  I would rather sit on cash and look than invest in marginal investments.  Small caps make it easier because I can read the annual reports of 10 companies in the time it takes me to read about one mid/large cap.

 

I don't limit myself to any size though, I'll invest in anything.  I own shares of Intel ($127b) and shares of Titon Holdings ($6m) and anything in between.

 

That makes sense--do you generally try to diversify on these small cap stocks (or said another way, not take large positions)?  I've been keeping my portfolio at less than 10 stocks (I'm actually more like 4 at this point), but it seems like these smaller caps are much more prone to going under than the big ones and/or it would be harder to get as much details about them.  I know Greenblatt talks about having 20 or so, but he doesn't bother to analyze, so that's probably not as relevant. 

 

As a side question, does anyone know if Greenblatt's system actually works?  The numbers he puts in the book are pretty high and the backtesting data from other sources I read could not reproduce them--it seemed like he cherry picked the best back test for his returns.

[oddballstocks]

I tend to favor small caps, I'll really look at anything from the Magic Formula stuff, to net-net's.  I like small caps because they're often a lot simpler so it's quicker to analyze.  As an example I was looking at Renault recently and to get a good grasp on their operations I'd have to dig through about 150pgs of reports and filings.  I also looked at a small pink sheet company, the annual report was 15 pages long.

 

To me the goal is to turn over as many rocks as possible, the more rocks overturned the better the chance of finding the fat pitch.  I would rather sit on cash and look than invest in marginal investments.  Small caps make it easier because I can read the annual reports of 10 companies in the time it takes me to read about one mid/large cap.

 

I don't limit myself to any size though, I'll invest in anything.  I own shares of Intel ($127b) and shares of Titon Holdings ($6m) and anything in between.

 

That makes sense--do you generally try to diversify on these small cap stocks (or said another way, not take large positions)?  I've been keeping my portfolio at less than 10 stocks (I'm actually more like 4 at this point), but it seems like these smaller caps are much more prone to going under than the big ones and/or it would be harder to get as much details about them.  I know Greenblatt talks about having 20 or so, but he doesn't bother to analyze, so that's probably not as relevant. 

 

As a side question, does anyone know if Greenblatt's system actually works?  The numbers he puts in the book are pretty high and the backtesting data from other sources I read could not reproduce them--it seemed like he cherry picked the best back test for his returns.

 

I know a lot of investors on this board really love concentrated investing, knowing everything about a company and then dividing investments into 10 or 20 holdings.  I know Buffett and Munger have talked about this, some discussion recently about Pabari as well.  The idea is that the 25th idea isn't as good as the 1st idea.  This sounds good, and I'm sure there's some merit in it for the full time guys.  The problem is as an external investor you are always at a disadvantage, no matter how much you know you're still an outsider.  I know this is true for companies that I've worked in, I've read some of the most detailed industry analysis and research reports yet the information is lacking compared to what I knew working in the company, and lacking in a large way.  Having that intimate knowledge is critical, I think this is what Wall Street misses the most.  Obviously you can handicap that a lot and that's what most people do, but I just can't get comfortable myself with this approach.

 

I take a bit of a different approach, I diversity because this isn't my full time job and I can't spend hours each day keeping pace with each investment.  All I care about is that a business is cheap enough, and has a large enough margin of safety, if it meets these requirements I'll usually add it to the portfolio.  Sometimes I'll add a small position and increase it over time as I learn more or as I'm looking and realize that the idea is a lot better than others out there.  Sometimes the position will stay small because I find better ones.

 

The advantage of the concentrated approach is that with five stocks if you get a five-bagger your portfolio rockets to the moon.  I prefer to look for $.50 dollars.  A lot of these can be chumpy companies and I've had a few go under, but I've also had a lot do really well, enough to more than compensate for the disasters.  I recognize that holding a bunch of stocks (20 currently, not evenly distributed) could limit my gains, but I'm fine with that.  I'm more concerned about my downside, if I have a large margin of safety the gains will take care of themselves.  In addition if I can't check a company for a few weeks because of other obligations I'm not concerned that some development will wipe me out.

