Micro caps

[watsa_is_a_randian_hero]

Thanks for sharing Nate and Tim.  PDRX does look good.  A few ideas that haven't been mentioned (skipping most ideas that I've seen already mentioned on this board somewhere):

 

FCBN - very large holding for me.  Good for a someone with very high patience.  Great mgmt.  No catalyst in sight, but very cheap relative to historical levels.  While ROE has been lower then historical levels, a major transaction seems to be announced every 12-18 months over the last 8 years.  All have been priced very well, with cash. 

DIT

PKBK

BOBS

TSX:CAL

MOCO - not cheap compared to many microcaps, but should be priced higher due to low risk

TSE:7122

BMBN - prob at FV now, bought lower

SUBK - same as above

NNEMF - Sprott is on board; mgmt had past success buying/selling mining co's.

 

Others:

TSE:8031 - not microcap but goes along with King888's point of international

OGZPY - same as above

[abitofvalue]

PDRX does seem interesting. 

 

Another one I like is Sitestar (SYTE) - Ragnar is a pirate has good information on this one.

MRVC is good too

GRVY - trades for less than cash but performance lately has been a bit disappointing (still below cash for a marginal business)

Addvantage Technologies (AEY) - this has been widely written up.

 

[LanceSanity]

I'm looking at CTCH (Commtouch Software). It is a high margin business with little capex needs and 100% recurring revenue. Its core business generates ~ $6m FCF. Using a 10x FCF multiple, the core business is $2.31. The upside opportunity is in its cloud SaaS services. The VIC article has a lot of good details about the business. I still have much more reading to do, but so far, I really like this business.

[abitofvalue]

Nate - how do you find quarterly information on PDRX?

[ItsAValueTrap]

Warren Buffett said that investing in very cheap small stocks is a good way to make money when you don't have the anchor of a large portfolio to manage.

 

I'm not sure that he said that.  He has said that buying Berkshire Hathaway was a mistake and that he should've probably bought a (well-managed) insurance company instead.

 

Originally he made money using Ben Graham's investing style.

Then he realized that investing in cigar butts works better if you have control over the company and can liquidate fast or realize the value of the assets quickly.

Then he realized that it's better to buy wonderful businesses like See's Candies than it is to buy cigar butts.  And insurance can be a wonderful business too, but only if the underwriting is good and only if their float is invested well.

 

There'd be a large focus on buying private businesses.  He'd probably buy stocks too through his insurance companies.

 

2- To me, there's a difference between Walter Schloss and Warren Buffett.  Schloss' style is very close to Ben Graham's and I'm sure he'd invest in a lot of microcaps if he was managing less capital.  But there's a reason why Buffett is in a league of his own.  His preferred investment is a private business, not a stock.

[Tim Eriksen]

Warren Buffett said that investing in very cheap small stocks is a good way to make money when you don't have the anchor of a large portfolio to manage.

 

I'm not sure that he said that.  He has said that buying Berkshire Hathaway was a mistake and that he should've probably bought a (well-managed) insurance company instead.

 

Originally he made money using Ben Graham's investing style.

Then he realized that investing in cigar butts works better if you have control over the company and can liquidate fast or realize the value of the assets quickly.

Then he realized that it's better to buy wonderful businesses like See's Candies than it is to buy cigar butts.  And insurance can be a wonderful business too, but only if the underwriting is good and only if their float is invested well.

 

There'd be a large focus on buying private businesses.  He'd probably buy stocks too through his insurance companies.

 

2- To me, there's a difference between Walter Schloss and Warren Buffett.  Schloss' style is very close to Ben Graham's and I'm sure he'd invest in a lot of microcaps if he was managing less capital.  But there's a reason why Buffett is in a league of his own.  His preferred investment is a private business, not a stock.

