Micro Caps and Buffett's >50% returns

[OracleofCarolina]

http://ballantynestrong.com/wp-content/uploads/2021/02/BTN-INVESTOR-PRESENTATION-v.7b.pdf

 

Hey,

 

Took a look at Ballantyne Strong and there is a Fairfax connection. BTN owns 30% of a company called GreenFirst Forest Products,

https://gffp.ca/wp-content/uploads/2020/11/Itasca-GreenFirst_11_9_2020.pdf

 

Paul Rivett, former president of Fairfax, is on the board there along with Rick Doman. Canadian lumber mill bought out of bankruptcy, could be interesting.

[Partner24]

I'm still mostly invested in very few conglomerates stocks, but lately, I've found that very small caps stocks have often more interesting valuations. It seems like there is a valuation trend on these kind of stocks:

https://www.barrons.com/articles/microcap-funds-super-cheap-big-returns-2024-95c1cd0b

Using a stock screener, I can find some interesting opportunities to dig further based on valuation (pe ratio, price to free cash flow, etc.), ROE and sound balance sheets (high liquid assets and low passive), especially in the 50 millions or less market capitalization microcaps. 

Financially speaking, I'm just dipping my toes in the water, but man I see things I don't remember having seen 20 years ago when I started to invest. Or maybe it's just that the stock screeners are more sophisticated now.

Anyway, if some of you are interested to share ideas based on metrics similar to that, I'm interested to read you. 

I can share some example of these, based on the metrics:

CAF.V (Canaf Investments)
FUL.O FullNet Communications)
TIE.V (Coloured Ties Capital)
ASH.AX (Ashley Services Group)
1397 (Baguio Green Group)
SFG1T (SFG1T)

Edited January 6 by Partner24

[Sweet]

14 hours ago, Partner24 said:

I'm still mostly invested in very few conglomerates stocks, but lately, I've found that very small caps stocks have often more interesting valuations. It seems like there is a valuation trend on these kind of stocks:

https://www.barrons.com/articles/microcap-funds-super-cheap-big-returns-2024-95c1cd0b

Using a stock screener, I can find some interesting opportunities to dig further based on valuation (pe ratio, price to free cash flow, etc.), ROE and sound balance sheets (high liquid assets and low passive), especially in the 50 millions or less market capitalization microcaps. 

Financially speaking, I'm just dipping my toes in the water, but man I see things I don't remember having seen 20 years ago when I started to invest. Or maybe it's just that the stock screeners are more sophisticated now.

Anyway, if some of you are interested to share ideas based on metrics similar to that, I'm interested to read you. 

I can share some example of these, based on the metrics:

CAF.V (Canaf Investments)
FUL.O FullNet Communications)
TIE.V (Coloured Ties Capital)
ASH.AX (Ashley Services Group)
1397 (Baguio Green Group)
SFG1T (SFG1T)

I have a problem trusting these small caps.

 

I was playing around in Finviz and there def cheapish companies.  A quick screens can be comparing current PE with forward PE - both should be low - this weeds out a lot of companies with one off earnings or some other shenanigans.

 

But I just don’t know enough about them to buy, I like to see and know a bit more about a company than just seeing a filing or some metrics.  Anything I’ve just bought in the past based on metrics and financials alone turned out to be a crap investment.

ie. JXN, DAC,FCNCA (not a microcap though)

 

Edited January 6 by Sweet

[Spekulatius]

Finding cheap small stocks is the easy part. Doing the research and finding out who owns them, if they can be trusted and how good of an operator they are and how good the business is the hard part.

 

You will have to sift through a lot of stocks to find a few good ones. There are some microcap conferences (some online ) that can be helpful to get a feel for management. this can quickly feel like a full time job. A good network of similar minded investors to collaborate with is probably a must.

[Blake Hampton]

On 2/18/2013 at 10:47 PM, oddballstocks said:

 

Man you're really going to pull me out of the cave for this one… Here's the simple answer, research them no differently than you would any other stock.  Everything seems daunting if you don't have familiarity with it.

 

The first time I looked at a Portuguese stock it felt strange, same with France, same with Canada.  But now they're familiar, same with micro-caps.

