Learn the art from private investor, Ian Cassel
Ian Cassel is a well-known, full-time, private investor. His hunting ground is dedicated solely to micro and nano caps. In fact, in 2011, he founded MicroCapClub, an exclusive forum for experienced microcap investors to exchange ideas, collaborate on due diligence, and learn from each other.
This long-only, quality focused investor will hold on to his position as long as he is convinced about his thesis. Being an inherently risky area in the field of investing, Cassel believes in deep qualitative analysis and constant due diligence so he is always aware of what he owns.
He dispenses some learnings for investors in smaller fare.
1) When it comes to investing, don’t be a chicken, be a hawk
Don’t be afraid to say no to 99.9% of investment opportunities. You only need to find one great company, before others, to change your life. Extraordinary returns follow extraordinary discipline. An investor’s goal should always be to make as few investment decisions as possible. Keep your hurdle rate high and embrace inaction.
Chickens will eat anything you put in front of them. They will eat insects, bugs, meat, fruit, vegetables, fish, and, yes, even chicken. They have no self-control and will even eat their own eggs and faeces.
A hawk can see up to 8x more clearly than the sharpest human eye. To put in comparison, if you had a hawk’s vision you could see an ant on the ground from on top a 10-storey building. A hawk’s eye is so large that it occupies a big portion of its skull. The hawk knows what it’s looking for.
The visual capabilities let the hawk distinguish the size, shape, and speed of the potential prey so it can recognize, target, and capture it quickly. Don’t be a chicken, be a hawk. Be picky. As you fly above the investment world looking for opportunities, develop tools, strategies, even statements, that you can apply quickly to evaluate opportunities. Know what you are looking for so you can develop the vision to recognize an opportunity quicker.
2) Don’t bother finding the next multi-bagger if you are not going to develop the conviction to hold it
Stocks rarely perform in the time frames we predict, and it’s why the market only works for investors that have a long-term portfolio focus. Performance is never linear, up and to the right, year after year. You sometimes have to hold onto a position for a few years before it goes up 100% in 3 months.
Every multi-bagger will have long periods (even years) of stagnation as fundamentals backfill, old shareholders get bored, and new shareholders enter. Just like a fine wine, sustainable multi-baggers often take their time to ascend and develop. If you’re invested in great businesses that continue to grow and earn more money, don’t let lulls in stock price and boredom scare you out of them.
Lee Freeman-Shor writes in his book The Art of Execution:
“One of the key requirements of staying invested in a big winner is to have (or cultivate) a high boredom threshold.
It is very hard to do nothing but focus on the same handful of companies every year; only researching new ideas on the side.
Many of us, seeing we have made a profit of 40% in one of our stocks, start actively looking for another company to invest the money into – instead of leaving it invested. This is precisely why lots of investors never become very successful.”
As human beings, we are very impatient. The hardest part of maturing as an investor is allowing ourselves the time. You can’t force it. Many investors “force it” by being active for activity’s sake. As Ed Borgato says: “What Wall Street perceives as productive activity is needless complexity”.
Investors tend to over-analyze when stocks are going down (fear) and under-analyze when stocks are going up (greed). ?The hardest part of investing is holding through these times, embracing boredom and inactivity, and distancing human nature-emotion from investment decisions.
3) Learn to differentiate between business performance and stock performance
Sustainable multi-baggers have certain characteristics: Long-term revenue and earnings growth with little to no dilution. When you are holding onto a position ask yourself – Is this business growing and making more money per share than it did a year ago, two years ago?
I started buying a company early 2012 when it was at $0.35-0.40 per share. As my conviction grew, I bought more. We are in January 2017 and the stock is still at $2 per share. On the face of it, this has been dead a dead investment money for 2.5 years. Years!
But, the company’s business is almost double the size it was 2.5 years ago. The stock hasn’t gone anywhere but the business is doing really well. I have no problem holding this stock. If the business wasn’t performing, I would sell.
Successful investors can differentiate business performance from stock performance and can take advantage of those investors who can’t.
Great businesses have great stocks. Great businesses always get overvalued. It’s important to make investing decisions based on business performance, not stock performance. It’s also important to know the distinction between external stock market forces driving a stock price lower (buying opportunity) versus business reasons you are not aware of (you should be selling).
4) Avoid piling into a position at one go
All my winners had one thing in common, I was always averaging up. Most of my losers had one thing in common, I was always averaging down.
My buying strategy has evolved over the years. Early on I would pile into positions too quickly after naively believing what management would tell me. Overtime I realized giving up a small amount of upside to de-risk the investment was well worth it. I normally buy my positions in thirds as my conviction grows. If something doesn’t check out along the way I’m not stuck in a huge position.
I buy my first third after extensive due diligence and after talking to management. I dig through all the filings, industry journals, place some calls into customers, suppliers etc. Think of this as passing the smell test. I’m also making sure I have ample margin of safety.
