A proven investment strategy

A Proven Investment Strategy

I have been getting quite a few requests to post examples of proven investment strategies which have been used to create consistent long term wealth. What better way to start than to explore how Ian Cassel who is a US based full-time micro-cap investor and founder of MicroCapClub, the MicroCap Leadership Summit, and co-founder of the Intelligent Fanatics Project. Ian started investing as a teenager and learned from losing his money over and over again. The below is a transcript I put together of a YouTube video called “All great companies started as small companies”. This represents the section of the video where Ian provides a detailed overview of his investment strategy. Please excuse any spelling or grammatical errors. The full video can be viewed here:

Now to give you a little bit more about my strategy, I’m really focusing on the bottom 15% of the micro-cap space, these are companies that have market caps less than 50 million and believe it or not there’s still over 8,000 of these companies that exist in the marketplace today. If I were to explain my strategy in one sentence, I want to own the smallest most illiquid least institutionally owned best businesses I can find that are run by intelligent fanatics. I’m a concentrated investor I only want to invest in the best four, five or six companies that can find any given time. I’m looking for quality businesses, I’m looking for businesses that that can hopefully become great businesses. It is really a bet on the jockey strategy, the reason it’s a bet on the jockey strategy is because the CEOs the founders of these small micro-cap companies they wear a lot of hats they’re not only the CEO, often times their the COO, sometimes they’re the CFO sometimes they’re the president of sales, the chief bottle-washer the garbage man you name it. These management teams and specifically what I find is the founders and CEOs wear a lot of hats inside those companies so you better be sure that you’re betting on the right jockey.

I really have a long only strategy I don’t short stocks I’m a long-term oriented investor you know holding these companies as long as they perform and I really believe in qualitative analysis because I believe qualitative analysis is the edge and investing for all the reasons I gave you about betting on the jockey as well. I believe it’s a really constantly learning cumulation of knowledge on your positions, on those management teams, on the businesses, on the industries is very important to my strategy as well.

I would say these are like the five strategy principles or pillars to my strategy. Number one know my investments better than most and we’ll get into this a little bit more later but make as few investment decisions as possible. You want to set a high hurdle rate mistakes and errors occur when you go down quality because you were either bored or because you just get bored really honestly. that’s probably the number-one reason why you go down quality you want to keep your hurdle rate high when you start looking at your investment checklist and start investing in companies that had a seven out of ten of the things you look for or 8 out of ten that’s when mistakes and errors occur.

I haven’t bought a new investment in the last two years and I refuse to go down quality looking for more investments just because I’m going to look at ideas and invest in new companies. keep your hurdle rate high at least that’s one of my strategies. I want to invest in companies that are undervalued that can get overvalued I’m not a deep value investor I really do not want to own an undervalued company that will always be undervalued. I really want to find an undervalued company that can get overvalued. great businesses always get overvalued because there’s a scarcity of great businesses in the marketplace today so I’m really looking to find undervalued companies that can hopefully get overvalued.

I want to scale into my positions as my conviction builds you know I’m trying to find great companies early but oftentimes greatness is not obvious when these companies are very small so oftentimes when you do your analysis your quantitative and qualitative analysis you take a position and then you have to sit back and wait for management to execute, let them prove themselves to you and then you end up buying more as your conviction grows. some of my biggest winners were companies that I was constantly averaging up in and I’m going to hold as long as management executes and this can be two or three days but hopefully it’s five or 10 years or more.

this is what I look for and why and this is a very broad checklist of what I look for in companies. I’m looking for intelligent fanatic iconoclasts and that is a mouthful I know. I believe that Charlie Munger is the one that really brought intelligent fanatics that term to light but it really it’s sunjai Bakshi that is making it famous today and sunjai Bakshi wrote a great piece on his blog several months ago talking about the intelligent fanatics of India these owner-operators of these businesses that most of them ended up you know growing these companies and creating significant shareholder value. these owner operators these intelligent fanatics had an intense focus, integrity, energy and intelligence and these owner-operators you know owned a significant piece of the business most cases as well you know owning 10 20 percent or more of those companies.

these intelligent fanatics also shared iconoclastic behaviour. William Thorndike in the book The Outsiders devotes a big portion of the book to talking about how Henry singleton and other people that were mentioned in the book had these iconoclastic behaviours. they didn’t care what I was thought about them they didn’t care what Wall Street thought about them they didn’t care about what the world thought about them they really judged their performance by their inner scorecard. what I find is that a lot of the micro-cap winners that come out of the micro-cap space, they’re the owner operators share this iconoclastic behaviour and it’s something that I look for. I’m looking for market leaders many people wonder well how can a micro-cap company really become a market leader? well it needs to dominate a small market.

it’s the old Peter Thiel zero to one approach. when I read Peter Thiel’s book zero to one you know I kind of put it down when I was done with and I said wow somebody actually summed up what I look for when I look for in my micro-cap investments and it’s what I do look for I look for companies that are dominating a small market niche that is expanding rapidly because what you’ll find is that the quality attributes that a market leader has it ends up funnelling down to the financials of that company and specifically in the micro-cap space when you find a market leader as a micro-cap company it’s somewhat vets the management team because either that company created the market that they now dominate or they took share away from their competitors in that marketplace and so it sort of showcases that management knows what they’re doing.

