Exploring Opportunities in Undervalued Micro-Cap Equities?
Transcript from The Motley Fool's podcast featuring Ian Cassel, a micro-cap investor, founder of MicroCapClub, and author of two books. In this conversational episode, they discuss investing in the smallest public companies, evaluating companies with market caps less than $500 million, the characteristics of an "intelligent fanatic," and why growing a stock position is like cultivating a relationship.
Starting off, Ian defines micro caps as companies with market capitalization lower than 500 million. He plans to initially invest in something sub 100 million, where there's no institutional ownership, no analyst coverage, and no buzz to lean on. He believes this independent mindset is key to becoming a better stock picker, and it's no surprise that the best stock pickers ever came from the micro-cap ecosystem.
Next, they discuss the criteria for identifying standout micro-cap companies. A good starting point is seeking profitable businesses, as only 17% of micro-caps are profitable. If investors can find a small public company that dominates a niche expanding market, they're more likely to stumble upon a competent management team that's likely to be profitable and sustainable over the long term.
Transformation stories, where new management teams recover mismanaged companies, are common in the micro-cap space. Ian uses the term "intelligent fanatics" to describe great business leaders who created a business from scratch, grew it up to dominate its niche, and did so over decades. Ideal candidates for this title are founders or new management teams who own a significant portion of the company, have a history of success, and are now taking their talents to transform another business.
Examples of success stories include Armanino Foods, which dominates the pesto sauce market in the United States, and AMNF, a company that grew its sales from 30 million to 60 million over 14 years without diluting its earnings per share.
Quantitative factors to look for include longevity, potential for organic growth, profitability growth, and leadership quality. Investors should aim for a sustainable growth trajectory and be mindful of potential red flags, such as overreliance on a single customer or product line.
In terms of position sizing and holding period, Ian suggests adopting a long-term perspective, shelving positions for an average of two years, and treating these small evolving businesses like young children that require diligent supervision. A normal shelf life of a position may be two years, but exceptional performers could be held for decades. In these cases, positioned sizing strategies like buying in thirds or fifteenths can be employed.
Key takeaways from this podcast include the importance of focusing on profitability, seeking out management teams with a history of success, and being cognizant of valuation while prioritizing growth opportunities.
- Ian Cassel, a micro-cap investor and founder of MicroCapClub, emphasizes the importance of investing in smaller public companies, specifically those with a market cap below $100 million, where there is little institutional ownership and no analyst coverage.
- Ian suggests that one criteria for identifying exceptional micro-cap companies is finding profitable businesses, as only a small percentage (17%) of micro-caps are profitable.
- Ian uses the term "intelligent fanatics" to describe great business leaders who are capable of creating a business from scratch, dominating a niche market, and doing so over a long period of time.
- Examples of successful "intelligent fanatic" business leaders include those who led Armanino Foods, a dominating force in the U.S. pesto sauce market, and AMNF, a company that increased its sales from $30 million to $60 million over 14 years without diluting its earnings per share.
