Use these three ideas to further your investment process and improve your returns
Active investing isn’t easy. Each day you’re reminded that you’ll likely not beat the market and investing in market ETFs is the only way to go.
I refuse to accept that.
Why? I’ve experienced first hand the inefficiencies of the microcap stock picking. Where extremely small companies are underloved, undiscovered, and ripe for investing.
This group of tiny companies brings its own set of challenges to the space. I’ll help you better understand the dynamics of these stocks and provide you with three principles to better your portfolio returns.
1. Asymmetric upside
Focus on opportunities where you can win more than you lose. In fact, I would say it’s most important to not lose.
Easier said than done. Our first principle wants you to look for companies that have a limited downside and hopefully HUGE upside.
What is “downside”? In short, the potential for losing money on your stock. “Upside” is the potential for making money.
It turns out you want the opportunity to make money to outweigh losing money!
How do you know what downside a stock has? Great question. I’ve included an example checklist below to help you understand what can contribute to downside and upside.
Note that this is not the all-included, magical checklist to make you millions. It’s meant to give you an idea and it’s up to you to create your own.
Why is this important for microcap investors?
Use this Asymmetric Upside Checklist to filter investment opportunities
|☐||Is this company trading at or below net asset value?|
|☐||Is it trading below cash value?|
|☐||Are the valuation multiples reasonable? (P/S, P/E, EV/EBITDA, etc.)|
|☐||Is the market value lower than revenue?|
|☐||Does the company have earnings? (EBITDA, EPS)|
|☐||Is it a relatively (compared to industry peers or competitors) low P/E?|
|☐||Are they at risk of going bankrupt?|
|☐||Did the company go through a recent CEO change?|
|☐||Did they launch a new product and are going to market?|
|☐||Are they implementing an acquisition strategy?|
|☐||Is there potential for the company’s valuation multiples to expand?|
|☐||Are there other companies trading at a higher valuation?|
|☐||Will this industry become more popular in the future?|
|☐||Does it lack analyst coverage?|
|☐||Is there strong secular industry growth (20%+ CAGR)?|
How should I be thinking about these questions?
Shoot over an email to firstname.lastname@example.org and I’d be happy to send you resources and explain my thought process. I don’t bite (at least I can’t over the interwebs)!
As you develop your checklist, you can weight each criterion to help you calculate a score to judge each investment opportunity.
Keep your checklist handy and continue applying it to your investments as the story can change. Again, you want to limit your downside.
2. Have at least one advantage
How are you going to beat the market without any edge over the market?
When I talk about the advantages, there are three kinds I’ve found for investing.
Three advantages you must possess to beat the market
All of these can be applied outside of the microcap realm too!
An informational advantage is the most straightforward out of all three. This advantage could involve having:
- Better quality information on the company
- More information from the company
- Complementary information from other areas
Before we go down the wrong path, this does not include material information that only insiders would know! Of course.
Ultimately, this comes down to a rock-solid analysis of a company. Information can include in-depth reviews from customers, technical understanding of a company’s product, and anomalies in the financial statements.
Note that there are diminishing returns when it comes to researching companies and you’ll need to find the right balance.
Three ideas to get you started in developing an informational advantage
- Read analyst reports from experts in an industry or a specific company
- Focus on a niche of companies like industrial manufacturing microcaps, which narrows your scope and the pool of people you’ll be competing with (think big fish in a small pond)
- Invest in your network of people, talking to more people allows you to learn more, gather more unique insight, and brings forth more investment opportunities
Getting this type of advantage requires you to be on the ground, putting in the work, and uncovering rocks others haven’t thought to touch.
It’s a lot of fun and the most approachable of the three!
Technicals. Candle Sticks. Simple Moving Averages. Financial Modeling. Statements.
You live and die for reading charts, financial statements, and your excel models. You’re a practitioner of support levels, resistance, sophisticated DCF (discounted cash flow) models.
This is an area I seldom know much of and akin to the PhDs and superstart analysts of the world.
I consider this advantage to be your technical abilities relating to areas such as trading, financial statement interpretation, and valuation modeling.
A key thing to note is that all of these can be done manually or through computer algorithms that are thoroughly “back-tested” to ensure they are robust to execute in the real world. This category is all quantitative.
“If you cannot control your emotions, you cannot control your money.”
– Warren Buffett
Human nature is inherently emotional. In the stock market, we’re constantly fighting between greed and fear.
Warren Buffett’s quote is timeless in reminding us that those who have control of their emotions will be more effective in managing their money.
Sometimes, it’s as simple as not buying and selling that leads you to better returns.
We saw this happen in the correction we experienced in December of 2018. Those who sold took a loss which quickly recovered weeks after.
How do your emotions affect your investments?
Three general recommendations for taking control of your emotions in investing
- Systemize your investing by creating clear constraints and rules for how you invest
- Expose yourself to emotional situations to better your reaction to events. You want to build self-awareness and this helps you become less destructive when reacting to situations.
- Accept the fact you are emotional and that stock market investing may not be right for you. Alternatively, you could give authority to someone else to execute trades for you or invest in other asset classes that aren’t as volatile
Why is this important for microcap investors?
3. Be an independent thinker
Lastly, it pays to be contrarian. This means going against the herd and not doing what everyone else is doing.
How will you beat the herd (market) by thinking the same as them?
Being an independent thinker requires you to come up with your own thoughts about stocks and have high enough conviction to act on it.
This goes beyond just having different thoughts but also being able to execute on them which can be challenging.
It’s easy to be contrarian but it’s hard to be contrarian and right, because most of the time the herd is correct.
What could being an independent thinker look like?
- A stock is at all-time lows, priced for bankruptcy and everyone tells you to avoid it because it’s been a dog but you believe that it will turn around for a number of reasons and invest
- All of your friends are telling you about this new HYPE stock that is going to change the world and hitting new highs. After doing more research you choose not to invest because it doesn’t hit the fundamentals you look for.
- You’ve developed a thesis that renewable energy will take off in five years because the market dynamics will dramatically change and have selected a few companies poised to capitalize on that. No one is thinking that far ahead and has realized the potential value of those companies and these stocks are cheap.
Why is this important for microcap investors?
It starts with these three principles and ends with your execution
How’s that for three principles to start with? My hope is that this has provided you with some insight into becoming a better investor.
There are many ways to make money with investing. One of the key takeaways I want you to come away with is that by developing a system that works well for you, you have the ability to succeed like others too.
Being disciplined, methodical, and putting in the work is what it comes down to.
Are you looking to buy more avocado toast and still afford your mortgage?
Welcome to the YOLO Fund. My name is Brandon and I’m a 24-year old serial entrepreneur who wants to help you start investing.
I’ve found that millennials want to invest but struggle to get started. Technology has made it easier than ever but doing it on your own is scary.
I know you’re ready for something different. You want someone like yourself who will help you navigate the financial world.
Now’s your chance to learn alongside a fellow millennial who understands what you want. Not only do you demand returns but you also want your money to go towards causes you care about.
My experiences of being a serial entrepreneur, managing a six-figure stock portfolio, and working in investor relations, will give you the toolkit you need.
Let’s make investing approachable, fun, and relatable for a better future!
Want to learn more? Watch my YouTube videos here.