Robin Speziale has applied his discovery and qualification processes to arrive at 60 Canadian micro cap, small cap companies that he will continue to track
Robin Speziale | July 25, 2018 | SmallCapPower: When I was younger, 18 – 25, I would usually pass on the smaller companies (sub $100M market cap) that popped up on my stock screener. I was fearful of undiscovered micro-cap stocks because of their small size, low institutional ownership, slim trading volume, and little analyst coverage. It was the fear of the unknown; betting on a tiny company that might fail. I did not want to lose my money on a dumb trade and look stupid. However, years of passing on these small companies would later lead to much regret, after seeing some grow from ~ $100M to $1B+ (10x) in market capitalization, achieving multi-bagger status that I believe most DIY investors pursue in the market. It was a painful phase, and I would repeatedly ask myself: “Why didn’t I invest in that stock!? It popped up in my screener, and I conducted extensive independent research. I should have pulled the trigger…”
But I am also a realist, and understand that while all great companies start small, not all small companies become “great” (i.e., big). Actually, very few small companies get there. The majority of small companies listed on the TSX/Venture exchange are un-investable, in my opinion, and some companies should have never gone public in the first place; shoddy business models, questionable shell holding companies, and bad actors promoting, pumping, and then dumping garbage. It is actually quite depressing sifting through and pulling up the charts of most Venture stocks. Countless flameouts. Therefore, I believe achieving a semblance of success in micro-cap investing comes down to first eliminating the bad batch (80% stocks) from the micro-cap universe, so that one can focus on the good batch (20%) that contain meaningful companies with real future prospects, managed by responsible, and enterprising owners/ operators. Because when companies are at an early-stage in their business life-cycle, you are betting more on the jockey than the horse, hoping that the jockey is not only honest, and able, but executes on his vision and delivers shareholder value.
Here is the thing, though. Even if you do pull the trigger, and invest in a promising small company, will you have the conviction and wherewithal to hold that stock from $100M to $1B+ market cap? Because successful small stocks do not just shoot up, they are highly volatile (i.e., lots of sharp ups and downs in price). Can you stomach watching a small stock drop -20% in a day, rise +10% the next, and then lose 75%+ of its value within the following year? Well, that was part of Amazon’s wild ride. Sure, from 1997 – 2017 (20 years), Amazon’s stock went up 38,155%, but its trajectory certainly was not linear. Amazon had its IPO in 1997 and started trading at $18/share. MarketWatch succinctly outlined its trials and tribulations over that period. Amazon fell -95% from December 1999 to October 2001 (tech bubble), and fell -64% in 2008 (financial crisis). In fact, Amazon suffered a double-digit drawdown each year since going public and a 20% drawdown in 16 of 20 years. Fun!
Who do you think has owned Amazon since its 1997 IPO? Very few investors bought Amazon’s stock at $18 and held until now at $1,849/share. The ones who held Amazon since 1997 were either crazy, genius, or simply forgot to check on their stock portfolio for 20 years. Though they are probably all now relaxing on a beach somewhere. In hindsight, it is interesting to think that most people thought investing in Amazon as recently as even 5-10 years ago was crazy. The majority in 2013 were still doubters, focusing on Amazon’s lack of net income, obscene P/E multiple, and calling the company grossly “overvalued”. Many so-called analysts were claiming that Amazon was overvalued all of the way up until recently when Jeff Bezos finally cracked the list of top 10 richest people in the world. However, it is only now that Bezos is the richest man in the world that most people have realized they missed out on one of the greatest wealth-creating opportunities the world has ever seen. I too am guilty. I should have listened to my non-investor University roommate, who in 2006 said: “Robin, you should really invest in Amazon”. My response: “it’s overvalued.” Doh!
Here is a similar, but Canadian story. In 2007 (age 20), I invested in a small company – SXC Health Solutions (Healthcare/Pharmacy Technology) – after conducting my own extensive research, and due diligence. After investing in SXC Health Solutions, the stock whipsawed so much, that I became fearful and sold 100% of my position that same year. I decided to banish SXC Health Solutions from my memory, never to look at, or invest in the company again. Years later, in 2012, it would change its name to Catamaran Corp, and then in 2015, I read in the Wall Street Journal that UnitedHealth Group had announced it was going to acquire Catamaran Corp. for $12.8 billion. I subsequently took a long walk around the block to cool off. Had I not sold my position in SXC Health Solutions, I would have generated multi-bagger returns in my portfolio.
