Survival is Most Important in MicroCaps: Q&A with Ian Cassel, MicroCapClub
[Originally published in the Planet MicroCap Review Magazine Summer 2023 Issue]
1. Reflecting on the first half of 2023, what trends have emerged in the world of MicroCap stocks, and how have they influenced the investment landscape?
Since 1927 value stocks have outperformed growth stocks and smallcap stocks have outperformed largecap stocks. It shouldn’t be surprising that smallcap value stocks were the best performing segment. In fact, since 1927 smallcap value has outperformed the S&P by 14x. MicroCapClub member Mark Vonderwell mentioned on our forum that during this ~100-year period, smallcap value suffered long periods of mediocre performance or even under performance. The longest period of mediocre performance lasted 19 years. The periods of outperformance can be explosive, and they normally last 5-7 years. We are currently in a 16-year period of underperformance. The EV/EBIT value spread which represents valuations of the cheapest 10% of the market has historically never been cheaper. Smallcap value is cheaper than it was during the DOT COM bubble and the global financial crisis. This is all to say smallcap value is staged to have a few good years. Perhaps even phenomenal years. In Q2 2023 we are starting to see signs of smallcap value turning out of the downtrend.
2. Can you highlight potential opportunities, risks, and key factors to consider when investing in MicroCap stocks in 2023 thus far?
Smallcap value stocks are a good opportunity, but the risks in microcap stocks don’t change year to year. Microcap is for stock pickers. The key is finding the ones that can both grow and survive. Some investors only focus on growth (growth investors). Some investors only focus on survival (value investors). I like to find both attributes in a business. Growth is rather easy to identify. The hard part of growth is finding a business that can sustain growth over a 5–10-year period. Does the business have the leadership, people, processes, culture that can scale? These are the growth questions you need to answer.
Survival is more important. As microcap investors, our biggest risk is dilution. It’s hard for a company to create shareholder value when they need to consistently sell equity to survive. It’s hard for management to make long-term decisions when they must constantly worry about their short-term stock price. In general, being an unprofitable microcap company is a big disadvantage. If you do invest in unprofitable companies, you must have confidence in their ability to hit short-term milestones and catalysts and also you are hoping/praying the market will reward the company with a higher stock price.
A much easier way to win is to focus on the 18% of microcap companies that operate profitable businesses or have large cash positions that can get them to profitability.
3. How has macro news influenced your current portfolio construction and when assessing new ideas?
I can’t control the macro situation. The best macro strategists in the world are right 50% of the time. We are all better off flipping coins if we want to predict the future. The way I handle the macro is the handle the micro. Focus on what you have control over, finding and holding great investments. My primary hurdles for new investments:
A business that can grow through a recession.
A balance sheet that can weather a storm and act with occasional boldness.
A leadership team and organization that show signs of intelligent fanaticism ie Find management teams that deserve to be running much larger companies.
A valuation that can conservatively double in three years.
Are there many companies that fit these four qualifications? No. It screens out 99% of the microcap investment universe. This is fine. I’m a stock picker. I can be selective. If I’m successful in finding businesses that fit these four parameters, I don’t have to worry about the macro.
4. For the rest of 2023, what are some key criteria, macro events, MicroCap events, etc... that you are watching and what actions will you take if those potential occurrences happen?
I’m 100% focused on the micro. Are the businesses I own executing or am I making excuses for them not executing? The businesses that are executing make it look easy. I don't stress over the stocks that move up and grow into big pieces of my portfolio. They've earned that right. I stress over the small ones I’ve been holding and justifying “let’s wait another quarter”. It’s those “wait another quarter” stocks that are like death by a thousand cuts. Holding losers is easier than holding winners. Why? Because losers always look cheap.
If you invest in microcaps you will have turnover. You must have turnover. 20% of what you own today will likely deserve to be owned 5 years from today. This means that 80% of what you own today will deserve to be sold. My intention with every purchase is to hold forever but very few will earn that right.
In a recent article I wrote titled, Conviction Investing, I mentioned that successful stock picking isn’t just picking winners. It also means picking out the losers in your portfolio. Warren Buffett wasn’t a coffee can investor. Most of the stock pickers you admire are conviction investors. They focus on finding the best opportunities, knowing them better than most, holding the ones that are worth holding, and selling mediocrity.
For more information about MicroCapClub, please visit: www.MicroCapClub.com
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