 

Hope this helps!

[Baoxiaodao]

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?

 

Read annual reports. Dive into markets people do not want to go. That is what I do.

 

How do I value my investments? That is a great question. To be honest I do not have a model for things. I never take a single factor into consideration. For me, the quality is more important. When you read a lot annual reports, you start to develop a sense as to how good this business is. Sometimes after reading an annual report for 5 mins, I can reasonably decide if there is anything interests me.

 

The hard thing is to pick your spot. When I buy stocks, I really do not know if they are going to work. Those picks last year were good, but things can go either way. A huge amount of knowledge can increase your chance to figure things out, but remember, nothing is for sure. Even the greatest investor with best intention can make a disastrous mistake. So when you think this is bullet-proof or cant-lose investment, you need to be really careful about it.

 

Small caps are very good for small investors because it is much much easier to analyze. Many people, including people on this board, prefer large-cap companies. But think about it. If you ever ran a business with 50 people and a business line, is it hard? How about multiply that by a factor of 1000? Many companies, in my opinion, are beyond 99.99% of people's comprehension. Yet they put money in them anyways.

 

Sorry to disappoint you for failing to give you a definite answer, but this one is the best I can get.

 

 

[Baoxiaodao]

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.

 

So, are you adding anything to his magic formula, or are you just selecting particular ones you like?  Any additional criteria you use?

 

I am the last person to add anything to Mr.Greenblatt's brilliant work. I did pick up everything he said and applied to investing and it worked very well. The only thing different is that sometimes the screening will not do the trick. It is especially true when the company is at the end of a restructuring process. Reading annual reports without looking at the stock price, in my opinion, is the best way to go.

[Baoxiaodao]

I tend to favor small caps, I'll really look at anything from the Magic Formula stuff, to net-net's.  I like small caps because they're often a lot simpler so it's quicker to analyze.  As an example I was looking at Renault recently and to get a good grasp on their operations I'd have to dig through about 150pgs of reports and filings.  I also looked at a small pink sheet company, the annual report was 15 pages long.

 

To me the goal is to turn over as many rocks as possible, the more rocks overturned the better the chance of finding the fat pitch.  I would rather sit on cash and look than invest in marginal investments.  Small caps make it easier because I can read the annual reports of 10 companies in the time it takes me to read about one mid/large cap.

 

I don't limit myself to any size though, I'll invest in anything.  I own shares of Intel ($127b) and shares of Titon Holdings ($6m) and anything in between.

 

That makes sense--do you generally try to diversify on these small cap stocks (or said another way, not take large positions)?  I've been keeping my portfolio at less than 10 stocks (I'm actually more like 4 at this point), but it seems like these smaller caps are much more prone to going under than the big ones and/or it would be harder to get as much details about them.  I know Greenblatt talks about having 20 or so, but he doesn't bother to analyze, so that's probably not as relevant. 

 

As a side question, does anyone know if Greenblatt's system actually works?  The numbers he puts in the book are pretty high and the backtesting data from other sources I read could not reproduce them--it seemed like he cherry picked the best back test for his returns.

 

I know a lot of investors on this board really love concentrated investing, knowing everything about a company and then dividing investments into 10 or 20 holdings.  I know Buffett and Munger have talked about this, some discussion recently about Pabari as well.  The idea is that the 25th idea isn't as good as the 1st idea.  This sounds good, and I'm sure there's some merit in it for the full time guys.  The problem is as an external investor you are always at a disadvantage, no matter how much you know you're still an outsider.  I know this is true for companies that I've worked in, I've read some of the most detailed industry analysis and research reports yet the information is lacking compared to what I knew working in the company, and lacking in a large way.  Having that intimate knowledge is critical, I think this is what Wall Street misses the most.  Obviously you can handicap that a lot and that's what most people do, but I just can't get comfortable myself with this approach.