"Size is always a problem," Mr. Buffett told me last month. "With tiny sums [to invest], it's extraordinary what you can find. Most of the time, big sums are one hell of an anchor."  source: ‘Behind the Decision, a Lesson from a Mentor’, Wall Street Journal, Nov. 5, 2009

 

and

 

“If I was running $1 million today, or $10 million for that matter, I'd be fully invested. Anyone who says that size does not hurt investment performance is selling.  The highest rates of return I've ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that. But you can’t compound $100 million or $1 billion at anything remotely like that rate.”  source: ‘Homespun Wisdom from the Oracle of Omaha’, Business Week, June 25,1999

 

The clear implication is that his investment universe would be larger (i.e. micro caps would be an option) if he were managing a smaller sum. 

[watsa_is_a_randian_hero]

Tim - Wondering why you classify Teton as "deep value".  I definitely agree with you that its illiquid (lol), but I'm it appears valued at standard multiples for its industry. 

[ItsAValueTrap]

Yes managing less funds is better.

 

But if you managed very little money, I don't think that it necessarily makes sense to focus on the absolutely smallest stocks.  There are probably some gems hidden in there.  But for the most part, a lot of the smallest stocks don't make sense.  You have to pay at least $100-200k/year to be publicly listed for the auditor, board of directors, somebody to prepare financial statements, filing fees, transfer fees, etc.  (Maybe if you are really cheap you can get that down to a little under $100k.)

 

When the market cap is very small, that overhead hurts you.  There are some delisted stocks out there where the overhead isn't a problem. 

 

2- There's nothing wrong with applying Ben Graham's style to microcaps. 

 

I'm just saying that it is something that Buffett may not do a lot of.  If Buffett had $1M, I think that he'd look at *every* company in an industry that he understands, even the large cap ones.  The mid/large cap stocks have options that may be attractive.  His stock portfolio would likely be mostly in small cap companies, but I wouldn't be surprised if he owned LEAPs or stuff like BAC warrants.

[Tim Eriksen]

Tim - Wondering why you classify Teton as "deep value".  I definitely agree with you that its illiquid (lol), but I'm it appears valued at standard multiples for its industry.

 

You could certainly argue that it is not deep value.  It is a tweener to me.  I probably should have created a category of Value (illiquid) for Teton.  It is valued at 9x current run rate of earnings which I would still put on the cheap side, particularly in relation to recent growth rates, industry averages, and the pluses in terms of management track record.     

[matjone]

I've recently started to get interested in these smaller companies.  A question for Nate, Tim Eriksen, DTEJD1997, and anyone else who invests in these companies... who do you figure is your competition, and why do you think they are selling to you?  This is something I am curious about with these stocks.  With larger companies you've got institutional money and a lot of other smaller players.  But the only people I know of that invest in micro-caps are smart guys like the ones listed above and idiots like me who buy companies after seeing them on the military channel (in my defense, that was years ago, before I'd ever heard of Warren Buffett or Ben Graham).

[rpadebet]

I've recently started to get interested in these smaller companies.  A question for Nate, Tim Eriksen, DTEJD1997, and anyone else who invests in these companies... who do you figure is your competition, and why do you think they are selling to you?  This is something I am curious about with these stocks.  With larger companies you've got institutional money and a lot of other smaller players.  But the only people I know of that invest in micro-caps are smart guys like the ones listed above and idiots like me who buy companies after seeing them on the military channel (in my defense, that was years ago, before I'd ever heard of Warren Buffett or Ben Graham).

 

Very good question. I would like to know the answer to this too. I always naively assumed some sort of momentum/ spread Algo based trader was on the other side.

[oddballstocks]

Yes managing less funds is better.

 

But if you managed very little money, I don't think that it necessarily makes sense to focus on the absolutely smallest stocks.  There are probably some gems hidden in there.  But for the most part, a lot of the smallest stocks don't make sense.  You have to pay at least $100-200k/year to be publicly listed for the auditor, board of directors, somebody to prepare financial statements, filing fees, transfer fees, etc.  (Maybe if you are really cheap you can get that down to a little under $100k.)