 

Some file with the SEC, so you could read their filings on EDGAR.  Some file with OTC markets so you can read their filings on there.  Some are "dark", if you buy a share and call the CFO you might get a copy of the annual report.  I talked to a CFO last week, seemed like the nicest guy promised to send an annual report right away, guess what, nothing, blowing smoke, happens a LOT, deal with it.  So you call sometimes verify ownership and then they email or mail you an annual report, make a decision from there.  I've been greedy and asked for multiple years, if the person I speak to is nice, and it's towards the end of the week they usually oblige, some states (hint Southern) have better luck.

 

Some really dark companies won't give out anything, here's the tip, this is very good or very bad.  Usually bad, management robbing from shareholders etc.  Or extremely good and they don't want shareholder to know how good it is, I've seen both.  If you pester you can usually get an annual report, sometimes with an NDA.  The NDA thing frustrates me, legally shareholders have so many rights that they just ignore.  You can sue a company to examine records (except if the company is a Nevada company, Nevada sucks…I digress) and literally look at anything you want.  You can go on company grounds and examine the premise, the company might call the cops, but it's impossible to trespass on something you own.  With computers we're so detached, just looking at these statements online.  We own pieces of companies, real living breathing companies with people working for us, don't lose sight of that.

 

There's a site where some of this information is available for a fee, a modern Walkers Manual, I won't mention because I'm affiliated.  You can buy the Walkers when they become available, but I think I pee-ed in that pool, I mentioned Walkers on my blog and the used price went from $1.27 a copy to $50 and $100, it's not worth that much, I have three copies here, I'd pay $5-10 max.  Maybe it's a micro-cap investor sin but I've considered offering my Walkers books out on Amazon for $100, I purchased all of them for $1 or less, if I ran that racket it'd probably be the three best returns I'd ever have, 100 baggers...

 

You can be creative, this is where these companies are fun.  Start digging into local records, talk to people, do exotic internet searches for anything related to the company.  I've been able to triangulate sales and income for places that won't talk.  Some companies like insurance companies have to publish to the NAIC, banks publish to the FDIC.  The craziest was a dark company selling for .1x sales that had a Belgian subsidiary.  Through the help of a board member I came to find that all companies in Belgium have to file reports public or private, so I hacked my way through a Dutch site and found this company's local sub filing then translated it.  This company wouldn't give out anything, it's because the company sucked, not worth the time.

 

For tiny stocks you really need to enjoy the process, I know I do.  There's an aspect that's fun finding this strange stuff about little companies.  I like the local nature too, I drive past hundreds of local companies and think that some of the stuff I own is like that, with real people working hard each day where I benefit.  Not some giant bland office park in the exurbs with half the people surfing Facebook all day where when employees show up and work book value is destroyed (my experience working at a mid-cap a few years back, pathetic, and I've worked for a few more since, the story is always the same).

 

I've worked at startups, small companies, medium and large cap companies, and hands down the people at the startups and small caps work the hardest and care the most.  At bigger companies up to 40% of the workforce could be fired and business would continue as usual.  My working experience has shaped my investing experience, I'd rather invest in a small hungry organization where jobs are on the line rather than one where half the people don't matter and are just sucking up a paycheck until retirement.

 

Here's the bottom line, I love microcap stocks and tiny stocks, but for the time I'd suggest learning enough French and investing in French small caps.  They're more liquid, they trade on an exchange, and they publish regulatory filings (in French).  If you just limited your portfolio to those French stocks you'd do well, and it's easier to learn French than dig for information on some of these tiny companies.  There's a bunch of other areas that have easier returns for now as well, but a magician doesn't tell all their secrets.

What an incredible post

[ValueArb]

You can't skimp on the research with microcaps. If they are still listed, they still have to provide almost as much financial data as large caps, but you would be wise to go beyond it whenever possible and verify what you can (store locations, property values, etc). Outright frauds are more common than in large caps, but still relatively rare and most are extremely obvious.

 

The problem is believing corporate spin, too many investors think they found a micro cap set to double or more because its "just about' to release/announce a major new product/expansion/investment/transaction. My feeling is microcap management are often more promotional than larger cap managers. I just put them on my ignore list if they make too many optimistic statements about future results.

 

And lastly, where microcaps shine is in the large number of net-nets. There are basically two options for investing in them, the Walter Schloss method of owning 100 at a time so diversification reduces risk, or the focused method I pursue of picking the best five at any one time and selling them as their discount disappears to buy the new best net-nets. But both require research, Schloss wasn't buying blindly, he was clearly filtering out the worst by some method (what, I'm not specifically sure of).