 

I take a bit of a different approach, I diversity because this isn't my full time job and I can't spend hours each day keeping pace with each investment.  All I care about is that a business is cheap enough, and has a large enough margin of safety, if it meets these requirements I'll usually add it to the portfolio.  Sometimes I'll add a small position and increase it over time as I learn more or as I'm looking and realize that the idea is a lot better than others out there.  Sometimes the position will stay small because I find better ones.

 

The advantage of the concentrated approach is that with five stocks if you get a five-bagger your portfolio rockets to the moon.  I prefer to look for $.50 dollars.  A lot of these can be chumpy companies and I've had a few go under, but I've also had a lot do really well, enough to more than compensate for the disasters.  I recognize that holding a bunch of stocks (20 currently, not evenly distributed) could limit my gains, but I'm fine with that.  I'm more concerned about my downside, if I have a large margin of safety the gains will take care of themselves.  In addition if I can't check a company for a few weeks because of other obligations I'm not concerned that some development will wipe me out.

 

Hope this helps!

 

The besting investing method is the one you are the most comfortable with. Well said, Oddball.

[ragnarisapirate]

Lots of good input here.

 

I will add that a lot of what I have learned is from where I screwed up. It seems that most people don't want to ever think about missing something in their investment thesis, but, I try to relish it; hard as it may be to put into practice.

 

One of the best things I ever did was have a big loss on a small bank that I didn't understand as well as I should have. It taught me a lot of good things. Another screw up was investing in a regional airline before oil went to $150/barrel.

 

I don't want to suggest that people should lose money to learn, but, the lessons I learned in the process, when I was (and, still am) pretty young, will hopefully keep me from making it an even bigger mistake on down the road. Plus, being young gave me more time to recover from the losses. In the event that you lose money, you might as well try to get some good out of it and learn something!

 

[oddballstocks]

Lots of good input here.

 

I will add that a lot of what I have learned is from where I screwed up. It seems that most people don't want to ever think about missing something in their investment thesis, but, I try to relish it; hard as it may be to put into practice.

 

One of the best things I ever did was have a big loss on a small bank that I didn't understand as well as I should have. It taught me a lot of good things. Another screw up was investing in a regional airline before oil went to $150/barrel.

 

I don't want to suggest that people should lose money to learn, but, the lessons I learned in the process, when I was (and, still am) pretty young, will hopefully keep me from making it an even bigger mistake on down the road. Plus, being young gave me more time to recover from the losses. In the event that you lose money, you might as well try to get some good out of it and learn something!

 

This is huge, seriously huge, probably the biggest secret to investing no one will tell you.  You will screw up, you'll lose money, no one bats 100%, learn from your mistakes, think them over that's where the growth really occurs.

 

It might have been John Templeton who said that if 60% of the time you're right you will be rich, whereas if you're only right 40% of the time you'll be broke.  Probably a paraphrase, and wrong attribution, but the key is even being wrong 40% of the time and you'll do really well.  Just be mindful of the 40% and why those mistakes happened.

[Baoxiaodao]

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.

[SharperDingaan]

In the small cap world you have to be able to tolerate extreme volatility & be able to capitalize on it. As the impact is worse the less diversified you are, you really need at least 2-3 small caps offset against a significant T-Bill holding.

 

A 40% valuation drop is not unusual - & it may be for no other reason that your favourite stock is just unloved, hence there is no liquidity. Similarly a 50% jump simply because of a change in the 'story' - when the fundamentals haven't moved. Hence the reason for the T-Bills.

 

SD

 

 

[Green King]

thank you for the response very informative.

[Morgan]

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.

 

Just looked breifly into JIN. Nice job on the analysis Baoxiaodao! As you said, if they sign the lease it'll be a home run. Depending on when you sold, you may have had a 10 bagger!

 

Any update on what you did with your position?

[petey2720]

I agree. Congrats on JIN!!!

[Green King]

Wow a blast from the past. I watched it become a 10 bagger. At the time I've looked at it and passed. I think it was 20% above liquidation. At that time I didn't have the understand of the post above or the relative scale to understand what kind of the barging it was. But over all it was above liquidation. Missed the timing today I would probably understand it better might have passed or had a very small position.