This was not the only case that I had invested in a small stock, and then later sold out of fear. In addition, I cannot count how many ‘errors of omission’ (not buying the stock after extensive research) I have committed throughout my DIY investing career. I have many regrets, which is why since age 25, I plant seeds and water the trees, or in other words; invest small amounts in micro-caps that intrigue me, and then invest more into the winners over time (average up). For example, Tweed. In my book, Market Masters, I wrote in its 50+ page conclusion that I had invested in Tweed, a small cannabis company at the time. The year was 2015, before marijuana became the must-own sector. Tweed was trading at ~$1/share, later becoming “Canopy Growth Corp”, a leader in the Marijuana industry that now trades at ~$40/share. Owning Tweed was not easy. Though I learned from my past mistakes. Tweed was a dead stock for about one year, and then soared on the marijuana legalization tailwind after the Liberals won the federal election. The stock then soared again following the announcement that Constellation Brands had invested (10% stake) in the company. However, throughout that time, Tweed/Canopy Growth incurred wild swings up and down. The stock did not shoot straight up and had many doubters. Investing in Canopy Growth early on and achieving a multi-bagger has certainly driven my pursuit of discovering more small companies with lots of potential. I might never top that 40-bagger, but I will certainly not fail to try. It is all about discovering new opportunities.
Here is my discovery process for Small Companies:
Once per quarter (every three months), I will scour all of the companies on SEDAR (official site that provides access to most public securities documents and information filed by issuers with the thirteen provincial and territorial securities regulatory authorities (“Canadian Securities Administrators” or “CSA”)) and look for new issuers, as well as new quarterly reports from existing companies. I will skip over every single Resource (oil & gas, mining, etc.) company. I only invest in Technology, Consumer Products/Services, and ‘Diversified Industries’. These three industry groups are less cyclical, and more predictable than other industries. I like to use SEDAR, as stock filters and screeners might eliminate worthwhile small companies from my view. Also, years of poring over thousands of financial statements on SEDAR builds an intuition-like skill in the future, whereby promising companies start to jump off the screen.
In quarterly reports, I look for high revenue growth, positive cash flow from operations, low levels of debt, and positive net income. However, I will still shortlist a small company that is not generating income but has a path to profitability. My biggest focus for small companies (<= $100M market cap) is high sustainable revenue growth (Quarter YoY, Annual YoY, and 3-5 Year CAGR), fueled by new contracts, accretive acquisitions, penetration into new markets, and/or expanding unit volume. I will also use the official TMX (Toronto Stock Exchange) stocking-listing inventories as reference to help guide me through my discovery process. I will access TMX’s Technology, and Diversified Industries (includes Consumer Products/Services) pages, and download each inventory excel file. Altogether, there are ~750 stocks in this initial universe.
Stock screeners still play a role in my discovery process, especially to focus on metrics like market cap (<= $100M), revenue growth, cash flow yields, etc. I use TMX stock screener, as I believe it is the most accurate for Canadian stock data, but in addition, I have used screeners on Stockwatch, and Yahoo Finance. However, I cannot stress enough that DIY investors should scour all companies on SEDAR, as screeners might miss some stocks.
Finally, I will check the predefined scans on StockCharts.com every day (Monday through Friday) after 4:00pm (market close). What interests me are the stocks making new 52-week highs, and/or stocks trading on higher-than-average volume. This gets me thinking that something interesting might be going on, and I search further into the possible catalysts via press releases, etc.
At this point, I have started to build a watch list of small Canadian companies (sub $100M market cap) and will exit the discovery phase and enter the next phase: research, and due diligence. I will dig separately into each one of these companies as much as possible, identifying factors that can lead to breakouts, and sustainable growth. Multiple sources of information aid me in this research process, including company websites (investor relations), Stockhouse.com (Bullboard forums), Twitter (there’s lots of great micro-cap investors tweeting about small companies, and sharing their research), and searches online (Google), which lead to press releases, and sometimes blog posts on these small companies. I also like to see whether any respectable funds / private investors hold these stocks in their portfolios. I will check on Gerry Wimmer’s Investor File, Mawer’s New Canada Fund, and Pender’s Small Cap Opportunities Fund, among others. Further, management access would be ideal. Unfortunately, most DIY investors cannot just pick up the phone and call the CEO. Therefore, in the past I have attended annual shareholder meetings, and have dialed into quarterly calls. I also try to find any CEO/ Management interviews on YouTube. Finally, if there is a storefront that I can visit (e.g. Organic Garage), I will make the outing and explore the store. Throughout my research process, there are certain qualities in these small company stocks that help me determine whether I move them from my watch list to my potential buy list. Below I share my qualification process in the form of questions.