 

And in my case, my horrible results last quarter illustrate that even with net-nets you need to go beyond the raw financials. It caused me to switch from using discount to cash value as my most important metric to co-equal with board and shareholder composition. Net-nets can be torturously cheap for years on end (or decades for GYRO investors) if they don't have a clearly identifiable near term catalyst and its the board and large shareholders who get to decide whether to enable that catalyst.

 

Lastly, i believe academic research has established a good deal of reason to believe that overall small/micro cap returns beat large caps over long periods. It's not just observation, there is also a reasonable hypothesis that the market demands they have higher returns due to their much lower liquidity. The reasoning is that investors should always demand higher returns for more uncertainty and less liquidity.

 

For active investors there is another reason to fish here. Almost all of professionally managed money is in funds too large to buy small or micro caps, and many are forced sellers when a company drops below their minimum cap size requirements. It should mean that they are much less efficiently priced with far fewer analysts and far more stocks. This of course means some should end up way overvalued, but unless you are a short seller you can just ignore those and filter to find the ones where that lack of efficency leads them to be well undervalued. 

 

Lastly, returns should also be higher because of uncertainty. When you find a growth microcap with a decade of great results, its really unlikely you can be as confident in its competitive moat and long term future as a midcap or large cap that's been doing it for 20 or 40 years. The microcaps always have a greater threat of geographic competition (someone doing the exact same thing in other territories moving into theirs) or competition from someone with greater resources (a much larger company with interest in the market and much deeper resources to put into play).

 

Its really hard to earn some of these extra returns passively. My belief in the superior returns of lower liquidity stocks is why I always recommend to friends they choose a total stock market index over a SP 500 index, but in truth the SP 500 stocks are still a huge portion of the total stock market index. Over the last decade the Vanguard Admiral Total Stock market index (VTSAX) has trailed their Admiral SP 500 index (VFIAX) by half percent a year, VTSAX only wins over last 23 years by 0.3% a year. Trying to carve out a single index like their small cap index (VSMAX) is risky because its far more volatile. For example, it is trailing SP 500 by over 1.5% a year the last decade, though its winning by 14% a year since 2000.

 

On the surface I could argue passive should own the VSMAX as a form of mean reversal, overall it generates higher returns than the SP500, so the last decade must be an aberration that will soon correct and restore the king to his throne. But this is all built on theorizing mixed with research based on long ago historical data. If some secular change in our economy has made it tougher for smaller businesses to be public companies it could easily obviate any historical trends. For example the number of micro and small caps seems to have declined over time according to some recent research I've read but can't recall at the moment, so I'll use this study instead.

 

https://corpgov.law.harvard.edu/2017/05/18/looking-behind-the-declining-number-of-public-companies/

 

So the reason why the small cap index has had such a poopy decade is structural changes driving some of the better businesses to go private. What those could be I as yet have no idea, which means they might not be done yet. 

[ValueArb]

16 minutes ago, blakehampton said:

What an incredible post

 

Nate's oddball stocks newsletter is only $600/year, which isn't too bad if you want to work this space full time. Its unclear to me if he's still publishing though, I didn't see any 2023 newsletters on his site.

 

I don't think Walker manuals has been published since 2006 that I can find, but the good news is otcmarkets.com is free and it does a pretty good job of linking to latest financials from dark companies if they are available.

[Blake Hampton]

14 minutes ago, ValueArb said:

 

Nate's oddball stocks newsletter is only $600/year, which isn't too bad if you want to work this space full time. Its unclear to me if he's still publishing though, I didn't see any 2023 newsletters on his site.

 

I don't think Walker manuals has been published since 2006 that I can find, but the good news is otcmarkets.com is free and it does a pretty good job of linking to latest financials from dark companies if they are available.

I definitely don’t manage enough money to afford an expense like that yet, though I still wish I could read it.

 

I’ve been blown away by the valuations that I’m currently seeing in micro cap stocks. I’m pretty new to this whole investing thing and have been sort of trapped within the field of large cap stocks, I guess I was watching too much CNBC. I’ve found reliable and strong companies, without any form of duress, selling for less than 6-8x last year’s earnings. This isn’t even considering their book values, which a great many sell for substantially less than. This is unheard of in large capitalization stocks. Any large company you look at is selling for a huge premium to book and when they’re not, the book is entirely intangibles.