 I also look for sustainable profitable growth companies that can grow 20% plus over the long-term profitable companies and maybe even more importantly companies that can self-fund their growth. a lot of companies can grow not many of them can actually fund that growth utilizing their own cash flows and become compounding machines you’re really looking for those compounding machines that are out there and the reason why that’s so important to the stock price as well is when larger money larger pools of capital specifically institutions know that that company doesn’t need to go raise money. to sell equity to fund its growth, that means that there’s larger pools of capital need to go into the marketplace and buy those shares in the open market and that’s when you see some very big moves in the micro-cap space.

I’m looking for companies that have low to no debt, what I found is that micro-cap companies in debt just don’t go well together so the old travel light travel far philosophy. I’m looking for companies that have a clean capital structure, a clean share structure and maybe the best analogy I can use to kind of share with you why this is important is if you wanted to find out the most about me as a person I would say you want to look at my bank statements because it would show you where I spend my money what I spend it on how much I spend and it’s the old you know your money follows your heart philosophy you really get to see what type of person I am by looking at my bank statements.

it’s very similar to when you look at the capital structure and share structure of a company over time the ability to go back three or four or five years and see how that management team how that founder or CEO issued shares to see you know is it all common shares are their preferred shares to see of super voting rights, how did he finance the company? was it with convertible debt and how is he incentivized? is it with a bunch of options or warrants? did that owner/operator by his stake or was his state was his ownership position given to him or did he actually write a check for it? all these things and watching how that share structure changes over time really tells you a lot about how that CEO and Founder or management team operates that company because what you want to find is a management team and CEO that really treats their shareholders their common shareholders like gold as they don’t issue shares frequently and freely.

I’m looking for companies that have immediate upside like I said before I want to find companies that are undervalued that can get overvalued and lastly I’m looking for companies that have no institutional ownership if you remember back to that  illiquidity chart you’ll remember that the worst place to invest is in small liquid companies and there’s small liquid companies is just a fancy way of saying that they’re institutionalized what you want to look for is illiquid small companies the best way I can put this is when you find a great business nobody else owns it only has one way to go and that’s up. how do you find these companies is a question I get asked quite frequently and really, it’s a combination of all of these things. I would love to say and point you took just one place that you need to go or one thing you need to do but it’s a combination of all these things.

Word of mouth is a big one it might be the biggest one, private message boards which is what micro-cap Club represents, public message boards you know investors have used to be raging bull back in the day when I got started Yahoo Finance things, other public message boards like that Silicon Valley silicon investor in me searching filing searching PRs. my partner at micro-cap Club Mike shellinger literally reads every PR and filing on every micro-cap company in North America every day sounds tedious and very manual and it sounds like a lot of hard work and it’s all three of those things but nothing can replace that manual and tediousness and hard work of searching filings and PRs for example.

I subscribe to the best screening software that’s out there it’s very expensive but I still find that a lot of companies fall through the cracks when I do micro-cap screens and oftentimes it’s the ones that fall through the cracks are the ones that you should be investing in and so nothing can replace really just hard work and the tedious manual nature of looking through PRs and filings and lastly just serendipity. we have a member on micro-cap Club that actually put a symbol of a stock in wrong and he stumbled on another company and he ended up investing in this company that he stumbled upon through serendipity and really liked what he saw and it ended up being one of his biggest winners I think ended up being a twenty or thirty bagger for him so even serendipity plays a role in how you find these companies.

 I’d like to now go through my analysis process and so once you find a company you know the analysis process begins and it really starts with quantitative analysis you want to look through all the filings all the press releases going back in time as far as you can. micro-cap companies are mostly small emerging companies many of them don’t have long operating histories some of these companies have been around for a year some have been around for ten years but you want to go back as far as you can to try to get a gauge on how well that management team has executed on how that company is positioned today.

I oftentimes like going back to see what that management team has said in their MDNA to figure out you know how much of what they said five years ago did they actually execute on. how their position in the company has changed and also looking at the competitors the peer analysis looking at industry reports really understanding the Tailwind in that business the undercurrents driving that business as well and really that’s the quantitative approach to investing and what you’ll find is that a hundred percent of experienced investors do quantitative research and analysis but what you’ll find is twenty percent maybe twenty-five percent actually do qualitative analysis and research and that’s why that really the qualitative analysis is the edge and investing is because so few people do it and especially when you’re analysing small companies qualitative analysis is really a must as well.

when I go through this analysis process as you’re kind of going from quantitative to qualitative to site visit to maintenance you’re adding more to your position or at least I add more to my position because mostly what happens is your conviction builds or if you see something that you don’t like you just stop and you have a rather small position you’re able to get out of it rather quickly because you decided to get into your position slowly as your conviction built but after the quantitative analysis you move on to qualitative and what I like to do is interview the company’s management team. this can be one conference call it can be a series of conference calls you’re really trying to gauge really understand where that management team is positioning that company for the future.

what I also like to do is talk to the large shareholders of that company the reason I like to talk to large shareholders of companies is because they’ve usually been in the company a very long time and so oftentimes you can pick up on different nuggets of information by speaking to these large shareholders stuff that’s not exactly you know illustrated in press releases and things of that nature to try to gain an understanding of how well or not so well this companies executed over time. I would then look for what Paul wounces would call trying to find that person a third party person with differential insights somebody that is really an expert in the business or industry of the business that you’re analysing and trying to find that person searching for that person and then interviewing that person to try to gain differential insights.