Here are the questions that I ask to qualify Small Companies:
– What are the products/services; does this company offer something new / unique to the market? Is there new technology? Would anyone be unhappy if this company went out of business tomorrow? Would I use their products or services? Is there lasting utility/appeal?
– Who is running the company – owner/operator or installed CEO? Is there a bold vision for the company? What is the CEO’s track-record in leading other public companies, and executing on a vision? What is management’s stake in the company? (i.e., insider ownership %)? Is management overpaying themselves (as a percentage of revenue)?
– How big is the addressable market? Can the company scale to expand and fulfill demand for its products / services domestically and globally? Can it achieve profitable growth? How easy will it be to acquire, and on-board new customers?
– What is the business model; are revenues repeatable and recurring (e.g. SaaS subscriptions), or inconsistent, and cyclical (e.g. gas tank manufacturers)? Are profit margins good; how will they improve? Is the company structure, workforce and sales / marketing group in place for the company to succeed?
– Is the company vulnerable to business cycles? What would happen in a recession? Does the company have ample net-cash on hand so they are not vulnerable to economic down-cycles? Can growth be funded through its own operations? What is the capital structure?
– Does management have a focused acquisition plan? Have they successfully integrated complimentary companies? Is the industry in which they operate fragmented, and so is there an opportunity for this company to consolidate smaller companies?
– Are there positive tailwinds? Are tailwinds anticipated in the future (e.g. eldercare)?
– What is the regulatory environment; can regulations dampen the company’s growth? Conversely, could regulation bolster company growth? (e.g. Cannabis industry)
– Does the company have sufficient cost controls in place?
– Will the company innovate; what is the culture? What is the current Research and Development spend? (note: R&D is more important for Technology companies) Does the company plan to expand its product / service selection?
– Can the company achieve a competitive advantage (moat), and fend off any competition? If there is competition, is there room for multiple players? Does the company own any intellectual property? What are the switching costs; is moving to a competitor easy?
– Who is promoting, and supporting the company? Is it under-followed by analysts, and under-owned by institutions? What is the daily/weekly share volume?
– Can a Chinese (or other low-cost) competitor simply produce these goods/services cheaper, or does this company have a following (brand), or a better way of making the product / delivering the service? Can a bigger company (e.g. Amazon) catch on to this opportunity and easily steal market share?
– Is the stock price validating the company’s positive developments, and quarterly releases (e.g. +25% Q1 YoY Revenue)? Does the stock have positive momentum?
– Does the company have any prominent short sellers? (E.g. Marc Cohodes, Andrew Left, Carson Block, etc.) If so, do you believe the short-thesis? Have you considered worst-case scenarios for the company?
– Finally, can this company grow 3x bigger (e.g. $100M – $300M market cap) in 3-5 years? Will the high sales growth continue for years to come? Can the company attract a shareholder base; large investors and institutions that can take the company to the next level?
Ultimately, I invest in small companies that pass most of my qualification questions (above). Because I allocate small chunks of capital to these micro-cap stocks at the onset, I have the wherewithal to hold through volatile swings in the market. After planting these seeds, I will water the stocks that grow (i.e., average up), and hold the stocks that I still have conviction in.
I would like to share with you my current Universe of Small Companies ($63M avg. market cap) listed on the Canadian TSX, and TSX/Venture exchanges. There are 60 small stocks on my list. I have applied both my discovery, and qualification processes to arrive at these 60 small companies and will continue to track them in my newsletter. However, this does not mean that I recommend any of these stocks. One might find some new ideas, and then conduct their own research/ due diligence.
I have also included some interesting recent information below on a subset of these under-followed companies:
AnalytixInsight (ALY): On May 16th, entered into a distribution agreement with Thomson Reuters (TSX:TRI) whereby Thomson Reuters will distribute financial research reports created by AnalytixInsight’s artificial intelligence platform to customers on Eikon and Thomson One.
