What got you into the markets in the first place?
It started out by just researching how to save on fees. I was not on board with paying a mutual fund 3% to hug an index. I ended up reading a couple of books about mutual funds and started to pick the funds myself. Eventually I got rid of all my mutual funds and started picking individual companies.
My goal was to gain independence as quickly as possible from the day to day grind of a corporate job. I didn’t enjoy the politics of work and really enjoy my time. For me gaining independence meant that I had to spend less time tied to my desk if I choose to. I get to read leisurely more. I get more time at the gym. I get more time with my kids and have a more flexible schedule which has been a blessing with the lockdowns and two school aged kids.
Also I don’t rely on a weekly pay check to pay for my living expenses. I do need to watch my finances and spending, but I don’t need to be at work at a specific time or feel the pressure of deadlines. I don’t have to be accountable to anyone but myself. It’s very liberating.
Can you give us a summary of your trading strategy?
I keep 50-70% of my portfolio in a few companies that I feel have very attractive long term fundamentals run by very competent management. These would be considered my core holdings. For these companies I usually continue to add as the company continues to deliver. Having only a few of these businesses in the portfolio tends to lead to volatility.
You need to be confident in these names when they deliver less than stellar results in the short term. There will be many naysayers along the way. I manage my risk by clearly defining what success looks like and not letting poor businesses or poorly run businesses be a large part of your portfolio. I clearly define success milestones and add to positions once these are reached.
Ultimately I own my mistakes and I approach things differently. I decided that it was ok to look dumb and even ask what might be dumb questions to ask people. It gave me more information to be comfortable with my positions.
The other 30-50% are smaller positions. These include companies that I’m still researching, cheap companies based on the balance sheet, potential mean reversion in cyclical businesses that are out of flavour and the odd arbitrage.
If there was one thing you know now that you wish you knew when you first started investing what would it be?
I wish I would have not spent so much time trying to find the strategy that produced the best results in a short time (less than a year) and focused on finding a strategy that worked for me. The most important thing is to stay in the game the longest.
Once I found what works for me and my family, my relationship with the market improved. I am only concerned about meeting my goals. I have nothing to prove to anyone and am accountable to only myself.
Tell us about your biggest winner
It’s not my biggest winner financially, but it was a company that really helped build conviction to my strategy. It’s actually the company that I profiled (and got accepted into) the MicroCapClub.
The company is IWG Technologies. They ended up getting bought by a European private equity group. The business provides water treatment products on business jets and introduced a tankless water heater recently. They were also trying to break into the commercial aerospace market.
The business was cheap based on just the core products alone. The added upside was if they broke into the commercial aerospace market, which was many multiples in size of the current business.
While holding shares I visited their facility and my operational background lent itself well to understanding (and validating) how they thought about operations. They had a dissident shareholder that almost voted out some board members. As well (and most importantly), they had some excess capital with a CEO who had a vision on what to do with it.
It was my first real life example of capital allocation. All this helped solidify my focus on fundamental investing in businesses that provide value for stakeholders as well as understanding board dynamics, share structure and incentives.
Tell us about your biggest loser and how did you mentally recover from that?
At the time it was my biggest loser and was the equivalent of throwing a grenade into my portfolio. It was Fortress Paper. At the time they had 3 different businesses. One was a banknote business that would bump around breakeven with some opportunities to optimize the business and remove some currency headwinds.
One was an extremely profitable and continually growing wallpaper business that was essentially funding everything else. The last was a dissolving pulp mill business. Dissolving pulp is a key ingredient in Rayon which is an alternative for cotton in clothing. Many old paper mills were being converted into dissolving pulp mills. It required lots of capital even with quite a bit of government assistance.
I got stuck only looking at the upside of the business and not the risks, especially given how long and complicated the conversion to a dissolving pulp plant is. I didn’t map out what the identifiable milestones would be along the way and what kind of capital they would require.
I kept averaging down as the company seemed cheaper and cheaper to my estimated fair value. I ended up capitulating and selling at an 80% loss to the largest position in my portfolio. It really hurt my confidence. It took several years to get back to where I would have been if I just left my money in mutual funds.
Thankfully I learned the lesson with much smaller amounts of capital than I have today, but at the time I was devastated. I decided that I would pick up the pieces and try again. I saw the lifestyle of a private investor and it motivated me to keep going. I set a 3 year timeline to measure my success and re-evaluate. I gave it everything I got. I checked my ego and did my best to learn from my mistake. I spent much of my time and energy trying to learn about the markets and read everything I could about capital allocation. I was like a sponge to successful private investors knowledge.
You may be thinking what stopped me from throwing in the towel? Well I read a book (sorry I can’t remember which one lol) that just said you need to stay in the game no matter what. That’s it. I licked my wounds, and decided to learn as much as possible. It was really hard to look at myself in the mirror some days when I did the math on how damaging my mistakes were for my portfolio.
I could have spent my time ruminating on my mistakes or I could let them be a lesson that I can learn from. It was very humbling. I have experienced that you don’t need a high IQ to be successful at investing. You need the executive functions that are very hard to measure. Metacognition, emotional regulation and goad directed persistence are a few.
I gave myself a 3 year window to perform better than the market or I would just go with low cost ETFs. That way I could still retire early(ish) and spend time with my family.
What are the usual warning signals that a spec stock has gone bad and it’s time to leave?
Execution. Management needs to execute. No excuses. If you purchase shares in a company and have a vision on what the business might become, they need to be executing continually. Understanding what they can control is important. It’s the circle of concern vs. circle of control.
Of all the different kinds of companies to invest in, why microcaps?
Microcaps are a place where I feel the most confident and feel like it’s the last frontier for individual investors. I’m not well educated and possess an (at best) average IQ. I just need to go where the competition is the lowest.
I think of it as playing basketball. I’m only 5’6″ with a terrible vertical jump. If I was going to play basketball, which team would I like to play against? The Harlem Globetrotters (large caps, short term focus, currencies, etc) or a team full of senior citizens and 8-9 month pregnant women (microcaps). FWIW, some of the seniors and pregnant women are better than me but overall I can win that game.
Once again the quality of responses in our QnA series continues to soar. A big thank you to Dean for all the time and effort he put into documenting his investing history and love of micro caps!