I want to then perform industry channel checks you know the normal scuttlebutt research talking to suppliers customers you know where appropriate then after that qualitative analysis then I would do a site visit what this means is traveling out to the company’s headquarters meeting with management team on their own turf if you will and oftentimes it’s the information that you get out of the conversation with management is sometimes not the best information you get is then it’s the other little things that you pick up with your other senses you know some things that you hear things that you see. you know for example when you are meeting with management does the CEO let anybody talk? does the CEO let the CFO talk? is it a dictatorship? when you are pulling into the headquarters you know does the CEO have his own spot that is marked CEO out front? does he drive a brand new Mercedes? does the license plate say you know I’m number one in the back? all these things give you a little clue you know when you’re touring the facility is it marble floors or do they pinch their pennies you know do they really spend wisely or freely?

I also love to talk to secondary employees these are employees that would be right below the sea level these folks that normally haven’t been warned of my arrival to be nice to me and what you’ll find is these secondary employees also have worked for the competitors so a lot of times you can gain really valuable insights by talking to some of these secondary employees on the competitive landscape on what this company is doing differently. maybe on what the culture is like as well inside this company is very important and also like I said before investigating the headquarters the manufacturing if they have a manufacturing facility there you know all these things that you would never be able to get these little nuggets of qualitative kind of scuttlebutt if you just stayed in your office at your home you can only gain these valuable insights by traveling and making a site visit and once you get through the site visit the due diligence doesn’t stop the analysis doesn’t stop the maintenance due diligence then it begins and it’s really getting back to continuously accumulating knowledge on this position.

 you want to be an expert in this business you want to accumulate knowledge on that management team on that business and on that industry you want to be in a constant state of what Jim Collins who wrote good to create calls a productive paranoia and the reason why it’s so important is because the most important thing in micro-cap investing is to know your positions better than most. we all want to be able to tell our grandkids or our kids or our friends that we achieved a multi bagger in the portfolio. that we remember this company that we bought at X and sold at Y and it was a ten bagger or a fifty bagger or maybe even a hundred bagger. but to achieve a multi bagger in the portfolio you have to hold a multi bagger in the portfolio and the only way you can hold a multi bagger in the portfolio is to really fully develop the conviction to hold and the only way you develop the conviction to hold is to know your positions better than most.

 the other reason why you want to know your positions better than most is because you’re investing in small illiquid companies and so the key to investing is letting your winners run and cutting your losers as quickly as possible and so part of knowing your positions better than most is really the fact that because of that you’ll have a heads up on being able to know when to sell before the masses.

so, when do I sell and these are really the four reasons why I would sell. number one is probably the most prevalent which is you would sell when you find something better. I don’t manage a fund I don’t have an RIAA I don’t have clients I’m a full time private investor so that means that to buy a new position I have to sell an existing position so what you’re doing is when you’re looking at new opportunities you’re constantly evaluating those new opportunities against what you already own. when you put in the time and energy to do the correct qualitative analysis into these companies.

You know it takes a few months it takes a lot of time and when you really develop that conviction in that company and into that management team you really believe in their long-term vision of the company when you look at a new opportunity that new opportunity just can’t be you know fractionally better than something you already own it needs to be multiples better than what you already own to be able to sell something you own and Trust to buy that new position. but it does happen and oftentimes it’s the biggest reason why you would sell a position is you finally find something that is a lot better than what you already own.

I want to sell when the story changes I have lost hundreds of thousands of dollars by not selling quick enough when I knew the story had changed this is something that I’m still getting better at and it’s taken 15 years to get even half good at. but it’s okay to fall in love with stocks but you need to be prepared to divorce them quickly. I want to sell at the first sign of management and competence or unethical behaviour. sometimes management teams make such a boneheaded move that you can’t help but you know sell the stock you can’t look at that decision they just made and sweep it under the rug because unfortunately really bad decisions.

it’s like the old cockroach theory where there’s going to be a lot more coming behind them and so oftentimes it’s best to just sell your position when you see a company and management team make a really bad boneheaded move and lastly you want to sell when a company gets very overvalued and I look I am a firm believer in holding your positions especially on the companies that are executed in doing well but there are sometimes unfortunately doesn’t happen enough but there are some times when a company goes up so far so quickly that it outstretches the fundamentals of that company and it just makes sense to take some off the table.

End of transcript.

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