Axion Ventures (AXV): On July 3rd, announced the commercial launch of the Company’s self-title, ‘Rising Fire’ in China through Tencent’s ‘WeGame’. Axion expects Tencent to distribute Rising Fire in a staged manner to approximately 1.5 million active WeGame users immediately, 15 million users by mid-July, and up to 100 million users by mid-August.
GreenPower Motor Company (GPV): On June 5th, announced that it received an order for 100 buses from Creative Bus Sales, the U.S.’s largest bus dealer for sales, parts and service. This 100 bus order represents its largest order to date.
Kraken Robotics (PNG): On July 5th, re-affirmed the Company’s 2018 revenue target of over $7 million, which represents at least a doubling of 2017’s reported revenue.
Organic Garage (OG): On June 29th, reported its first quarterly positive cash flow from operations and a 38% increase in revenue. Its Liberty Village location is on track to open in fall 2018. On July 11th, announced that its sixth location will be in the central Toronto area.
Symbility Solutions (SY): On May 8th, announced it had completed a definitive agreement to sell its Symbility Health Division business to TELUS Health (CA$16.5 million), allowing the company to apply greater focus to its core Property and Casualty insurance platform while contemplating further transformative M&A with the proceeds of the sale.
WELL Health Technologies (WELL): Chairman & CEO, Hamed Shahbazi previously founded TIO Networks (TSXV:TNC), a multi-channel payment solution provider specializing in bill payment and other financial services. TIO Networks was acquired by PayPal (Nasdaq: PYPL) for CAD$304 million (Jul 2017).
Wow Unlimited (WOW.A): Michael Hirsh, CEO, co-founded Nelvana Limited (known for Babar, Tintin, Berenstain Bears, Care Bears, and Magic School Bus, etc.). Nelvana was sold to Corus Entertainment in 2000. Later, Hirsh co-led an investment group to start Cookie Jar Entertainment Inc. where he served as CEO until the acquisition by DHX Media in 2012.
“Future 60”: Small Company Stocks on TSX and TSX/Venture:
(For Information Purposes Only. These stocks are not recommendations)
|Caldwell Partners International||CWL|
|Cortex Business Solutions||CBX|
|Diamond Estates Wine & Spirits||DWS|
|Drone Delivery Canada||FLT|
|FLYHT Aerospace Solutions||FLY|
|Good Life Networks||GOOD|
|GreenPower Motor Company||GPV|
|Hempco Food & Fiber||HEMP|
|Legend Power Systems||LPS|
|Patriot One Technologies||PAT|
|Reliq Health Technologies||RHT|
|Smart Employee Benefits||SEB|
|Ten Peaks Coffee||TPK|
|Vigil Health Solutions||VGL|
|WELL Health Technologies||WELL|
“Future 60”: Highest Proven Growth
(For Information Purposes Only. These stocks are not recommendations)
If you are curious, below is a subset (1/3) of “Future 60” stocks that have all achieved the following hurdles, achieving an average 20% YTD 2018 return (as at July 10, 2018):
- >= 0% Latest Quarter YoY Revenue Growth (Average = 26%)
- >= 0% Latest Annual YoY Revenue Growth (Average = 39%)
- >= 0% Last 5-Year Revenue CAGR (Average = 21%)
- >= 0% Cash Flow Yield (Average = 8.6%)
|Diamond Estates Wine & Spirits||DWS||10%|
|Caldwell Partners International||CWL||9%|
|Ten Peaks Coffee||TPK||-7%|
|Cortex Business Solutions||CBX||-11%|
I really enjoy finding promising small companies. The enterprising DIY investors’ edge is the ability to not only find companies when they are small, but also to invest in them as institutions have restrictions on holding low market-cap stocks in their funds. In addition, there is usually no analyst coverage for sub $100M market-cap stocks. Thus, the micro-cap universe is largely uncharted territory. The delight comes when a small company that you find, and invest in grows into a larger one, crossing that chasm from micro-cap, into small-cap, and then maybe into mid-cap and beyond. That is the dream. While it is rare for any company to grow from $100M to $1B (10x), and even rarer to grow from $100M to $10B (100x) the process is still fun, in my opinion. In those rare cases it can be very rewarding for DIY investors, managing a small portfolio (e.g. < $1,000,000). Buffett once said, “The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It is a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
/// Join the Capital Compounders Club on Facebook (it’s Free!) ///
To read our full disclosure, please click on the button below: