Why Microcaps Are Not Buy-and-Hold Investments

During their recent episode, Taylor, Carlisle, and Ian Cassel discussed Why Microcaps Are Not Buy-and-Hold Investments. Here’s an excerpt from the episode:

[Ian] No, no, you framed it correctly. I mean, because I believe a lot of people make a big mistake in micro cap by applying things that are applicable in larger caps down to micro caps, such as coffee canning, buy and hold and forgetting. I think you can do that, but it could be a painful lesson that you learn.

And it’s mainly because micro caps are small businesses and small businesses that are a lot different than large business, mainly because they’re filled with concentration risk. Key man risk at the top, probably product concentration, probably customer concentration, probably jurisdictional concentration. It was just a fancy way of saying they’re a lot more fragile and the possible outcomes are a lot wider and mainly the bad outcomes.

And so it’s important to kind of live in that reality in the micro cap space and realise that a lot of the winning micro caps, it’s just the season of winning. Very few of these companies deserve to be owned for more than a few years. The average hold period of my portfolio is still probably 12 months, 16 months, somewhere in that arena.

And I feel like I know what I’m doing. And it’s because it’s really hard to find a quality business. And really what you’re looking for is a quality management team that can execute consistently more than a few quarters, more than getting one good contract because they won and died in the right person, where, yeah, they show a 30% growth the next four quarters and then they have to replace that.

And it’s like, oh crap. And so that’s why like a micro cap winning stock normally does resemble that Lassonde curve, which I have in the book, which is kind of this discovery mechanism where all of a sudden they announce a big contract, they get a big order, you see the velocity of the contribution margin flow through the income statement because they’re probably under-investing in the business. All of a sudden they show up a big bottom line, then they put up another quarter.

The 10 PE goes to 30 to 50 to 60 as all the Excel junkies, Excel spreadsheet this thing out 10 years, it’s gonna be the next Tesla. And then guess what? They fall flat on their face at some quarter, probably at the next comp period when that contract rolls off.

And then it comes back down that first discovery of the Lassonde curve. And then most of them, and I mean like 90% of them never get back to that old high because the next move, the first one was momentum mainly. The second move needs to be a purely fundamental move.

And it’s gonna take probably two or three X the earnings power as it took the first move to get to the same price. And so that’s my rambling answer to it. It’s hard to find a management team that can execute though over more than a couple of years.

FREE U.S. Large-Cap Stock Screener

Don’t forget to check out our FREE Large Cap 1000 Stock Screener here at The Acquirer’s Multiple.