Microcaps: 1-10-100 Rule
Had written few bullet points on investing here https://lifeandequities.wordpress.com/2016/03/06/investing-rules-maximise-money-per-hour-of-research/, thought of listing something for small/micro caps now.
You may have seen various matrices showing historic returns for microcaps exceeding that of mid and large caps. Similarly market returns for lowest quintile PE are the best relative to highest PE.
These simple metrics such as above give a toss to the fact that Microcaps are laden with landmines. One out of 50 or fewer succeeds. While people are busy searching for the next 10-20 or 100 baggers being deluded by the jackpot seeking lottery mentality, the process over outcome model is given a blind eye. So, if one wants to become an instant multi millionaire, then the chances are stock market is a wrong place. That said, micro caps are more volatile and if they move in favourable direction, then money is made quickly (or lost if the direction is unfavourable).
Also, one needs to build up several years of experience before becoming comfortable with microcaps.
You may have read Thomas Phelps and thought its quite easy to score 100 bags every now and then. The rule 1-10-100 that I made up means you should have turned over / researched at least 100 companies to find a single one with a 10 bagger potential. I have been rummaging through a pile of poo every week for the past 10 years to find that lucky one. Now, as Charles Duhigg says in the Power of Habit, its easy to form good and bad habits, so its my habit and I like going through the poo in more than one way, that is because I am an expert in changing nappies that have poo too.
Paradigm shifts and large opportunity
Do not invest in companies which may be market leaders but they provide goods, services to a very professional and specialized audience eg: equipment to professional biochemistry research labs, stethoscope (Littman) to doctors. They do not create 10+ baggers in any short time frame.
Invest Before the Institutions
Rob the train before it arrives at the station 🙂
I want companies that have less than 5% institutional ownership.
Measure the company and value it
Ignore stock prices, understand the industry and market forces operating.
Growth is a must
You could be set up for failure in the absence of revenue and profit growth, profitless growth is not growth, its grostitution (new word I made) addiction to growth [derived from postitution].
Validate product acceptance
Check the deals, stores, competitors and industry announcements.
Concentrate on best ideas
Rather than falling for the next novel idea in the heat, try to maximise from what you already know more than most and have a stronger conviction on.
Run mental checklist
Excel spreadsheets are not for everyone 🙂 so run through what can go wrong and briefly write the thesis for investing in 4-5 bullet points.
Invest in superior firms
Invest in high quality companies, while mean reversion is strong theme and one can make money in mining companies or commodities but its harder for an average Jo to spot cycle reversals.
Don’t fall for sexy story
Almost always avoid companies trying to over reach like Algae, cleantech, biotech, revolutionary drug etc. Finding a life partner may be better in a library or other boring setting than a sexy bar or disco.
Size position according to conviction
The greater the conviction the bigger the position.
Other important factors are downside and time to play out.
Alignment of interests
Management should value shares like gold, and own a considerable chunk.