 

When the market cap is very small, that overhead hurts you.  There are some delisted stocks out there where the overhead isn't a problem. 

 

2- There's nothing wrong with applying Ben Graham's style to microcaps. 

 

I'm just saying that it is something that Buffett may not do a lot of.  If Buffett had $1M, I think that he'd look at *every* company in an industry that he understands, even the large cap ones.  The mid/large cap stocks have options that may be attractive.  His stock portfolio would likely be mostly in small cap companies, but I wouldn't be surprised if he owned LEAPs or stuff like BAC warrants.

 

There was a video on neatvalue.com (and posted here) that's down, but Buffett answers this exact question directly in 2011.  While in India someone asked him what he'd invest in if he had less than $10m in capital, he said "Graham stocks" the net-nets, low book value, cigar butts, then he quickly said he has too much money and started to speak his standard line about great companies and how you can hold them forever.

 

I'm always fascinated at this dynamic anytime this discussion comes up.  The Graham/Schloss investors will buy loads of cigar butts and diversify, yet every one I've talked to can understand the great companies and good price idea, and why someone might concentrate.  Yet the Buffett groupies seem to have this dogma that the only "true" way to invest is exactly how Buffett does right now, in giant brands at reasonable prices.  I don't know why the Buffett people are so strict and so exclusive.

 

I've said it many times before, clearly the best way to get rich (if that's your goal) is to buy some tiny small cap and ride it to the moon, and only own that company.  Buy Starbucks when it's three branches and ride the wave, it's undeniable. I can understand concentrating, I can understand buying companies with moats.  But I know myself, I'm too stupid to figure those things out.  Companies pay millions of dollars per year to consultants to help them develop competitive advantages, most which are a fiction.  If those guys who do this day in and day out are hit or miss why should I, someone who does this part time think I can suddenly divine moats and the next great growth company?

 

Buffett is a genius, he is the Michael Jordan of investing.  No matter how hard I practice I will never be Michael Jordan, it's a natural talent.  I like Graham because he lays out a simple framework for all the non-geniuses, I am not a genius, at best I have absolutely average intelligence, so I have found a style that suits me.  I also recognize there are some VERY bright investors on this board, I would absolutely hate to play Trivial Pursuit with most of you, for you guys the Buffett thing is probably the right approach.  I also know this, you'll probably end up with much more money then I will, and I'm perfectly fine with that.  My goal is to invest prudently with the skills and talent that I have.

 

As to funds size, a Graham deep value strategy could easily accommodate $30-40m or possibly more.  I know there are fund managers on the board, so this strategy is out for you, which is also why it works so well for us little guys.

[watsa_is_a_randian_hero]

I disagree with the statement that the "other side" is algo traders...

 

For these smaller companies, a lot of times I think the "other side" is a combination of retail investors, employees, and former employees. 

 

As with retail investors, I think a lot of times people may have bought these companies recently or long ago for many different reasons.  They could have bought on "tips," read something on seeking alpha or because they knew employees or management, and now the account is turned over to a new manager who is selling everything, the investor run out of patience, the investor gifted or bequeathed the stock and the beneficiary doesn't want it, the stock is down and they are selling as a stop loss, or the stock is up and they are taking gains.

[Guest wellmont]

i think he was asked this question a few years ago at the annual meeting and he said he would be looking at bankruptcies.

[oddballstocks]

To answer a few others questions.

 

Returns: My goal is 15% annual returns, I think that's an achievable target over the long haul.  I have done better then that since the financial crisis.  The last time I tallied anything this year (end of July) I was up 27-28% for the year.  As long as my accounts are increasing in value I am satisfied.  Here's the thing about performance, I'm not as worried about bull market years, I'm expecting to underperform, I'm hoping to outperform in down years, that's where I believe the money is made.