[brobro777]

Yikes these micro caps sound like an absolute ton of work 

 

I'll just stick to free riding off other people's good ideas, thanks

 

 

 

[LC]

Im not sure I buy the “less efficient” pricing for illiquid microcaps. Large caps have tons of investors- and are perhaps more prone to herd thinking? After all take a look at 30+% gains/drops in large caps over the past years. 
 

Ultimately you have to do work. Large caps the info is easily presented but there is just so many moving parts. Micro caps are easier to understand but may be a lot of work to get all the relevant info.

[Blake Hampton]

I actually meant to say nano-caps. There is certainly value in both micro and small, but nano has some real crazy valuations sometimes. It takes a lot of sifting to find them though.

[Sweet]

15 hours ago, brobro777 said:

Yikes these micro caps sound like an absolute ton of work 

 

I'll just stick to free riding off other people's good ideas, thanks

 

 

 

Same.  Familiarity with the business is undervalued - food chains you visit, shops you shop at, companies you use - makes it easier to hold when you have a good grasp of what the company does.

 

Edited January 7 by Sweet

[oscarazocar]

18 hours ago, ValueArb said:

 

Nate's oddball stocks newsletter is only $600/year, which isn't too bad if you want to work this space full time. Its unclear to me if he's still publishing though, I didn't see any 2023 newsletters on his site.

 

I don't think Walker manuals has been published since 2006 that I can find, but the good news is otcmarkets.com is free and it does a pretty good job of linking to latest financials from dark companies if they are available.

 

Oddball newsletter came out in Jan/Mar/Jun/Aug/Nov of 2023, 5 issues.

[Spekulatius]

With nanocaps the hard part is people factor - if management is capable and on your side. I feel like foreign exchanges are a better hunting ground than the US market, as the US market is quite plucked over and the quality of what remains is quite low.

 

In foreign markets, it is quite possible to IPO a business at an $100M (equivalent) or even less EV and those are really business with profits not startup projects or shell companies.

[SharperDingaan]

Sleep with the dogs ... and you will get fleas; you buy quality 'cause it's a lot less work, more predictable, and less prone to fraud ....  it does not mean no fraud and/or manipulation! Then keep in your head that this beloved nano cap is little more than a start-up which has run out of money; they couldn't meet 'angel' expectations, had to capital raise on speculative exchanges instead, and have to keep 'promoting' - in order to raise the new funds to prevent a financial collapse, once the money is spent. The best prospects are private; and they only go public when angels either want out now, or they need new funds to 'take the company to the next level', and bought out later (same angels, exiting later at higher valuations).   

 

If you insist on this approach, and are willing to put in the work, it's better to go with private limited partnerships. You're still a minority owner, and it will still be a local business (in its area), but you will have a lot better oversight as one of the operators ... vs simply as a passive investor. If you are sh1te at what you do, the end will come quicker, and you'll also 'move on' faster. 

 

Partnerships can be valuable, very refreshing, and a lot of fun; but they are also a lot of work ... and it needs to be worthwhile. They aren't liquid, you have to be good at what you do, and you have to like the people you work with. The responsibility of collectively coming up with the payroll every 2 weeks, separates the boys and girls very quickly. 

 

In the craft brewing business there are a lot of people who can make really good beer; but few who are really good at selling the stuff, and fewer still who are really good at the capital side of the business. It's typically regional, most everybody knows their counterparts, and largely an invitation only club.

 

Different quality investments, different strokes.

 

SD

 

 

 

 

[KJP]

On micro/nano vs. large cap and management quality, amount of work, etc, compare these two documents:

 

https://www.citigroup.com/rcs/citigpa/storage/public/citi-2022-annual-report.pdf

 

https://ir.truxtontrust.com/static-files/a30c48a8-5f9a-4bac-9273-062f5f3dad41

[brobro777]

6 hours ago, Sweet said:

Same.  Familiarity with the business is undervalued - food chains you visit, shops you shop at, companies you use - makes it easier to hold when you have a good grasp of what the company does.