I buy my second third after traveling and meeting management at their head quarters. I want to see what their offices look like, the interaction between management. Is it a dictatorship or a democracy at the management level? Can I find an employee who hasn’t been told “to be nice to me” and ask them questions? Does the company do the little things well? Do they pay attention to detail? What do they drive? What are their motivations? etc.
I buy my last third after the management team does 25% of what they say. The majority of microcaps over promise and under deliver. You make money on the ones that under promise and over deliver. It takes time to make sure you are betting on the right jockey. They need to prove this to you by executing, so buying this last third might not happen for months. With most of my winners, I bought this final third 100%+ higher than my first third.
My personal investment philosophy is to buy microcaps that I think can be 5-10x in a few years. It might sound insane, but I don’t buy stocks where the peak potential return is less than 100%. I’m look for and buy undervalued companies that have the potential to get very overvalued. If I’m initially buying a $0.50 per share stock, I’m likely buying it because I think it can be a $5.00 stock in a few years. So who cares if I’m buying my last third at $1.10 after the investment has been greatly de-risked by management execution? Even after these small microcaps double, let’s say from $10 million market cap to $20 million, they are still very under followed and not even on institutional radars.
In all my big winners, I was constantly averaging up.
5) Successful investing isn’t about being right all the time; it’s more about the ability to identify when you are wrong quicker
Investing is tough because you have to constantly anticipate how the thinking of other people is going to change before they know it themselves. This means you have to buy investments early, before the investment is obvious. But, there is a thin line between being early and being wrong. If you are constantly buying the stock lower it is likely the latter. If you find and buy great investments, you’ll likely be making subsequent purchases at higher levels.
Always keep your ego to the minimum. The market loves to humble boastful investors.
When you find yourself constantly averaging down it’s normally a sign that your ego has taken over. You’ve convinced yourself you have to be right, but you forget that being broke and right is the same thing as being wrong. Your ego clouds your judgment and slows your thinking. Many investors have gone broke trying to prove the market wrong, and you certainly aren’t going to prove yourself right by throwing good money after bad.
6) The management makes the difference
The smaller the company, the more should be the focus on management and qualitative analysis. CEOs of small microcap companies tend to wear a bunch of hats, so their influence is much greater than larger companies. Founders are the difference makers.
Microcap investing is really entrepreneurial investing, which means you really need to talk to management. I’m cautious in saying this because not every small investor should expect to be able to call up and talk to management. The point I’m making is on quarterly conferences calls, etc. take advantage of the opportunity to ask good questions.
A qualitative attribute in most of my winners was a CEO that figured out how to swim on his/her own. They grinded it out and dug their way out of the hole. Most importantly they did it without diluting shareholders. When management does right by shareholders in the worst of times, it’s much easier to fully trust them in the best of times.
Invest in management teams that focus on the long-term and let their execution do the talking: 90% of microcap management teams say too much and do too little. This rare breed is called “intelligent fanatics”. I want to invest in owner-operators that have an intense focus, integrity, energy, and intelligence.
Once I find an “intelligent fanatic” running a potentially great business I start the due diligence process. If everything checks out, I invest. As management executes, I buy more at higher prices.
Intelligent Fanatic = (Long Term Vision + Focus + Energy + Integrity + Intelligence) x Execution
The combination of all these traits multiplied by execution is what makes an “intelligent fanatic”. Many investors mistake an executive with charisma for being an intelligent fanatic. The microcap space in particular is filled with snake oil salesman and executives that talk too much and do too little. Don’t mistake a story telling, charismatic CEO as an intelligent fanatic. In fact, many intelligent fanatics are not charismatic. Intelligent fanatics let their execution do the talking.
In conclusion, keep this in mind:
- I like companies with no debt, or at least low debt. Small companies and debt just don’t go well together. Travel light, travel far.
- Cash flow, not reported earnings, is what determines long-term value. Undiscovered companies that can sustain 30-40+% growth rates from internally generated cash flows are hard to find.
- Look forowner-operators with intense Focus, Integrity, Energy, and Intelligence.
- For a small microcap company to be a market leader, it must dominate a small market. I want to own businesses that dominate a small market that is expanding. This normally pushes quality attributes down to the financials.
- Look for a clean capital structure. I look for low outstanding shares, all common shares, and low amount of warrants/options as a percentage of outstanding shares. You want to invest in a management that treats its shares like gold.
- I prefer no institutional ownership. When you find and invest in great businesses that bigger money doesn’t own, the stock has nowhere to go but up.
- Find repeatable, sustainable, profitable growth. My biggest risk as a microcap investor is dilution. I want to find companies that are self-funding their growth.
- Buy when the business is fundamentally undervalued to limit risk and to fully leverage multiple expansion. Your margin of safety is buying an undervalued business that can get overvalued.
- What counts in the long run is the increase in per share value, not overall growth or
This article was first published in Morningstar on January 30,2017.