 

Who is my competition?  This is a great question that I've thought about, and actively explored.  There are multiple sellers, the largest contingent is legacy holders from when the stocks were bigger, or listed.  There are thousands of these holders who own insignificant amounts of shares.  When I looked at SODI's shareholder record list I saw this.  People who own 200 shares.  One day they will decide to sell, or their heirs will sell and the shares come on the market.  These legacy holders own a LOT of stock.

 

You also get former employees, they received a bunch of stock, left or were fired and now want to liquidate their holding.  So they're selling.

 

There are then heirs to larger blocks, these are the best sellers.  When a stock suddenly has volume for no reason and a large drop you can almost be sure someone wants their cash now rather than later, a broker is happy to execute.  When this happens, if you've been following the company and know the story, and know nothing has changed buy with two hands as much as possible.  If you want to make money in microcaps I just gave away a huge secret, know the market.

 

Then there are institutions, there are market makers and advisors who make a living in these markets.  I know some of the players, they will buy positions as things come on the market, just because they don't get liquidity often, even if it's not a great price.  They'll hold and sell when the right buyer comes along.  They aren't necessarily value investors, but they are holding the market together.  If you want a fill on a big block you'll have to hunt these guys down, once you are plugged in you can get much bigger fills if you want.

 

Then there are all the retail investors like myself.  Guys like the person who posted a message on the FRMO message board today, they said they think this stock is great, they love Stahl but don't quite understand the relationship with Horizon Kinetics.  That person is my competition, in FRMO's case I understand how it works, so I'm at an advantage.  For some stocks just having an annual report puts me at an advantage.  I know someone reached out to me a while back and said they purchased Ash Grove Cement because they thought cement would benefit from the recovery, they never saw a financial statement. 

 

There are some VERY smart players in this market as well, and when one of them is selling, or they think an idea of mine is junk I take a long and hard look at my thesis.  You need to have the courage of your own conviction, but be willing to adjust when needed.

 

As for how long this takes, I spend a few hours a week on it.  Some companies like PDRX report once a year, it takes 20m to read their annual report.  I spend 20m on that position once a year.  I have ~50 positions, at most they take an hour to read the annual report, so maybe 50 hours a year minimum.  My goal is to find 1-2 investments per month, I spend a few hours doing this, most of it is spent writing things up on the blog.  I spend more time looking and discarding ideas, no clue how much time that takes.

 

And PDRX, they don't release quarterly financials, most of these companies don't.  You need to be comfortable holding something that you'll receive information from once a year in the mail.  Although you can call the CFO any time you want and talk to them with ease, so that's the tradeoff.

 

Nate

[oddballstocks]

I disagree with the statement that the "other side" is algo traders...

 

For these smaller companies, a lot of times I think the "other side" is a combination of retail investors, employees, and former employees. 

 

As with retail investors, I think a lot of times people may have bought these companies recently or long ago for many different reasons.  They could have bought on "tips," read something on seeking alpha or because they knew employees or management, and now the account is turned over to a new manager who is selling everything, the investor run out of patience, the investor gifted or bequeathed the stock and the beneficiary doesn't want it, the stock is down and they are selling as a stop loss, or the stock is up and they are taking gains.

 

You beat me to it...I agree

[Palantir]

I invest in franchise/moat firms because it's easier. Great companies are very easy to spot, the only painful part is waiting until the market presents an opportunity, and having the cojones to buy into it. This microcap/netnet/special situations stuff is really hard to understand for me.

 

Also, being a man of leisure, I prefer to leave the hard work to the company managements while I sit on my a__.

 

That being said, I'd rather invest in microcaps/netnets/special situations, as those will probably do better, and to improve my technical skill as an investor.

[no_free_lunch]

This is regarding 'the other side'.

 

Personally there are a couple micros in my town that I have invested in.  One I worked at previously, no insider info but I know it well enough to know that it won't go bankrupt so I buy it every few years when it is down.  I have also seen and heard other locals invest in the 2 companies.  My dentist was telling me that he invested in one.  The word gets around and the local community buys into it.  I don't know how significant this is relative to the market cap but with a $10M company, and local investors putting in 5,10,50k I could see them being a significant force.