 

Interesting how things changed. Might have brought if I can understand the economic benefit provided to the monopoly owner from JIN. Might look closer next time.

 

Overall congrats.

[hillfronter83]

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?

[siddharth18]

Great discussion here. I personally can't convince myself to invest in a large cap because I know there are bigger and better firms/money managers out there doing this that have more resources, experience and understanding of the large cap in question. It's for this reason I believe that small caps are most likely to be priced inefficiently most of the time.

 

This blogger sums it up nicely:

 

 

...I am not at an informational disadvantage. Small as these stocks are**, no one is going to spend an awful lot of money in an information arms war to gain a slight edge over other market participants. iSuppli doesn't cover Lectra, Tessi, Haynes, or James Halstead. If the price is low, it’s most likely just low, not priced for risk.

 

 

There are, I know, retail investors who like taking the other side of the trade on well-watched stocks like Apple, and opaque stocks like Citi, situations in which they know that they are likely at a severe informational disadvantage (in terms of both the known unknowns and the unknown unknowns) armed with the belief (perhaps justified, perhaps true, but nevertheless suffering from a Gettier problem) that professional investors are stupid or myopic or whatever else. I’m not one of them and that kind of trade is not my bag. I like to know at least as much about a stock as any non-insider. Otherwise, and this is a personal thing – necessarily so – I’d feel as silly as if I opened a neighborhood grocery store in the shadow of a Walmart.

 

[greenwave]

Lots of good input here.

 

I will add that a lot of what I have learned is from where I screwed up. It seems that most people don't want to ever think about missing something in their investment thesis, but, I try to relish it; hard as it may be to put into practice.

 

One of the best things I ever did was have a big loss on a small bank that I didn't understand as well as I should have. It taught me a lot of good things. Another screw up was investing in a regional airline before oil went to $150/barrel.

 

I don't want to suggest that people should lose money to learn, but, the lessons I learned in the process, when I was (and, still am) pretty young, will hopefully keep me from making it an even bigger mistake on down the road. Plus, being young gave me more time to recover from the losses. In the event that you lose money, you might as well try to get some good out of it and learn something!

 

This is huge, seriously huge, probably the biggest secret to investing no one will tell you.  You will screw up, you'll lose money, no one bats 100%, learn from your mistakes, think them over that's where the growth really occurs.

 

It might have been John Templeton who said that if 60% of the time you're right you will be rich, whereas if you're only right 40% of the time you'll be broke.  Probably a paraphrase, and wrong attribution, but the key is even being wrong 40% of the time and you'll do really well.  Just be mindful of the 40% and why those mistakes happened.

 

------

 

Anyone here have an awareness of this company ( I D N D ),...  and its prospects ? 

 

I believe Lou Simpson or his wife may still be actively involved in this small cap company. As I recall , Lou Simpson or his wife was/or /is a Director of the company .... (not sure about current status ).

 

As I understand it, the founder, Greg Abbott ,has continued for about 10 + years to personally assure most of  the funding shortfall (without taking a salary).

 

It seems to me that he has  done this to keep his innovation ideas alive while patiently acquiring the patents and global connections to sustain the company for  the longer term prospects of their invention:  "an aseptic valve and related high speed packaging machines " for the food and beverage packaging industry.  No refrigeration is required for long periods of time when foods and beverages are packaged with this new methodology. I think Pepsi-China division has signed on along with several other well respected internationally recognized companies.

 

 

 

IDND

 

International Dispensing Corp.

1020 Fifth Avenue

4th Floor

New York, NY 10028

--------------------------

 

Below is a very long awaited news release on some of their recent and longer term history .

 

http://www.idcinnovation.com/why-idc/investors/ 

 

I would very much appreciate any feedback/comments  on this company and your take on its probabilities of success or failure .

 

Thank you very much.

 

greenwave

 

[Hielko]

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.

[DoddDisciple]

What screeners do you all use for small/micro caps around the world? Only cost effective ones I've seen are screener.co and value-investing.eu. Do you all use F, M, and Z scores? How does the data for these compare to doing it by hand against the screener results?