 

 

I agree that's a good point about familiarity

 

Yet another thing about doing the work in micro caps or anything really is that some people are better at research and analysis. Like that guy at https://www.scuttleblurb.com/ is way better at research than I will ever be (helped me make good returns off TTD years ago). 

 

So guys, keep posting your research and ideas on this forum - I wanna continue the free ride!

 

 

[Blake Hampton]

5 hours ago, Spekulatius said:

With nanocaps the hard part is people factor - if management is capable and on your side. I feel like foreign exchanges are a better hunting ground than the US market, as the US market is quite plucked over and the quality of what remains is quite low.

 

In foreign markets, it is quite possible to IPO a business at an $100M (equivalent) or even less EV and those are really business with profits not startup projects or shell companies.

I completely agree. It feels almost like an offer to buy a cheap vault full of cash, caveat being that you don’t hold the key.

 

In the partnership years, Buffett would talk about “control” situations where he could combat bad management by buying a majority stake. I can’t do that so I’m assuming good due diligence and relatively good diversification might do the trick. I feel like most situations should work out decent enough if bought at a low price.

Edited January 7 by blakehampton

[Partner24]

Do you know some groups of investors who invest in nanocaps and have the fundamental value investing mindset? I would like to share and dig some idea.

 

And if some are interesting in doing so here, we could start a post in the investment ideas section!  Interested to join?

Cheers!

[Spooky]

10 hours ago, Partner24 said:

Do you know some groups of investors who invest in nanocaps and have the fundamental value investing mindset? I would like to share and dig some idea.

 

And if some are interesting in doing so here, we could start a post in the investment ideas section!  Interested to join?

Cheers!

 

I would be interested in digging into some micro / nano caps.

[KJP]

33 minutes ago, Spooky said:

 

I would be interested in digging into some micro / nano caps.

 

There are several threads about small caps and nano caps on this board, but they don't get much interest.  See, e.g., the threads on Terravest, Keck Seng, Black Diamond (now Clarus), Hamilton Thorne, ECA Marcellus Trust, Unit Corp, New Lease Office Properties, Macfarlane Group, NIcholas Financial, Hirequest, MachTen, Hingham, Solitron Devices, Calloway's Nursery.

 

 

[gfp]

For very small stuff, Tim's investor letters and fund are very good.  He also posts occasionally on twitter.  (He used to post on this board infrequently)  The problem with a nano-cap forum is that many of these don't trade much and discussing them publicly just guarantees you will have competition on the bid.

 

https://www.eriksencapitalmgmt.com/investor-letters

https://twitter.com/eriksen_tim

 

[Blake Hampton]

1 hour ago, gfp said:

For very small stuff, Tim's investor letters and fund are very good.  He also posts occasionally on twitter.  (He used to post on this board infrequently)  The problem with a nano-cap forum is that many of these don't trade much and discussing them publicly just guarantees you will have competition on the bid.

 

https://www.eriksencapitalmgmt.com/investor-letters

https://twitter.com/eriksen_tim

 

Unfortunately that’s why I don’t bring them up on here. I’m afraid some of you will push up prices.

 

Congrats, you all can now officially call yourselves whales lol.

[Longnose]

I quite enjoy looking through the nano cap pile. Ive built several screeners in TIKR to sift through nanocaps periodically. I dont invest in tons of them but like to hold 1 or two at a time. Sizing the position according to the risk. I made a nice double on one a just before covid. A local company to me that i didnt know was listed. Bought it for 39M marketcap and sold when it went to 64M marketcap. I used smile every time i drove by them thinking I own a piece of that. 

 

Had another one I felt i had done some decent due diligence on and found out shortly after buying in that it was a shite company. I ended up taking a loss on this one reinforced the lesson that you need to really do your due diligence in this space and even then its still a risk. 

 

I currently have 2 positions the nano cap space. One ive been holding since pre-covid and the other I just started in late 2023. 

 

Companies in this space are fun and exciting and aren't without their risks but ill probably always have 1 or 2 risk adjusted nanocaps in my portfolio. 

[Spekulatius]

I am shocked when I look up the capitalization range of what is called small cap, micro cap or nano cap etc. . I don't think the "nano cap" classification even existed 20 years ago. A stock with $2B in market cap is now a "small cap" and $2B used to be huge, a business that employed 10 thousands of people...

 

I guess that's what inflation and a decades long bull market do to my perception.

Edited January 8 by Spekulatius