[Tim Eriksen]

I've recently started to get interested in these smaller companies.  A question for Nate, Tim Eriksen, DTEJD1997, and anyone else who invests in these companies... who do you figure is your competition, and why do you think they are selling to you?  This is something I am curious about with these stocks.  With larger companies you've got institutional money and a lot of other smaller players.  But the only people I know of that invest in micro-caps are smart guys like the ones listed above and idiots like me who buy companies after seeing them on the military channel (in my defense, that was years ago, before I'd ever heard of Warren Buffett or Ben Graham).

 

That is a great question.  In the beginning I feared that it was someone who knew more than I did.  Time has shown me that is rare.  One because I try to do my homework, and therefore be the one with the informational advantage.  Two I don't think most of the sellers are sophisticated.  They buy on the news (i.e. usually earnings reports) and then get bored when volume dries up.  The stock pulls back they then have a loss and sell.  I try to do the opposite.  Know what earnings are going to be.  Buy between earnings when there is nothing going on.  Trim or sell out when earnings come out.

 

I am also continually amazed at the slower speed that information is sometimes processed with micro caps.  A large cap tends to react quickly (in terms of time maybe not share volume), while the micro cap may take a few hours to digest earnings.  Sometimes it is the next day (which is why I assume many of the shareholders are retail investors that aren't monitoring things constantly).    I also don't think most of them are well versed in accounting.  They seem  to be slower to pick up on rising earnings.  If an asset manager (or bank) earned a clean 15 cents in Q1 and clean 20 cents in Q2, all else equal, Q3 will be higher than Q2.  Basic math.   

[ItsAValueTrap]

Yet the Buffett groupies seem to have this dogma that the only "true" way to invest is exactly how Buffett does right now, in giant brands at reasonable prices.  I don't know why the Buffett people are so strict and so exclusive.

 

I'm starting to think that if you wanted to emulate Buffett, you'd go buy an entire insurance company.  Kind of like Prem Watsa, though Watsa doesn't seem to have an obsession with first-rate businesses with first-rate management.

 

If you look at Berkshire Hathaway, most of it is invested in private businesses.  Of what remains, most of that is invested in a highly concentrated portfolio of (mostly) quality businesses.  And then there are some random odds and ends like derivatives, corporate bonds, etc.

 

I do agree that he's the Michael Jordan of investing and very difficult to duplicate.  Ben Graham's method is easier to execute and probably makes more sense for most people.  Warren Buffett makes very few bad investments and I think that's very, very hard to duplicate.

[Kiltacular]

I'm always fascinated at this dynamic anytime this discussion comes up.  The Graham/Schloss investors will buy loads of cigar butts and diversify, yet every one I've talked to can understand the great companies and good price idea, and why someone might concentrate.  Yet the Buffett groupies seem to have this dogma that the only "true" way to invest is exactly how Buffett does right now, in giant brands at reasonable prices.  I don't know why the Buffett people are so strict and so exclusive.

 

This is a good point.  I think you (and others in this thread) are right when they say that Buffett was doing what you're doing when he was managing small amounts.  And, since, as you point out, he is the MJ of investing, he got big enough pretty fast that his early style was no longer well known by the time he was.

 

This is a guy who said he went through every stock in those stock manuals -- he wasn't looking for U.S. Steel.

 

Your as well as others' comments in this thread about who the sellers are is very useful.  Excellent thread for those of us looking to improve in this area.

 

 

[JEast]

People who study Buffett should spend more time on the early partnership years IMO.

 

It is true that we all should study the master, but one should not conclude that we are in the same environment.  Micro Caps in the 50s had an open playing field unlike today.  Today's challenges and competition in the space are more tough from medium to large caps.  A few of several examples are that large companies approve of regulations that they know smaller companies can not handle (think freon), plus insurance costs from directors to healthcare.  Toss in every increasing auditing fees, scale factors and the list just grows of chipping away at the advantage.  Finally your small company wins the big contract and then has to file because they ran out of capital supporting the contract.

 

I just would be more cognizant of the playing field instead assuming things are like they were.

[Hielko]

PD-Rx, yes, I really like them.  They are an example of what's great about these companies, a press release came out two (maybe three) weeks ago saying they signed a $40+m contract with the government.

It might be me, but can't fidn a press release anywhere.

[SharperDingaan]

Most microcaps are actually niche companies with dominant local market shares. Their small size, & local dominance, makes them too costly for the industry players to put out of business; & ensures that most of their share ownership is local. Essentially, if you don't live in the area; you have no idea that XYZ local company even exists.

 

The better run, the more profitable, & the more dominant the local company, the more likelihood the company is private. Public ownership, & being a bigger company, is a major disadvantage; & usually only because the original owners needed the liquidity of an IPO to exit. Doesn't mean that every XYZ 'public' business in the local business pool is 2nd tier, it just means that most investments will be via invitation only partnerships.

 

Most micro-cap portfolios are a collection of 10-40% partnership stakes in related businesses. Valuation is your proportionate interest of the business as a whole, less a liquidity discount typically ranging from 15-40%+. You make your money through annual distributions, & view your portfolio as a whole, as being the equivalent to a lower quality pfd share. The text book example is a retired dentist with 2-3 partnerships in small, &  local, dental practices; with dentistry being the common link. Alternatively, .... a master brewer with 2-3 partnership investments in local stand-alone brew pubs/craft breweries, with the master brewer making some of the beer in each of those establishments ;)

 

Expect to buy at around 60% of IV (after 40% liquidity discount), exit at around 85% (after 15% liquidity discount) when the sector becomes fashionable again, & make a healthy cash flow while you are waiting. Growth in IV is nice, but it is not the dominant factor (liquidity is).

 

To use numbers: Assume IV is $100 on day 1, Year 1; $150 on day 365, Year 2, & get a distribution of $8/yr every year. You bought somebody out at a 40% discount, & sold to a new partner at a 15% discount when the sector is hot.

 

Cost of purchase is $60 ($100 x 1-40% discount)

Cash yield, Yr 1-5 is 13.33% ($8/$60)

Proceeds on exit is $127.50 ($150 x 1-15% discount) 

Compound ROI is 27%

 

SD

 

 

 

 

[matjone]

I think the thing for me to do is to build a list of companies to work through, but first I'd like to solicit the help from those who are experienced in this area.  On OTC markets it looks like they've got 3 tiers, OTCQX, OTCQB, and OTC Pink.  So here are my thoughts on each tier and how they relate to the construction of this list

 

OTCQX - larger, more visible, more liquid, probably fewer bargains.  I am sure that that there are good investments here, but in the interest of starting with something smaller and more manageable, I'll keep this off the list for now.

 

OTCQB - comprised of smaller and development stage companies.  I don't invest in development stage co's, but I don't mind smaller ones.  I am thinking that this tier may or may not be worth adding to the list.

 

OTC Pink - this seems like the most bountiful area, and I am thinking it should definitely be included in the list.  My only question is whether it might be beneficial to exclude certain sub-categories within this tier.  I read the descriptions for these a few years ago when I first started investing and I all I remember thinking is "you are going to lose your ass investing in this stuff".  The general tone of the warnings are about as scary as the ones on cigarette labels, but when you read it carefully and think it over, it seems like even the lower quality tiers might contain some real established companies.

 

Any help that you guys can give me constructing this list will be helpful and much appreciated.  I'd also like to add a thank you to Nate, Tim Eriksen, DTEJD1997, ragnar, and probably some others I am forgetting.  If you guys hadn't been so generous in sharing your experiences in navigating this area I would never have gotten the courage to try it myself.